What Happened At AIG?

The story has been changing over time. This is from a WSJ editorial on 1-28-2010, page A18 called The Latest AIG Story: Regulators can't agree on what the real systemic threat was. The key exerpts are:

"At yesterday's House hearing, Secretary of the Treasury Timothy Geithner and predecessor Hank Paulson said they didn't bail out AIG to save its derivatives counterparties. Instead, said Mr. Geithner, the now-famous 100-cents-on-the-dollar buyouts of credit default swap contracts were necessary to prevent a further downgrade of AIG by credit-ratings agencies."

"the Federal Reserve Bank of New York, where Mr. Geithner was president, had by that time already seized AIG. We're guessing that a ratings agency is pretty comfortable with the creditworthiness of a firm 79.9%-owned by Uncle Sam."

"... the hearing showed that the story of why AIG could not be allowed to fail continues to change,..."

"The original Beltway line was that the systemic risk was caused by AIG's inability to back up the credit default swap contracts it sold..."

"Yesterday, however, Messrs. Geithner and Paulson went further than ever in stating that the real systemic risk was to AIG's heavily regulated insurance businesses. Their testimony directly contradicts that offered to Congress by former New York Insurance Superintendent Eric Dinallo, who was AIG's principal insurance regulator at the time."

"The Geithner and Paulson story now is essentially that the system of heavy state insurance regulation was a sham. When push came to shove, policyholders were not protected from a default by the parent company."

"This also makes us wonder about all of the political and media chatter over the last year that derivatives were the doomsday machine that caused the meltdown. If this testimony is correct, then the systemic risk wasn't that if AIG collapsed it would infect Goldman and other financial companies like falling dominoes across the world."

"But if bad bets on derivatives would only have ruined AIG and its subsidiaries, that's not the same kind of danger to the entire financial system."