2010 0610 – COP – Report – The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy, June Oversight Report, Congressional Oversight Panel – Snippets

2010 0610 - COP - Report - The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy, June Oversight Report, Congressional Oversight Panel

2010 0610 - COP - Report - The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy, June Oversight Report, Congressional Oversight Panel --- [BonkNote] --- [PDF-337p]

(p152) - iv. Would Bankruptcy Have Been as Bad as the Government Claims?

(p9) - One consequence of this approach was that every counterparty received exactly the same deal: a complete rescue at taxpayer expense. Among the beneficiaries of this rescue were parties whom taxpayers might have been willing to support, such as pension funds for retired workers and individual insurance policy holders.
(p19) - In the words of Marshall Huebner of Davis Polk & Wardwell, a law firm that represented FRBNY, the securities lending problems contributed to a ‘‘double death spiral.’’²²
- ²² FRBNY and Treasury briefing with the Panel and Panel staff (Apr. 12, 2010).
(p19) - AIG was taking risks with the assets of its life insurance subsidiaries through its securities lending program, creating a potential $15 billion-plus cash drain on their operations, a shortfall that may have threatened the solvency of these units in the absence of government assistance, as discussed in Section B3b.²³
(p22) - The states, through the National Association of Insurance Commissioners (NAIC), coordinate so that AIG‟s insurance subsidiaries have four lead regulators. Texas is the lead regulator for life insurance companies, Pennsylvania for property & casualty, New York for personal lines, and Delaware for “surplus” or specialized lines
(p25) - a. Credit Default Swaps
- AIG's downfall stemmed in large part from its CDS on multi- sector CDOs, which exposed the firm to the vaporization of value in the subprime mortgage market.\25\
  - While many counterparties purchased these contracts to hedge or minimize credit risk, AIG essentially took the other side, a one-way, long-term bet on the U.S. mortgage market.\26\
  - This bet was premised on the presumed security of the `AAA'-plus ratings on the underlying CDOs, aided by the subordination structures built into the underlying collateral pools, as well as AIG's once stellar `AAA' credit rating. AIG relied on these factors to serve as a bulwark against market volatility that would undermine the value of the reference securities, and necessitate mark-to-market valuation losses and the posting of collateral to AIG's trading partners.
  - AIGFP's model for CDOs was insufficiently robust to anticipate the impact of the significant declines in value associated with the market meltdown.
  - This basic failure of comprehensive modeling and prudent risk/reward analysis on what was a relatively small slice of AIGFP's business ultimately brought down the entire firm and imperiled the U.S. financial system.
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    \25\ See Annex III for an explanation of AIG's CDS business and the CDS market more generally.
    \26\ This was in contrast to other market participants, particularly dealers, which sought to balance the risk in their portfolios by accumulating both long and short positions to better net risk positions.
(p40) - Of the 2008 capital contributions, $22.7 billion went to the domestic life insurance subsidiaries, primarily to cover losses in the securities lending portfolio.¹³⁸
(p40) - In 2009, AIG contributed $2.4 billion to its domestic life insurance subsidiaries ‘‘to replace a portion of the capital lost as a result of net realized capital losses (primarily resulting from other than- temporary impairment charges) and other investment-related items.’’¹³⁹
(p44) - (“AIG parent also deposited amounts into the collateral pool to offset losses realized by the pool in connection with sales of impaired securities”);
*(p46) - 116 The New York Insurance Department has subsequently stated that there would have been sufficient capital and assets within the subsidiaries to resolve the securities lending issue without assistance from the parent. Panel staff conversation with New York Insurance Department (June 3, 2010).
(p48) - 122 Plaintiffs‟ Complaint, 2-4, People v. American International Group, Inc., N.Y. App. Div. (May 26, 2005) (No. 401720-2005) (online at www.ag.ny.gov/media_center/2005/may/Summons%20and%20Complaint.pdf). In 2005 problems with AIG‟s reinsurance division led to an investigation by the Securities and Exchange Commission, the New York Attorney General, the New York State Insurance Department, and the Justice Department as to “whether reinsurance companies controlled by AIG were treated as separate entities in order to help hide AIG's exposure to risk; whether reinsurance transactions are tantamount to loans that should have been so listed; whether assets and liabilities were swapped to smooth earnings; and, finally, whether AIG used finite reinsurance to smooth earnings.” The reinsurance revelations contributed to the rating agencies‟ downgrade of the credit rating of AIG in 2005, AIG‟s amendment of its 2005 10-K filing, and Mr. Greenberg‟s departure as chairman and CEO of AIG

(p106) - The regulators have also stated that the subsidiaries had a plan in place to manage an immediate securities lending liquidity crunch on their own, without the infusion of government funds.
- Panel staff conversation with Texas Department of Insurance (May 24, 2010).
(p107) - ⁴⁰⁶ Some of AIG‟s insurance subsidiaries were insulated from reputational harm because they operated under different brand names.
- This may have prevented some existing customers from making a connection between their insurer and AIG.
(p110) - Testimony of Sec. Geithner, supra note 11, at 5–6 (stating that ‘‘if AIG had failed, the crisis almost certainly would have spread to the entire insurance industry.’’
- And that ‘‘the seizure by local regulators of AIG’s insurance subsidiaries could have delayed Americans’ access to their savings, potentially triggering a run on other institutions’’); House Committee on Financial Services,
  - Written Testimony of Timothy F. Geithner, secretary, U.S. Department of the Treasury, Oversight of the Federal Government’s Intervention at American International. (Mar. 24, 2009) (online at www.house.gov/apps/list/hearing/financialsvcs_dem/statement_-_geithner032409.pdf);
(p111) - Policymakers have pointed out that some runs were seen in foreign jurisdictions.
- According to press reports, insurance policyholders in Singapore, Taiwan, Thailand, Vietnam, and Hong Kong sought to terminate their insurance policies with two of AIG’s insurance subsidiaries (AIA and Nan Shan Life Insurance) after learning of AIG’s financial troubles and despite the Federal Reserve’s $85 billion rescue.
  - See, e.g., Hundreds of AIG Policyholders Throng Asian Offices, Agence France Presse (Sept. 17, 2008) - [link]
They <Federal Reserve and Treasury> also feared a run driven by a substantial influx of life insurance policyholders either drawing on the savings and credit features of their policies or surrendering their policies entirely, especially since some such ‘‘runs’’ were seen in foreign jurisdictions.⁵²⁰
- ⁵²⁰ E-mail from Alejandro LaTorre, assistant vice president, Federal Reserve Bank of New York, to Timothy F. Geithner, president and chief executive officer, Federal Reserve Bank of New York and other FRBNY personnel (Sept. 16, 2008)
(p117) - ⁴⁴⁸ Panel staff call with National Association of Insurance Commissioners (Apr. 27, 2010).
- The NY insurance regulators have provided Executive Life of New York as an example of seizure not being automatic for solvent insurance subsidiaries upon the bankruptcy filing of the holding company but later becoming necessary; the NY insurance regulators seized Executive Life of New York insurance subsidiaries several months after the parent company bankruptcy filing because a run on the insurance subsidiaries had developed. Panel staff conversation with New York State Insurance Department (June 3, 2010).
(p117) -⁴⁵⁰ It should be noted that state insurance guarantee funds carry statutory caps on the amounts that can be assessed annually from solvent insurers. See, e.g., Tex. Insur. Code § 463.153(c). Because of AIG‟s size, it is likely that guarantee fund assessments would have reached these caps.
- Panel staff conversation with Debra Hall, expert in insurance receivership (May 14, 2010); Panel staff conversation with David Merkel, insurance actuary (May 18, 2010).

(p63) - In a recent interview with the Panel, Secretary Geithner said that on Sunday night, he got government officials to start thinking about the implications of an AIG failure both on U.S. insurance subsidiaries and around the world.²²²

(p221) - A. The Bankruptcy Rules That Would Have Applied to AIG
- Generally, when a company files for bankruptcy, its creditors will be subject to an automatic stay or an injunction that prevents the creditors from taking further action to collect on their debts.⁸⁸⁹
- Thus, the debtor’s assets will be protected while negotiations take place with creditors.

Had the AIG parent entity filed for bankruptcy, it would have received a ‘‘D’’ credit rating, and because of the three notch rule, the subsidiaries would have likely been downgraded to CCC+, CC¥, or lower.
According to the Federal Reserve and Treasury, any ratings downgrades that might have occurred would have increased the odds that the subsidiaries would be subject to heightened scrutiny by the regulators or placed into conservatorship or receivership.
⁵⁸⁵ The consensus among industry analysts is that once confidence is lost in an insurance company like AIG, policyholders will pull their policies, insurance agents will dissuade clients from purchasing insurance policies from the company, and that, in effect, all the insurance companies would have become ‘‘run-off’’ businesses. Panel staff conversations with industry analysts.
Warren Buffett maintains that the property/casualty business would have gone into run-off, while there would have been a disastrous run on the life insurance companies. Panel staff conversation with Warren Buffett (May 25, 2010).