Treasury’s Geithner, Fed’s Bernanke Testify on AIG, Need for Reform

U.S. Treasury Secretary Timothy Geithner told an angry Congress on Tuesday that he needs authority to step in to shut down troubled institutions like American International Group to avoid future government bailouts.

Geithner’s call for new authority to take over big non-bank financial companies that run amok was strongly supported by Federal Reserve Chairman Ben Bernanke, who told the same Congressional committee hearing that AIG was a poster-child for the need to update regulation.

“AIG highlights the urgent need for new resolution procedures for systemically important nonbank financial firms,” Bernanke said in prepared testimony to the House Committee on Financial Services.

The two were testifying in front of lawmakers still fuming over the payment of some $165 million in bonuses to AIG executives at a time when AIG had received around $180 billion from the government’s bailout funds.

Most of the problems at AIG, which ran a respected insurance operation worldwide, stemmed from activities of its London-based financial products division that was a counterparty on derivatives contracts to major financial institutions and other entities around the world.

“This division was an unregulated entity operating in unregulated markets,” Geithner said, which forced Treasury, the Fed Board in Washington and the New York Fed to step in with loans and support because its collapse could endanger the whole financial system.

“A disorderly failure of AIG risked deepening and prolonging the current recession,” Geithner said, adding the problem was that there currently was no legal mechanism for winding down a non-bank financial institution like AIG.

He said new legislative authority, which requires Congressional approval, was needed to allow the government to make loans to a troubled institution, buy its obligations, take over its liabilities or possibly take an ownership stake in it while it regains its footing.

The government would be able to act as a receiver and, in that capacity, gain sweeping powers like the right to sell or transfer assets of non-bank financial institutions that get in trouble, renegotiate contracts including with employees and stop contracts from being terminated if necessary.

It would act similarly in the case of non-banks to the way that the Federal Deposit Insurance Corp., a regulator, does with banks when it steps in to shut them down. The banks then are under under FDIC stewardship until they typically either reopen under new ownership or are taken over by other banks.

(Additional reporting by Alister Bull and David Lawder. Editing by Chizu Nomiyama)

Geithner’s written testimony can be found at:
http://www.house.gov/apps/list/hearing/financialsvcs_dem/statement_-_geithner032409.pdf

Bernanke’s writen testimony may be found at:
http://www.house.gov/apps/list/hearing/financialsvcs_dem/statement_-_bernanke032409.pdf

Topics AIG