Wall Street's Golden Goose

AIGFP's sales of credit protection on various assets grew from $20 billion in 2002 to $533 billion in 2007.

It agreed to post collateral for these CDS contracts if the value of the underlying securities dropped or if the rating agencies downgraded AIG's long-term debt ratings. That promise ultimately proved disastrous. In early 2005, AIG lost its triple-A rating after auditors found it had manipulated earnings. Eventually, that led to Maurice "Hank" Greenberg resigning as CEO.

In his own testimony to the FCIC, Greenberg said that when AIG lost its triple-A rating, it should have gotten out of backing CDS or at least reduced its presence in that business. Other AIG executives told the commission that by 2005 they were getting increasingly worried about the extent of AIG's commitment to CDS in view of the high percentage of subprime mortgages they were backing. Yet AIGFP sold another $36 billion in CDS in 2005. And it completed 37 deals between September 2005 and July 2006–one of them on a CDO backed by 93% subprime assets.

In July 2007, this house of cards began its long, slow collapse. Goldman Sachs sent a margin call to AIG for almost $2 billion on super-senior credit default swaps because their market value had declined.

Ultimately, in September 2008, the Federal Reserve Bank stepped in to enable AIG to meet its need for increased collateral, in return for giving taxpayers an 80% stake in the company.

The tale told in the Financial Crisis Inquiry Report is one of acute corporate mismanagement and inept Federal regulation. Unfortunately, in all probability the report will not lead to kinds of regulatory changes needed to mitigate a similar financial disaster in the future.

The report shows AIG executives were not doing their jobs. Regulators, too, including the Federal Reserve and the Office of Thrift Supervision, blundered.

It remains to be seen whether Wall Street and Washington will take steps to assure a similar financial crisis will not happen again. Sadly, it appears the financial system is not much different today than before the crisis.

Because of the deregulation of over-the-counter derivatives, state insurance regulators were blocked from regulating AIG's sale of CDS. That continues to be the case.

Efforts to reform the system through the Dodd-Frank Act seem feeble, largely due to the ability of big banks, with allies in government, to block the excessive use of the types of derivatives that led to the failure of the entire financial system. What the whole dismal episode shows is the need for more regulation. Unfortunately, what we are hearing out of Washington right now is that we need less.