AIG Questions

As the financial market crisis of 2008 has receded, there is considerable controversy about its causes and the actions the government took in response.

A slew of books have been hurried to print on the subject. That they have been written in a hurry shows. For example, Andrew Ross Sorkin, in his interesting book, Too Big to Fail, makes mistakes, such as incorrectly describing Washington, DC geography, stating that fiscal policy is decided in the Fed Board room, and confusing the relationship between the yields and prices of Treasury securities. The book also contains numerous typos, but still researchers for years will find the book interesting for the story it tells.

While Sorkin's book has been called too big to read by some, it is interesting. It is, though, true that it is nearly impossible to read all the books that have been produced. But as the attention and controversy has currently centered on AIG, I would like to suggest some questions and issues which could very usefully be addressed in one place.

● Some of AIG's counterparties were purchasing credit default swaps (CDS) in order to minimize their capital requirements. Because AIG had a AAA rating, banks could apparently reduce the capital needed to support their holding of collateralized debt obligations (CDOs). What proportion of AIGs derivatives business was for the purpose of minimizing its counterparties capital requirements? How much did AIG's activities in this area enable banks to increase their leverage?

● Were the federal banking regulators and the SEC aware of the concentration of risk at AIG, caused at least in part by incentives in capital rules? How much sharing of information concerning this was there within regulatory agencies, for example among bank examiners responsible for specific banks? Was this issue discussed among the various regulatory agencies?

● What was the motive for Goldman Sachs to enter into CDS’s with AIG? Was it capital, hedging, or something else?

● Goldman claims that the direct effect of a AIG failure would have been negligible on the firm. Apparently, it had offset it positions with AIG with other counterparties. (Of course, Goldman's hedges of its AIG positions may not have worked if its counterparties had been financially weakened in the fallout of an AIG bankruptcy.) How and with whom did Goldman hedge its credit exposure to AIG?

● Why was Goldman pushing as hard as it was for additional collateral from AIG, since this could push AIG into bankruptcy and cause systemic problems in the market and resulting financial pressure on Goldman itself? Was Goldman betting that some solution would be found by the Fed or the Treasury?

● Goldman reportedly told AIG that it should accept Goldman’s valuations of the CDO’s that AIG had effectively insured with CDS’s, because Goldman and AIG shared the same auditor, PricewaterhouseCoopers. How did PwC manage its role in this affair? What are the implications for auditing firms that get caught in valuation disputes among their clients?

● Were there any significant tax motivations underlying AIG’s derivatives transactions?

● What percentage of the securities that AIG effectively insured by selling CDS’s have defaulted?