March 24 (Bloomberg) -- The top two U.S. economic leaders called for new powers to take over and wind down failing financial companies after the government’s rescue of American International Group Inc.
“As we have seen with AIG, distress at large, interconnected, non-depository financial institutions can pose systemic risks just as distress at banks can,” Treasury Secretary Timothy Geithner said in testimony to a House Financial Services Committee hearing today in Washington. Federal Reserve Chairman Ben S. Bernanke said “AIG highlights the urgent need for new resolution procedures.”
Bernanke and Geithner also called for stronger regulation to constrain the risks taken by firms that could endanger the financial system. The remarks presage some of the likely changes to U.S. regulations in the aftermath of the worst crisis since the 1930s.
The two reiterated their opposition to bonus payments for AIG’s financial-products division, with Bernanke saying he had initially sought a lawsuit to halt them. The testimony provides new details on officials’ efforts to halt the $165 million payout, news of which sparked a furor and spurred the House to pass an excise tax on bonuses at firms that receive more than $5 billion of federal aid.
‘Our’ AIG
“The taxpayer, the average person, and the politicians” look at AIG “as our company,” said Andrew Laperriere, managing director at International Strategy & Investment Group in Washington. Congress is “going to assert more control over how those companies operate” as banks receive billions in taxpayer aid, he said.
While the government controls almost 80 percent of AIG through stock and warrants, New York Federal Reserve Bank President William Dudley said his bank doesn’t have day-to-day management authority over the company. “Responsibility for AIG’s day-to-day affairs continues to rest with AIG’s chief executive officer, Edward Liddy, under the oversight of AIG’s board of directors,” he said in testimony to the committee.
Lawmakers stressed the public outrage over the $182.5 billion federal bailout of AIG. The New York-based insurer paid the bonuses to employees of the division that triggered the rescue with losses on credit-default swaps less than two weeks after reporting a $61.7 billion fourth-quarter loss on March 2.
Investment Losses
Representative Donald Manzullo, a Republican from Illinois, said taxpayers have suffered losses of 40 percent to 50 percent on their investment portfolios, while people with insured retirement plans at AIG lost nothing.
“They are paying $40 billion so other people don’t lose anything on their retirement plan,” Manzullo said. “That is what you are saying. That is what happened isn’t it?”
Bernanke said the aid to the insurer was provided to avoid a “catastrophic” collapse of the financial system that could have produced even higher losses on Americans’ portfolios.
“Give me a yes or no, please,” Manzullo demanded. “Not one of you three can give me a yes on that answer or no?”
“It is a poorly posed question,” Bernanke said.
“Well, then it is poorly written in your statements,” Manzullo said.
Lawsuit Considered
Bernanke told lawmakers earlier this month that “if there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG.” The company operated like a hedge fund and “exploited a huge gap in the regulatory system,” he said.
“It was highly inappropriate to pay substantial bonuses to employees of the division that had been the primary source of AIG’s collapse,” Bernanke said in his prepared remarks, adding, “I then asked that suit be filed to prevent the payments.” No lawsuit was filed after the central bank’s legal staff counseled against litigation because punitive damages could be awarded if the suit failed.
Geithner told the panel he found the bonuses “deeply troubling” when he learned of them on March 10.
“I share the anger and the frustration of the American people, not just about compensation practices at AIG and in other parts of our financial system, but that our system permitted a scale of risk-taking that has caused grave damage to the lives of so many Americans,” Geithner said.
AIG Aid
AIG was first saved in September with an $85 billion rescue, and agreed to hand over an 80 percent stake to the U.S. government. The bailout swelled to $122.8 billion and then $150 billion as the government sought to prevent losses at banks that did business with the insurer.
U.S. officials are still increasing the amount of public money committed to rescues. On Monday, the Treasury announced a plan aimed at financing as much as $1 trillion in purchases of illiquid real-estate assets from banks, using $75 billion to $100 billion of the Treasury’s remaining bank-rescue funds.
During the hearing, Representative Edward Royce, a California Republican, warned against government support undermining incentives and creating an unfair playing field.
“At the end of the day, we undermine market discipline because we telegraphed the message to the market that the government is behind these institutions,” Royce said.
Downward Spiral
Federal aid has yet to pay off for taxpayers. A self- reinforcing downward spiral of falling home prices, declining employment and market instability has led to what economists now forecast will be the longest recession in more than 25 years.
The economy contracted at a 6.2 percent annual pace in the final quarter of last year and economists expect a 5.2 percent decline in the current quarter, according to the median estimate in a Bloomberg News survey. The unemployment rate hit 8.1 percent in February.
The crisis may prompt the most sweeping overhaul of U.S. financial oversight since the Great Depression, with lawmakers such as committee Chairman Barney Frank, a Massachusetts Democrat, committed to designing a systemic risk regulator.
Geithner also said the regulatory system must be fixed after it failed to rein in excesses at AIG.
“All institutions and markets that could pose systemic risk will be subject to strong oversight, including appropriate constraints on risk-taking,” Geithner said. “Regulators must apply standards, not just to protect the soundness of individual institutions, but to protect the stability of the system as a whole.”
While the Federal Deposit Insurance Corp. has the power to take over failing deposit-taking firms and wind down their assets, no such authority exists for financial firms that aren’t classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system.
“AIG highlights the urgent need for new resolution procedures for systemically important non-bank financial firms,” and the need for consolidated supervision of “all systemically important financial firms,” Bernanke said.
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