You Can't Hedge Yourself
The sharp-eyed and highly intelligent Andrew Samwick writes:
Trouble Below the Surface at AIG | Capital Gains and Games: If you are going to regulate an industry, by all means, empower the regulators to intervene when sensible policies are violated. Mary Williams Walsh -- in my opinion one of the very best reporters working today -- has the story in yesterday's New York Times....
state regulatory filings... show that A.I.G.’s individual insurance companies have been doing an unusual volume of business with each other... investing in each other... borrowing from each other... guaranteeing each other... even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect.
A facade of regulation is worse than no regulation at all. How many examples of this will we have to observe before we learn our lesson?
And sends us to Mary Williams Walsh:
After Rescue, New Weakness Seen at A.I.G. - NYTimes.com: In the months since A.I.G. received its $182 billion rescue from the Treasury and the Federal Reserve, state insurance regulators have said repeatedly that its core insurance operations were sound — that the financial disaster was caused primarily by a small unit that dealt in exotic derivatives. But state regulatory filings offer a different picture. They show that A.I.G.’s individual insurance companies have been doing an unusual volume of business with each other for many years — investing in each other’s stocks; borrowing from each other’s investment portfolios; and guaranteeing each other’s insurance policies, even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect.
More ominously, many of A.I.G.’s insurance companies have reduced their own exposure by sending their risks to other companies, often under the same A.I.G. umbrella. Echoing state regulators’ statements, the company said the interdependency of its businesses posed no problem and strongly disputed that any units had obligations they could not pay. “There is absolutely no concern about the capital in these companies,” said Rob Schimek, the chief financial officer of A.I.G.’s property and casualty insurance business. The company authorized him to speak about these issues.
Nothing is wrong with spreading risks to other companies, a practice known as reinsurance, when it is carried out with unrelated, solvent companies. It can also be acceptable in small amounts between related companies. But A.I.G.’s companies have reinsured each other to such a large extent, experts say, that now billions of dollars worth of risks may have ended up at related companies that lack the means to cover them...
