Geithner Says AIG, Monoline Insurers 'Most Damaging Examples' in Derivatives Fallout

Treasury Secretary Tim Geithner momentarily touched on the insurance industry as he spoked to Congress about over-the-counter derivatives and proposed reforms of the U.S. financial system.

"Under our existing regulatory system, some types of financial institutions were allowed to sell large amounts of protection against certain risks without adequate capital to back those commitments. The most conspicuous and most damaging examples of this were the monoline insurance companies and [American International Group Inc.]," Geithner said.

He testified that they sold "huge amounts of credit protection on mortgage-backed securities and other more complex real estate-related securities without the capacity to meet their obligations in an economic downturn."

Geithner contended the Obama administration's proposed reforms "would substantially alter the ability of financial institutions to choose their regulator, to shape the content of future regulation and to continue the financial practices that were lucrative for parts of the industry for a time but that ultimately proved so damaging. But this is why we have to act and why we need to deliver very substantial change."

Under the Obama plan, the role of the Federal Reserve as regulator of the largest U.S. banks would be expanded to cover insurance companies and other financial firms that could pose a systemic risk due to a combination of size, leverage and interconnectedness. It would have the authority to set capital, liquidity and other requirements, including mandatory set-asides of additional reserves. Additional steps will regulate credit default swaps and other derivatives (BestWire, June 17, 2009).

AIG  was nearly driven into bankruptcy in September by bad bets on credit derivatives by its Financial Products unit, and has survived under a federal rescue program that has grown to $182.5 billion in loans and other assistance (BestWire, June 30, 2009).

Most AIG insurance companies currently have current Best's Financial Strength Ratings of A (Excellent).

(Jesse A. Hamilton, Washington bureau manager: Jesse.Hamilton@ambest.com)