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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

COMMISSION CONCLUSIONS ON CHAPTER 19
The Commission concludes AIG failed and was rescued by the government prima-
rily because its enormous sales of credit default swaps were made without putting
up initial collateral, setting aside capital reserves, or hedging its exposure—a pro-
found failure in corporate governance, particularly its risk management practices.
AIG’s failure was possible because of the sweeping deregulation of over-the-
counter (OTC) derivatives, including credit default swaps, which effectively elim-
inated federal and state regulation of these products, including capital and margin
requirements that would have lessened the likelihood of AIG’s failure. The OTC
derivatives market’s lack of transparency and of effective price discovery exacer-
bated the collateral disputes of AIG and Goldman Sachs and similar disputes be-
tween other derivatives counterparties. AIG engaged in regulatory arbitrage by
setting up a major business in this unregulated product, locating much of the
business in London, and selecting a weak federal regulator, the Office of Thrift
Supervision (OTS).
The OTS failed to effectively exercise its authority over AIG and its affiliates: it
lacked the capability to supervise an institution of the size and complexity of AIG,
did not recognize the risks inherent in AIG’s sales of credit default swaps, and did
not understand its responsibility to oversee the entire company, including AIG
Financial Products. Furthermore, because of the deregulation of OTC derivatives,
state insurance supervisors were barred from regulating AIG’s sale of credit de-
fault swaps even though they were similar in effect to insurance contracts. If they
had been regulated as insurance contracts, AIG would have been required to
maintain adequate capital reserves, would not have been able to enter into con-
tracts requiring the posting of collateral, and would not have been able to provide
default protection to speculators; thus AIG would have been prevented from act-
ing in such a risky manner.
AIG was so interconnected with many large commercial banks, investment
banks, and other financial institutions through counterparty credit relationships
on credit default swaps and other activities such as securities lending that its po-
tential failure created systemic risk. The government concluded AIG was too big
to fail and committed more than  billion to its rescue. Without the bailout,
AIG’s default and collapse could have brought down its counterparties, causing
cascading losses and collapses throughout the financial system.