Joe Baca: When Was It Broken?

Joe Baca (D-CA) asked Ben Bernanke a very simple question in today’s House Financial Services hearing on AIG: When was AIG broken? When did it get so screwed up that we would have to bail it out.

Bernanke, however, didn’t give Baca a clear answer. He did say this:

The Office of Thrift Supervision is a small agency that specializes in addressing the problems of thrifts. It was, in this case, involved only because AIG owned a small thrift. It’s main concern is the protection of the thrift. It’s true, as [Polakoff] said, that he looked at some of these elements in the AIGFP division. But I do think that, given the size of the company and the risks being taken, a larger, more effective, stronger, better funded regulatory effort would have been needed in order to identify these problems.

What Bernanke didn’t want to say was:

1999. When Congress dismantled the regulation on this kind of gambling.

Matt Taibbi explained it in more depth. First, he talked about Glass-Steagall (passed killed with Gramm-Leach in 1999 [oops, gotta pay attention when I try to clarify]), that made it possible for insurance companies to dress up as trading firms. Then, he explained that Gramm pushed through the Commodity Futures Modernization Act (in 2000), which made it impossible to regulate CDS.

The blanket exemption meant that Joe Cassano could now sell as many CDS contracts as he wanted, building up as huge a position as he wanted, without anyone in government saying a word. "You have to remember, investment banks aren’t in the business of making huge directional bets," says the government source involved in the AIG bailout. When investment banks write CDS deals, they hedge them. But insurance companies don’t have to hedge. And that’s what AIG did. "They just bet massively long on the housing market," says the source. "Billions and billions."

Then, another bit of 1999 deregulation made it easy for huge companies like AIG to select to be regulated by the undermanned Office of Thrift Supervision (the one that Bernanke talks about above). 

In the biggest joke of all, Cassano’s wheeling and dealing was regulated by the Office of Thrift Supervision, an agency that would prove to be defiantly uninterested in keeping watch over his operations. How a behemoth like AIG came to be regulated by the little-known and relatively small OTS is yet another triumph of the deregulatory instinct. Under another law passed in 1999, certain kinds of holding companies could choose the OTS as their regulator, provided they owned one or more thrifts (better known as savings-and-loans). Because the OTS was viewed as more compliant than the Fed or the Securities and Exchange Commission, companies rushed to reclassify themselves as thrifts. In 1999, AIG purchased a thrift in Delaware and managed to get approval for OTS regulation of its entire operation.

Making matters even more hilarious, AIGFP — a London-based subsidiary of an American insurance company — ought to have been regulated by one of Europe’s more stringent regulators, like Britain’s Financial Services Authority. But the OTS managed to convince the Europeans that it had the muscle to regulate these giant companies. By 2007, the EU had conferred legitimacy to OTS supervision of three mammoth firms — GE, AIG and Ameriprise.

That same year, as the subprime crisis was exploding, the Government Accountability Office criticized the OTS, noting a "disparity between the size of the agency and the diverse firms it oversees." Among other things, the GAO report noted that the entire OTS had only one insurance specialist on staff — and this despite the fact that it was the primary regulator for the world’s largest insurer!

Finally, Taibbi described how the guy in charge of overseeing AIG concluded the CDS were harmless–solely on AIG’s say-so.

When AIG finally blew up, the OTS regulator ostensibly in charge of overseeing the insurance giant — a guy named C.K. Lee — basically admitted that he had blown it. His mistake, Lee said, was that he believed all those credit swaps in Cassano’s portfolio were "fairly benign products." Why? Because the company told him so. "The judgment the company was making was that there was no big credit risk," he explained. (Lee now works as Midwest region director of the OTS; the agency declined to make him available for an interview.)

See, Ben Bernanke could have offered Congressman Baca a very simple answer: 1999. But if he did so, he’d have to admit that the answer to "when was it broken" is "when Phil Gramm and friends deregulated everything." And for some reason, Bernanke didn’t want to give such a clear answer. 

39 replies
  1. bobschacht says:

    Right on! We need Congressional hearings on repealing the Commodity Futures Modernization Act (which ought to be labeled the Commodity Futures Scam-enabling Act) and the Gramm-Leach-Bliley Financial Services Modernization Act, which repealed Glass-Steagall.

    BTW, I think 1999 is the date for the latter act; the CFMA was in 2000, if Wikipedia is correct.

    Bob in HI

    • prostratedragon says:

      I think 1999 is the date for the latter act; the CFMA was in 2000, if Wikipedia is correct.

      It is. Just before Xmas recess, as I recall. Since nothing else matters if you can’t pass the stuff off, I think of it as the lynchpin of the whole scheme.

      • readerOfTeaLeaves says:

        I use Wikipedia a ton because I’m lazy and don’t have to leave the keyboard to locate info; however, do not count on its accuracy all the time — particularly with respect to political topics and financial topics.

        IIRC, just when Palin was announced, EW reported the number of very recent changes to Palin’s Wikipedia page, and it was astounding — someone had been working furiously to clean up her info at the last minute.

        I use it a ton, but ‘let the reader beware.’

        • PJEvans says:

          I’d say, when using it, also check the change history page. (Most of Wikipedia is probably safe.)

    • readerOfTeaLeaves says:

      But if he did so, he’d have to admit that the answer to “when was it broken” is “when Phil Gramm and friends deregulated everything.” And for some reason, Bernanke didn’t want to give such a clear answer.

      Maybe Bernanke doesn’t want to antagonize Congressional votes? Otherwise, I’m hard pressed at this point to understand why he hasn’t told Wall Street to take a flying f*ck at a rolling donut.

      At this point, I’d like to see Eliot Spitzer as a fully deputized (by an Act of Congress) Special Investigator.

      This looks to me like we’re observing a Death Match, in which Wall Street has already won most of the rounds against Congress and D.C.

      I sorely wish Bernanke would say, “Game on!”

  2. LabDancer says:

    Isn’t this pretty much part of the same bolt of cloth as avoiding admitting to Plan N as the back-up?

    And until Geithner-san is able to recruit a bunch of anti-Addingtons to create a new regulatory regime, isn’t Ben perfectly aware the system is every bit as vulnerable to Gramm’s Gambit today as at any time since Paulsen talked the SEC into putting the banksters on the honor system back in 2003.

  3. Hmmm says:

    Ordinarily I’m loathe to suggest playing politics when such serious issues are on the table, but I can’t help noticing that there really is a golden opportunity here to pin the entire poop-pile on the Rs. Clenis’ past complicity notwithstanding.

  4. chetnolian says:

    “AIGFP — a London-based subsidiary of an American insurance company — ought to have been regulated by one of Europe’s more stringent regulators, like Britain’s Financial Services Authority.”

    The FSA stringent? Oh if only…. Read up on Royal Bank of Scotland.

  5. ezdidit says:

    Damn straight – glad to see we read the same opp. You ought to re-read Huffington yesterday on Geithner:

    It was painful to watch Obama, just hours after Geithner had admitted his role in the Dodd/bonus loophole affair, go on Jay Leno and say that Geithner is doing an “outstanding job.” Even before Frank Rich’s Sunday column was titled “Has a ‘Katrina Moment’ Arrived?,” Obama’s assessment had more than a whiff of Bush telling Brownie he was “doing a heck of a job.”

    My dictionary defines outstanding as “excellent, exceptional, superior to others in the same category.” So how could Obama say that and then, not a minute later, tell Leno that his administration plans to “open up separate credit lines outside of banks for small businesses” and “set up a securitized market for student loans and auto loans outside of the banking system” in order to “get credit flowing again”?

    Back in January, after the Senate voted to release the second $350 billion tranche of TARP money, Obama had told the nation that he was “gratified” he’d been given the authority to “maintain the flow of credit to families and businesses.”

    Now, here he was, just over two months later, basically admitting that we have to find other ways to “maintain the flow of credit to families and businesses” — completely contradicting a central tenet of the bank bailout, expressed by Axelrod in January when he told George Stephanopoulos that the president was “going to have a strong message for the bankers. We want to see credit flowing again. We don’t want them to sit on any money that they get from taxpayers… And we have to make sure that the money doesn’t go to excessive CEO pay and dividends when it should be going to lending.”

  6. randiego says:

    OT: Some pull-quotes from Obamas “Global Editorial” today:

    …Our leadership is grounded in a simple premise: We will lift the American economy out of crisis and reform our regulatory structure, and these actions will be strengthened by complementary action abroad…

    We are working aggressively to stabilize our financial system. This includes an honest assessment of the balance sheets of major banks, and will lead directly to lending that can help Americans purchase goods, stay in their homes and grow businesses.

    …While these actions can help get us out of crisis, we cannot settle for a return to the status quo. We must put an end to the reckless speculation and spending beyond our means, and to the bad credit, overleveraged banks and absence of oversight that condemns us to bubbles that inevitably bust…

    All of our financial institutions—on Wall Street and around the globe—need strong oversight and common sense rules of the road. All markets should have standards for stability and a mechanism for disclosure. A strong framework of capital requirements should protect against future crises. We must crack down on offshore tax havens and money laundering. Rigorous transparency and accountability must check abuse, and the days of out-of-control compensation must end…

    I heard him use words to this effect last week somewhere.. 60 Minutes I think. He’s saying it loud, and he’s repeating himself.

    I’m seeing this as a softening of the ground, to let Wall Street know in no uncertain terms what is coming. We’ll need to be holding him to it.

    I believe that he means it when he says he’s going re-regulate. I am hopeful that is the case. I realize that’s not a very popular position (trust in Obama) around these parts recently, and for good reason, but that’s where I’m at.

    • BayStateLibrul says:

      I’m with you on this.
      It seems that Obama has been beated up lately.
      When this happens, I immediatley go for the underdog.
      He’s not perfect, but without Bush, I’ve been a constant state of

      • BayStateLibrul says:

        beated = beaten
        “I’ve been a constant state of euphoria” should be “in a constant state of euphoria”
        and I think I’ve had too much wine….
        did I misspell immediately…

      • randiego says:

        The screeching over Obama after 60 days drives me absolutely insane. I’m not talking about healthy criticism, I’m talking about other stuff… it’s like we forget what we went through…

    • readerOfTeaLeaves says:

      I’m seeing this as a softening of the ground, to let Wall Street know in no uncertain terms what is coming. We’ll need to be holding him to it.

      I think that Wall Street and the banksters have been holding him up, and holding the other democratically elected EU leaders up. They should realize that the global finance Ferenghi’s don’t give a rat’s ass about any nation, nation state, nor specific culture.

      Robert Reich’s ‘Supercapitalism’ takes on this whole topic better than anything else that I’ve read, by kind of getting inside the logic of global finance and following it through it’s ‘life cycle phases’ so to speak.

      I really think this is a period in which either Global Finance is going to run the world quite openly (and cruelly, and amorally) or else the democracies are going to have to root out 30 years of bad policies and outdated processes and really fundamentally restructure.

      Quite a moment in history, as far as I can tell.

  7. prostratedragon says:

    From CFTC:

    For your convenience, we provide the text [PDF] of the Commodity Futures Modernization Act of 2000 (Appendix E of P.L.106-554, 114 Stat. 2763).

    Somewhere I’ve run more than once up on the lore that the bill was a 200-page slip-in on the literal eve of a major adjournment; pretty sure it was Christmas and the cover date on the Bill supports, but that’s more tracking down than I’m doing at this moment.

  8. bobschacht says:

    First, he talked about Glass-Steagall (passed in 1999), that made it possible for insurance companies to dress up as trading firms.

    A-a-ack! No-no-no EW!!! What we got in 1999 was the Gramm-Leach-Bliley Financial Services Modernization Act, which repealed Glass-Steagall!!! Sheesh, did my comment @2 mislead you?

    Bob in HI

      • bobschacht says:

        Better, yes. Apologies for jumping up and screaming; after reading your stuff for 2 years, this is the first time I’ve actually had a chance to “correct” you. Thanks for all the great stuff you write– I look here first thing every morning.

        Bob in HI

  9. emptywheel says:


    Seriously, thanks for the correction. I need that kind of help.

    I get very buried in stuff I’m doing and when I’m trying to load up a bunch of stuff at once, I don’t see straight. Fairly often, too.

    • selise says:

      How many trillions must a federal employee lose before they are fired?

      so long as larry summers still has his job, there is no upper bound that i can see.

      • allan says:

        $40 million (the cost to Harvard of the Andrei Schleifer disaster), $40 billion,
        pretty soon you’re talking about real money.
        When you’re the smartest person in the room, “personal responsibility” in not in your vocabulary.

      • Sparkatus says:

        Indeed…and utterly appropriate to bring him up on this thread. Summers and Rubin (and Clinton) put the brakes on the CFTC effort to regulate CDSs. Good work Larry.

        Exactly WTF was Obama thinking putting that guy in charge when we are reaping what was sown then?

  10. SanderO says:

    I had to listen to my soon to be ex boss rant for the right in a 45 minute car ride… alone. YIKES. Rarely do I get to here how a small biz owner feels. He hates unions although his father was a union leader in the ILGWU and has run a union shop before (not now). He is a catholic and told me that the admin is passing laws forcing catholic owned hospitals (in NYC) to perform abortions or else they licenses will be revoked. He insists that people on welfare get all the taxes the rich pay and are about to get more when they tax anyone with more than $250K income (him). He likens the increased burden of taxes for the well off as communism and wealth distribution from the rich who earned it to the poor who do nothing but take. He is outraged that AIG execs are / were intimidated by “protesters” and thought that they were under attack and that was unamerican. He was fuming at what Obi is doing and he’s not seeing work coming his was as people have pulled back on their “luxury contruction” spending. The increased taxes is drying up the money spent in HIS work. YIKES. I sat there and listened to his rant. Oh and he said they want to take his hunting guns away from him too.

    What I find amazing is that this is an intelligent man who doesn’t get it and is armed with all sorts of falsehoods which he believes are facts. He saw the Crucible over the weekend and it made him thing that the AIG execs (one is a friend of his) are like the witches of Salem. YIKES.

    This sort of ignorance is probably widespread. When things go bad he blames it on the left and the poor, the unions who are in power now.

    That was a most depressing trip.

  11. selise says:

    Gramm pushed through the Commodity Futures Modernization Act (in 2000), which made it impossible to regulate CDS.

    emptywheel – it wasn’t just gramm who pushed through the CFMA. in fact, i think it would have been passed just fine without him because of the pushing the clinton administration was doing.

  12. PJEvans says:

    the global finance Ferenghi’s don’t give a rat’s ass about any nation, nation state, nor specific culture.

    Ooh, nice analogy! (Ferenghi will sell their mothers, if you make them a good offer. Also their sisters, their cousins, and their aunts.)

  13. MarkH says:

    The curious thing about the political argument that less regulation is good and doesn’t lead to disasters is that it’s somewhat akin to the argument that “deficits don’t matter”. Republicans wanted less regulation, so their buddies could run amok and yet they wanted large debt and deficits to tie the hands of Democrats who want health care reform and the like.

    Less regulation led to disaster, though broader world trade can be good.
    More debt and deficits is very bad, but Dems can now show health care reform as a solution.

    Similarly, they say health care reform is socialistic and bad, but when large companies like GM say they NEED health care reform to compete, then the argument is won by Dems.

    There isn’t yet the same kind of public understanding of EFCA. Far too many people don’t understand their own nation’s past use of unions for the public good.

  14. timtimes says:

    The political criminals retire in comfort, having achieved immunity from even the horrendous crimes of illegal war and torture.

    The economic criminals get bonuses instead of jail cells.

    In the final analysis, the Republican thieves stole so much we’re really screwed no matter what. See America’s future in the new hit movie Slumdog Millionaire.


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