AIG: Stealth or Regulatory Incompetence?

In the last GlobalRiskBlog, quotes from Geithner and Bernanke which seemed to blame the AIG CDS fiasco on its ability to fly below the regulatory radar were prominently featured. This morning we read that such a notion is being disputed by one of their own! On Thursday, Scott Polakoff, acting director of the OTS (AIG's primary regulator) appeared before the Senate Banking Committee and agreed that the perception that London-based AIG Financial Products exploited a lack of supervision was incorrect. So what is it then? A 2007 GAO report said that OTS "lacked the needed expertise to regulate complex financial products like credit default swaps". Polakoff admits that some of the issues and problems at AIG were identified but steps taken were insufficient to head off disaster. Doesn't it always seem to work that way? A lack of urgency ultimately winds up blowing up in your face and upon reflection the problems seem so crystal clear. Think about 9/11 or consider baseball's battle with performance enhancing drugs. In a similar way, times were good and people were happy. Warnings went unheeded or were met with symbolic or half-measures. Yet, when disaster struck everything was reconsidered and the vigilance pendulum swung completely in the other direction. Naturally, it will be the same this time.

The links:

• US experts clash on who can monitor risk. While lawmakers seem to agree that the financial regulatory system is broken, they are not necessarily all in the same boat as to how to repair it.
• The Washington Post chronicles the Obama administration's quest to put a valuation on toxic assets at the heart of the crisis.
• Uh oh. Merrill Lynch says its risk officers discovered a trading "irregularity". Beleaguered chief Ken Lewis can't be happy.
• All sizzle and no steak? Paul Krugman is growing impatient with Obama and Geithner.
  
• The CDS market is killing Buffett and Immelt.
• In an obvious blow to Geithner, two picks for top jobs at Treasury have withdrawn from consideration. Deputy Treasury Secretary choice Annette Nazareth and International Affairs Undersecretary pick Caroline Atkinson have decided to stay put.
• Philly Fed President Plosser says the Fed needs a better roadmap to deal with crisis.
• Times Online has some good outtakes on the crisis from Mervyn King.
• Sen. Dodd is moving to allow the FDIC to borrow up to $500B from the Treasury.
• William D. Cohan has written House of Cards, the first of what should be many looks at the collapse of Bear Stearns. James Freeman reviews the book for the WSJ.
• And finally, just in case you missed it, the Daily Show's Jon Stewart proves once again that Hell hath no fury like talk show host scorned. His guns are blazing at CNBC in this video.
  

Regulation Monday

The regulators are back in the top of the news this morning, with two prominent articles in the NY Times Business pages. SEC chief Mary Schapiro has used her first month to move aggressively toward reversing major decisions by prior chief Cox, and to strengthen the enforcement program which has been blasted for missing several huge frauds. Cox had a policy which required enforcement lawyers to obtain consent of commissioners before moving to resolve major cases. With the commission largely made up of opponents of government regulation, the residual effect was to discourage cases and reduce penalties. Schapiro is under the gun to restore crdibility to the agency, as Congress prepares legislation which may overhaul the entire securities regulatory structure. Schapiro is moving quickly to adopt rules to minimize conflict of interest at credit-rating agencies, as well as looking at new restrictions on short selling. Schapiro's moves will be made more challenging by news of the latest collateral damage from the Cox era, as the Agency faces scrutiny for its handling of allegations of insider-trading by former Lehman executives. Sen. Grassley wants answers...

• Bank stress testing will be in the spotlight this week as the Obama administration scrutinizes the financial condition of the 20 biggest banks to assess their fitness to weather a worse downturn than expected. The U.S. said that banks would have access to capital necessary to keep them afloat. Read the joint statement from Treasury, FDIC, OCC, OTS and Federal Reserve here.
  
• More news on "Creeping Nationalization" as the Obama administration may take another step in that direction if it converts the government's preferred shares in Citigroup into common equity to help the stumbling giant withstand losses. Paul Krugman says just do it, but Gerald O'Driscoll says to beware.
  
• Phil Gramm, often pointed to as the architect of deregulation weighs in on Gramm-Leach-Bliley and what it all meant.
• From Bloomberg, word that the US and Europe are discussing joint regulation of the $28T credit default swap market.
• US regulators are being forced to sell real-estate loans of failed banks at a discount to lure buyers spooked by the likelihood of increased loan losses.
• A major CDO is bankrupt.
• Sen. Dodd tells Al Hunt short-term bank nationalization is a possibility.
• Sovereign CDS is being used to speculate on currency strength.
  

The N-Word

With the G-7 meeting kicking off in Rome today, Treasury Secretary Geithner will want to tap into his European counterparts for experience with the big N: Nationalization. Ireland injected €7B into its two largest banks this week, four of Britain's largest banks are under de facto control of the new government holding company, and now word that Germany may be ready to get in the act as Hypo Real Estate Holdings could be nationalized by Merkel. Europeans have put the questionable banks on a tight leash, while the US so far has been committed to keeping its banks in private hands. Who has the better approach? Economists seem to agree that the government needs to exercise some control to get bad assets off the books, but disagree on how much control. It is not surprising that Nouriel Roubini is one who believes it's time to nationalize U.S. banks. Roubini says the banking system is basically insolvent, with bank and finance company losses already passing the $1T mark and possibly peaking at $3.6T. He estimates the banks will need another $1.4T in new capital to resolve the credit crunch. Scary stuff. Keeping with that theme, Steve Lohr of the NYT says banks look like "dead men walking". Without a cure for the bad assets, the problem will linger and keep dragging the economy and banking system further into the mire. In a preview of the Washington Post's Sunday Outlook section, Roubini and fellow NYU professor Matthew Richardson push the idea of nationalization even further. Although Obama seems to be against a full scale nationalization, some say the U.S. is engaging in "creeping nationalization" as it empowers regulators and implements bank stress testing, but where we end up is anybody's guess at this point. Who knows, maybe some of that European aggressiveness rubs off on Geithner this weekend...

On to the Headlines:

• With all that is happening at Treasury, it looks like Geithner is understaffed. Bloomberg reports that a dearth of staff experts is slowing him down. Hmmm, hasn't he heard of GlobalRiskJobs?
• There's more grist for the regulatory mill. Hedge fund insider trading is top news today as unsealed court documents obtained by Bloomberg indicate Kynikos, SAC and other funds are being accused of trading on material non-public information. New regs may be on tap in Europe as France seems to be calling for a hedge fund crackdown. The US and UK have been oceans apart on hedge fund regulation.
  
• Regulators from the SEC are probing Stanford Financial Group.
• AIG's London-based financial products unit is being investigated.
• George Mason University law professor Todd Zywicki says the price for mortgage modification is too high in this WSJ opinion piece.
  
• Ahhhh, politics. Are campaign contribution rules going to stifle real regulatory reform?
• A Tale of Two Cities in the Junk market. Charter's filing is more evidence that souring corporate debt starting to fester, but the amount of new issue high yield bond sales tripled ($2.38B) this week, signaling investor appetite for risk may be increasing.
• Former HBOS risk chief Paul Moore stood firm on his claims against the bank.
• John M. Reich, Director of the Office of Thrift Supervision stepped down yesterday. Read the official press release.
• More negative news for big banks as Wells adds an impairment.
• Art imitates life on the big screen, as Clive Owen stars in "The International" a new film about, yup, financial corruption.
  
• And finally, some snark from Michael Lewis to get the weekend started. No matter what you think of his views, they are usually entertaining.
  

OTS takes another bullet

Late news on the regulatory front. Officials at the Office of Thrift Supervision allowed 5 banks to improperly report capital infusions in a way that can make them appear healthier, a big blow to an agency already under fire for its role in the financial crisis. The OTS allowed banks to backdate capital infusions to earlier quarters, which would have allowed them to skirt regulatory penalties that might have occurred had their capital levels fallen below certain thresholds. OTS had already been under fire for its handling of IndyMac Bank. It's just one more data point that leads GlobalRiskJobs to believe that BIG change is going to come on the regulatory front sooner rather than later.