Senators Doubt Fed Could Regulate Systemic Risk

WASHINGTON — As the House Financial Services Committee met Thursday to discuss the creation of a systemic risk regulator, Senate Banking Committee members were questioning the mettle of the main candidate for the job, the Federal Reserve Board.

Senators openly doubted whether American International Group Inc., which has received four government bailouts so far, ever poised a systemic risk to the economy, and they asked if the central bank made a mistake in providing the company with assistance.

It seems as if the Fed led the government to make a "large blunder — the largest in modern history," according to Sen. Bob Corker, R-Tenn.

"I have a hard time understanding the systemic risk issue," Corker said at a hearing on the AIG bailouts.

Senate Banking Committee Chairman Christopher Dodd, D-Conn., said regulators would have to do a better job explaining how and why they rescued AIG.

"Public confidence in what we're doing is at stake," he said.

Sen. Richard Shelby of Alabama, the No. 1 Republican on the panel, warned that AIG would need more assistance. "You're going to be coming back for more money and more money and more money, and people don't understand what you're doing with it." Shelby told Fed Vice Chairman Donald Kohn. "Your answer may be the Federal Reserve's answer, but it's not the answer we're going to accept."

Corker grilled Kohn on what would have happened if the Fed had simply guaranteed any potential counterparty losses at AIG, instead of extending an $85 billion line of credit to the company Sept. 16 to help it meet its increasing collateral obligations.

Kohn responded that the guarantees would not have been dramatic enough, and that the only power the Fed had at the time was the authority to lend.

In questioning that cut across party lines, lawmakers showed that they clearly lacked confidence in the Fed's decision.

"We keep hearing that AIG is a systemic risk," said Sen. Robert Menendez, D-N.J. "Well, even systemic risk has to be quantifiable. … What is the quantifiable risk here? Particularly, in your minds, in the worst-case scenario, what are AIG's assets really worth — or do you even know?"

Kohn replied, "I don't have a calculation of a severe stress kind of scenario, what AIG's assets would be worth in those situations."

The answer did not satisfy Menendez. "How can you keep coming back and asking for monies in which you cannot quantify for us the systemic risk and the assets here?" he asked.

Kohn shared the witness table with two other regulators, Acting Office of Thrift Supervision Director Scott Polakoff and New York Insurance Superintendent Eric Dinallo, who were also criticized for not doing enough to stop AIG's collapse.

But even Dinallo suggested that AIG did not pose a systemic threat to the system — a claim that Kohn denied. "There would have been solvency" in AIG's insurance companies "with or without the Federal Reserve's intervention," Dinallo said.

Kohn responded, "I'm not sure I agree with Mr. Dinallo's assessment."

The three witnesses agreed about the need for more general oversight of large financial firms. During their testimony, they called for the creation of a separate regulator for systemic risk.

Some regulators even acknowledged making mistakes in overseeing AIG.

Polakoff said that even though the OTS had the authority to oversee the activities of an AIG subsidiary that others had said was technically unregulated, the agency failed to exercise its authority properly. "We were clearly responsible, as the consolidated regulator" for Financial Products, the business that witnesses said caused many of the problems that led to a bailout for the company. "We, in 2004, should have taken an entirely different approach than what we wound up taking regarding the credit default swaps," he said.

Kohn said the episode was proof that a regulator was needed that could look at the entire operation.

"What we have learned over the last 18 months is that the focus of the systemic risk regulator needs to be much wider," Kohn said.

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