Last weekend AIG released information about the amounts and recipients of roughly $100 billion of its government loans from September to December 2008. The utterly unreported surprise is that the staid, boring, heavily regulated insurance businesses managed to run up losses on securities lending requiring $44 billion of government support. By way of contrast, the credit derivatives widely blamed for bringing down the world's financial system were consuming $27 billion of direct government support [and another $27 billion of indirect support, totaling $54 billion]; municipal investment agreements (essentially, deposits) made by municipalities with AIG Financial Products took another $12 billion, and maturing debt took $13 billion.
Why the misdirected coverage? My guess is that we are seeing an unholy alliance of insurance regulators who would rather point the finger at unregulated credit derivatives, people who always favor more regulation as the answer to everything, and public officials who don't want people to wonder whether other staid, boring insurance companies that don't do credit derivatives might still have huge problems in their core portfolios. Since securities lending lacks the glamour of M&A or international "Master of the Universe" trading, the media is easily distracted.
Let's cut to some numbers:
Government support of AIG - Where Did The Money Go
Securities lending: $44.0 billion
AIG Financial Products
Credit Derivatives - collateral $22.4
Credit Derivatives - Maiden Lane equity 5.0
Credit Derivatives through Maiden Lane: 27.4
Municipal Investment Agreements 12.1
Maturing Debt 12.5
The recipients of payments for the securities lending is a Who's Who of global finance and reeks of systemic risk; here are the top names:
Barclays $7.0 billion
Deutsche Bank 6.4
BNP Paribas 4.9
Goldman Sachs 4.8
Bank of America 4.5
Yet how is this presented in the media? Its all about AIG FP. Here is ABC News today reporting on the AIG bonuses and the upcoming Congressional hearing:
The testimony of Edward M. Liddy, who took over as AIG's CEO in September as part of the government's rescue efforts for the embattled firm, will come days after a furor erupted over the revelation that AIG awarded fat retention bonuses to employees of the AIG Financial Products unit.
The Financial Products unit is blamed for plunging AIG into the financial turmoil that eventually led the government to lend and invest about $170 billion in taxpayer money in the company.
After a big skip we get this:
Part of the purpose of today's hearing is to examine how AIG arrived at its "terrible situation" and why it is receiving so much taxpayer money, according to a statement issued by the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises.
"Taxpayers do not understand how AIG ended up in such a terrible situation, nor do they understand why the federal government continues to give it money," Rep. Paul E. Kanjorski, D-Pa., the chairman of the subcommittee, said in the statement. "We must assess AIG's progress, as well as how we move forward to ensure that any taxpayer money AIG receives is spent efficiently and effectively."
In addition to Liddy, witnesses scheduled to testify at today's House AIG hearing include Joel Ario, the insurance commissioner for the Pennsylvania Insurance Department; Scott Polakoff, the acting director of the Office of Thrift Supervision; Orice M. Williams, the director of Financial Markets and Community Investment at the Government Accountability Office; and Rodney Clark, managing director of insurance ratings at Standard & Poor's.
Stable Insurance Companies, Shaky Hedge Fund?
Ario told ABCNews.com Tuesday that today's hearing represents "another opportunity for us to clarify the difference between the financial products which are regulated -- to the extent it was regulated at all, by the federal government -- and the insurance companies which are regulated by, we think, a very effective state-based regulatory system."
Ario said he agreed with Federal Reserve chairman Benjamin Bernanke, who has described AIG as a hedge fund attached to a large, stable insurance company.
That hedge fund, said Ario, was AIG's Financial Products unit and that is "what's caused systemic risk in this case."
"The larger, stable insurance company is the 71 separate domestic insurance companies of AIG," Ario said. "They've had some difficulty because of the problems at the holding company level but basically they were not the cause of the systemic risk and they remain large and stable insurance companies."
The problem of "systemic risk" is what AIG and bailout proponents cite in arguments in support of the government's multibillion-dollar AIG rescue.
Look, I understand why an insurance commissioner who failed to do his job would like to point the blame elsewhere; I even understand why people who champion more regulation as the answer to every problem are willing to play along and blame unregulated credit derivatives. I even understand why public officials (like Bernanke) who want to promote public confidence in the insurance industry and its regulators will prefer to point at credit derivatives (since AIG was alone among insurance companies in this activity in a way it is probably not alone with securities lending).
I am less sure why the media is willing to play along. And to be fair, Sen. Shelby took a tough line with NY State Insurance Commissioner Eric Dinallo at a March 5 Senate hearing, as reported in the Times:
Mr. Shelby expressed doubts that A.I.G.’s state-regulated insurance companies were entirely innocent. He said they had engaged in a risky securities lending business and ended up needing $35 billion of the Fed’s bailout last fall.
“Are you trying to evade your responsibility?” he asked Mr. Dinallo. “You can claim here today that you have little responsibility for all of these problems?”
Mr. Dinallo said that it was true that the securities in the lending program were the property of A.I.G.’s insurance companies, but that the lending activity had been orchestrated by another part of A.I.G. — a special unit set up and controlled by A.I.G. the holding company. State regulators had no jurisdiction over the special unit, but it could layer big risks back onto the insurers, he said.
Financial Products' trillions of dollars of transactions created systemic risk. Securities lending did not.
Let's snip this:
AIG securities lending was consolidated by the holding company at a special unit it set up and controlled. This special unit was not a licensed insurance company. As with some other holding company activities, it was pursued aggressively rather than prudently.
AIG maintained two securities lending pools, one for U.S. companies and one for non-U.S. companies. At its height, the U.S. pool had about $76 billion. The U.S. security lending program consisted of 12 life insurers, three of which were from New York. Those three New York companies contributed about 8% of the total assets in the securities lending pool.
The program was invested almost exclusively in the highest-rated securities. Even the few securities that were not top rated, not triple A, were either double A or single A. Today, with the perfect clarity of hindsight, we all know that those ratings were not aligned with the market value of many mortgage-backed securities, which made up 60 percent of the invested collateral pool.
As early as July 2006, we were engaged in discussions about the securities lending program with AIG. In 2007, we began working with the company to start winding down the program.
Unfortunately, the securities lending program could not be ended quickly because beginning in 2007 some of the residential mortgage securities could not be sold for their full value. At that time there were still few if any defaults, the securities were still paying off. But selling them would have involved taking a loss.
Still, we insisted that the program be wound down and that the holding company provide a guarantee to the life companies to make up for any losses that were incurred as that happened. In fact, the holding company provided a guarantee of first $500 million, then $1 billion and finally $5 billion.
And what is the guarantee of an insolvent holding company worth? Or, how would the insurance subs have been helped by the return of formerly AAA housing bonds?
Let's close with Dinallo's explantion that AIG Financial Products sneezed on his house of cards:
At that point, the crisis caused by Financial Products caused the equivalent of a run on AIG securities lending. Borrowers that had reliably rolled over their positions from period to period for months began returning the borrowed securities and demanding their cash collateral. From September 12 to September 30, borrowers demanded the return of about $24 billion in cash.
Cash which was not available, despite Dinallo's rigorous oversight.
Here is Sen. Shelby yesterday calling for wholesale revisions to the regulation of insurance companies:
AIG’s insurance subsidiaries suffered more than $20 billion in losses from their securities lending operations and had to be recapitalized with a loan from the Federal Reserve, Shelby said.
“The circumstances that permitted AIG’s securities lending operations to potentially threaten the solvency of several of its insurance companies and their counterparties suggest that our regulatory system has not been keeping up with developments in the market,” Shelby added.
We will see which way the wind blows today.
For background, Bloomberg reported on AIG's securities lending losses last year and gave some background. Sorry, no highly paid traders or exotic locales to hold your interest. But you get a trip to Texas!
Whining is allowed in Texas? I try to learn something new every day.
STILL MORE: Some background on losses in securities lending at pension funds and asset managers.