Volcker Says States Share Some Blame On AIG Woes

By Leslie Scism and Serena Ng
The Wall Street Journal
February 26, 2010


The financial-crisis regulatory blame game has taken another turn, with former Federal Reserve Chairman Paul Volcker saying the near-collapse of American International Group Inc. in 2008 was partly a result of ineffective state insurance regulation.

AIG "had no effective federal regulation. And, it turned out, I don't think they had any effective state regulation," Mr. Volcker said Feb. 18 at a gathering of financial advisers and their clients at the New York offices of French insurance giant AXA SA, according to a transcript of his remarks posted to the company's Web site on Thursday.

New York State, where AIG is headquartered, "has a strong system of regulation," he said, according to the transcript. But "I don't think [regulators there] saw themselves as looking outside the insurance company into the rest of the holding company," where the big problems loomed.

Eric Dinallo, who was superintendent of New York's insurance department in 2008 when AIG was forced to seek a federal bailout, said in an interview that he didn't want "to pick a fight" with Mr. Volcker. He said that he and other state regulators support strong "holistic holding-company supervision" that identifies risk at the top that can spread to hurt operating units.

Mr. Dinallo, who is pursuing a run for the state's attorney general position, disputed that state regulators hadn't looked outside the insurance units to see the bigger picture. "We did have meetings with the Office of Thrift Supervision," he said. "We were told everything was fine." The thrift office regulated AIG and its financial-products unit.

"The complete responsibility," he said "lies at [the] doors" of federal regulators and with the lack of regulation of the financial products that got AIG into its troubles, credit-default swaps. The products are insurance-like contracts that let investors wager on the likelihood that debt will default. He said Congress "must look in the mirror" to resolve the problems with the products.

AIG was brought down by tens of billions of dollars in soured credit-default swap trades on mortgage-linked assets put on by a financial-products division separate from its insurance units. After the division and AIG, which had guaranteed its obligations, ran into liquidity problems, the U.S. government eventually committed as much as $182.3 billion in taxpayer support to the firm.

Mr. Volcker's views on the financial crisis helped shape an Obama administration proposal earlier this year, dubbed the "Volcker rule," that essentially would prevent any commercial bank with federally insured deposits from owning a division that makes speculative bets with its own capital. The rule has stalled in the Senate.

A person in Mr. Volcker's office said he wasn't available Thursday to comment.

Mr. Volcker's remarks on possible shortcomings by the states pick up a theme expressed in recent congressional testimony by Treasury Secretary Timothy Geithner and his predecessor, Henry Paulson. At a hearing last month, Mr. Geithner, who headed the Federal Reserve Bank of New York when it led the bailout of AIG in September 2008, said the company shouldn't have been allowed to take the huge risks it did outside of its traditional insurance businesses.

He added that AIG's insurance regulators in 20 states and its federal supervisor, the Office of Thrift Supervision, "did not act to constrain the risks AIG was taking" and "had no idea of the risks to the insurance firms" from a possible bankruptcy filing by their parent.

State insurance regulators have staunchly maintained that AIG's insurance businesses are solvent and insulated from their parent's financial woes, thanks to their oversight. They point to state regulatory-capital rules that ensured the units are amply capitalized.

A letter posted Jan. 29 on the Web site of the National Association of Insurance Commissioners, the organization of state insurance regulators, said the NAIC long has supported "greater information sharing among regulatory bodies to better understand and anticipate how operations outside our respective authorities could affect" all the units of a financial conglomerate.

The letter notes that the products that nearly caused AIG's collapse remain unregulated. "Fixing these problems, and not deregulating the insurance sector, is where we believe the Congress should focus its efforts," the NAIC letter reads.

At the event at AXA, Mr. Volcker said the recent crisis "just reinforces the case" for large insurance companies and financial institutions around the country to be subject to a regulator overseeing systemic risk.

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