Former Treasury Secretary Henry Paulson and current Secretary Timothy Geither both told a skeptical congressional committee today that if U.S. action was not taken to bail out American International Group it would have been a catastrophe for the nation.
Their comments came at a hearing before the House Oversight and Government Reform Committee, which has questioned all elements of federal bank and U.S. Treasury actions to supply billions of dollars to bail out the insurance conglomerate and pay its bank trading partners in full for claims against depreciated assets.
Mr. Geithner was scrutinized about his role as Federal Reserve Bank of New York president before he became secretary and the FRBNY's steps to squash disclosure of how much the banks were getting.
Two lawmakers on the committee doubting his denials in that effort asked for his resignation.
Mr. Geithner said that Federal Reserve Board acted to bail out American International Group because it was “the only fire station in town.”
Republicans on the panel, in a report, have said the FRBNY), which Mr. Geithner headed in 2008, pushed through the bailout by the Federal Reserve that provided a bonanza to banks that were AIG trading partners. They attacked the decision to pay off AIG’s bank counterparties to complex and highly speculative collateralized debt obligations in full and not to press them to take “a haircut” and accept only a percentage of what was owed.
At the conclusion of the testimony from Mr. Geithner, who denied he was part of the FRBNY demands that AIG withold information about the 100 percent payout to bank counterparties Rep. Darrell Issa, R-Calif., the committee’s ranking Republican member, said he “no confidence” in the secretary and called for his resignation. He told him “you are either incompetent” or tried to cover up the details of what was going on through payoffs of the CDS [credit default swaps].”
Rep. John Mica, R-Fla., said Mr. Geithner had given "lame excuses" and asked, "Why shouldn't we ask for your resignation." Mr. Geithner said that was his right, but, he still takes pride in decisions made by federal banking officials.
Committee Chairman Edolphus Towns, D-NY, while complianing in opening remarks that, "In the case of AIG nobody got a haircut. Instead, everybody got a piggy bank full of taxpayers money, said after questioning Geithner, “I don’t know what else you could have done.”
Mr. Geithner testified it was “important to remember that the Federal Reserve, under the law, had no role in supervising or regulating AIG, investment banks,.." but Congress gave the Federal Reserve authority to provide liquidity to the financial system in times of severe stress, he added.“Given that responsibility, the Federal Reserve had to act,” he said, because the Federal Reserve was “the only fire station in town.”
The AIG bank trading partners had hedged their investment in collateralized debt obligations backed by U.S. residential mortgages through purchase of insurance through credit default swaps issued by AIG.
Mr. Geithner said that “imprudent risk-taking in better times” at AIG “meant that, when the financial cycle turned, AIG had hundreds of billions of dollars in commitments without the capital and liquid assets to back them up.”
He said such “excessive risk-taking should not have been allowed. But it was.”
He added, “Despite regulators in 20 different states being responsible for the primary regulation and supervision of AIG’s U.S. insurance subsidiaries, despite AIG’s foreign insurance activities being regulated by more than 130 foreign governments, and despite AIG’s holding company being subject to supervision by the Office of Thrift Supervision (OTS), no one was adequately aware of what was really going on at AIG.”
He defended the decisions of the FRBNY, the Board of Governors of the Federal Reserve and the U.S. Treasury by saying that the steps the government took to rescue AIG “were motivated solely by what we believed to be in the best interests of the American people.”
“We did not act because AIG asked for assistance,” he said. “We did not act to protect the financial interests of individual institutions. We did not act to help foreign banks.
“We acted because the consequences of AIG failing at that time, in those circumstances, would have been catastrophic for our economy and for American families and businesses.”
Mr. Paulson called AIG “an unregulated holding company” and a “mismanaged and misguided enterprise.”
The former treasury secretary said, “Although the road to complete recovery is slow and unemployment is still high, had AIG failed I believe we would have seen a complete collapse of our financial system, and unemployment easily could have risen to the 25 percent level reached in the Great Depression.”
The committee as part of its inquiry is probing whether the FRBNY acted inappropriately in limiting disclosures that as part of the bailout arrangements AIG would be paying off the banks in full.
“The rescue of AIG was necessary, and I believe that we in government who acted to rescue it—including [Treasury] Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and me—acted properly and in the best interests of our country,” he said.
Mr. Paulson said AIG needed rescue because it was “incredibly large and interconnected,” it was “seriously underregulated,” and because “it could not have been effectively wound down.”
Specifically, he said it had a $1 trillion dollar balance sheet; a massive derivatives business that connected it to hundreds of financial institutions, businesses and governments; tens of millions of life insurance customers; and tens of billions of dollars of contracts guaranteeing the retirement savings of individuals.
“If AIG collapsed, it would have buckled our financial system and wrought economic havoc on the lives of millions of our citizens,” Mr. Paulson said.
The second reason was that it was not effectively regulated. “Although many of AIG’s subsidiaries—including its insurance companies—were subject to varying levels of regulation, the parent entity was, for all practical purposes, an unregulated holding company.”
Consequently, there was no one regulator with a complete picture of AIG or a comprehensive understanding of how it was run. “It was not until AIG started to fail that regulators began to understand how badly managed it had been and how much the toxic aspects of parts of its business had infected otherwise healthy parts,” Mr. Paulson said.
Third, AIG could not be effectively “wound down,” he said. “Unlike failed depository institutions which can be taken over by the FDIC with little or no harm to depositors, or the GSEs [government sponsored enterprises] which were seamlessly placed into conservatorship by Treasury and the Federal Housing Finance Agency, there was—and is—no resolution authority available to wind down a failing institution like AIG.
“The only option is bankruptcy, a process that is simply not capable of protecting the millions of Americans whose finances are intertwined with AIG’s,” he said.
Mr. Paulson commented, “I do not mean to say that I am happy that we needed to intervene,” noting that taxpayer money should not have to be spent to save a “mismanaged and misguided enterprise.”
But, he added, “the fundamental problem lies not in how we intervened, but in why we needed to intervene.”
He said the U.S. needs to modernize its regulatory structure by creating a systemic risk regulator and resolution authority so any large firm that fails can be liquidated without de-stabilizing the system.
“Large financial enterprises in this country will always play a role that is essential to our economic growth, but they must only be permitted to grow and interconnect throughout our economy under careful oversight and with a mechanism for allowing those connections to be broken safely,” he added.
Meanwhile, Federal Reserve Board Chairman Ben Bernanke said stabilizing AIG, not the financial health of the trading partners, was the reason the Fed decided to pay off the AIG credit default swaps at par.
His statement came in a written response to Rep. Issal, who oversaw the minority report suggesting AIG bank counterparties were paid too much and the FRBNY and Federal Reserve attempted a cover up of bailout details.
Mr. Bernanke said, “The overriding motivating factor in structuring the payments to the counterparties was to relieve AIG of the destabilizing drains on its liquidity caused by the requirement to continue to post collateral as required by the CDS [credit default swaps] contracts.
“All counterparties were treated the same for payment purposes. Whether the individual counterparties were in relatively sound financial condition or not was not a factor in the decision regarding the amount paid to the counterparties or whether concessions should be sought from them.”
Mr. Geithner In response to a question, said the Fed had no legal or other authority to take any other action than it did in paying off the CDS. He said there was no way to put AIG in bankruptcy.
“To stand back and let it burn,” he said would be irresponsible and the Fed acted to protect the innocent through the bailouts and made an effort to reduce the cost to the American taxpayer to the lowest amount possible,.
He noted that the protections in place against bank bankruptcy do not exist for insurance companies.