Banking Law

Fed Bails Out AIG, Prompting Debate on Regulation

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In an about-face, the federal government has agreed to loan the American Insurance Group $85 billion in return for a nearly 80 percent ownership interest in the company, prompting debate about government bailouts and the need for regulations.

Additional regulations can mean more work for lawyers who will need to guide their clients through the regulatory thicket, the Daily Journal reports (sub. req.).

The Federal Reserve is using its emergency authority granted during the Great Depression, the Washington Post reports. It allows the Fed to lend money to individuals or corporations in unusual and exigent circumstances when funds are not available to the borrower in other ways. The first time the Fed used this power was in March when it bailed out Bear Stearns.

U.S. Rep. Barney Frank said Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke did not request any new authority for the bailout in meetings yesterday, the New York Times reports. “This is one more affirmation that the lack of regulation has caused serious problems,” he said. “The private market screwed itself up and they need the government to come help them unscrew it.”

The latest bailout could create a kind of conflict of interest for lawmakers who will be considering legislation to regulate the kind of financial transactions in which AIG participates, the Los Angeles Times reports. Some lawmakers are calling for greater regulation of investment banks and hedge funds that are not within the regulatory authority of the Federal Reserve and bank regulators, the Associated Press reports.

One idea suggested by Frank is to create a government entity similar to the Resolution Trust Corp. that oversaw the liquidation of assets of 747 thrifts, the Wall Street Journal reports (sub. req.).

An independent panel of academics sponsored by the American Enterprise Institute opposes new regulations for investment banks on the ground they could stifle innovation, reports. But the group, the Shadow Financial Regulatory Committee, said structures should be put in place to require the industry to bear the cost of any future bailouts.

The LA Times story tallies the money pledged in the recent government bailouts: $30 billion in backing for the Bear Stearns purchase, up to $200 billion to buy preferred stock in Fannie Mae and Freddie Mac, and now the $85 billion loan to AIG. The decision about which entities need to be rescued appears to be based on whether they are too big to fail, the story says. But there also appears to be an assessment about whether the failure of an institution would pose a “systemic risk” to the financial system.

Washington University law professor Cheryl Block criticized the lack of guidelines. “We don’t have any rules about whether the government should get involved or not,” she told the Los Angeles Times. “Certain things happen in the middle of the night, and no one knows who’s in the meeting.”

Critics contend the government’s actions will encourage excessive risk-taking. But Northwestern emeritus law professor David Ruder, a former chairman of the Securities and Exchange Commission, said an AIG failure would have posed an economic risk greater than the 1987 stock crash, the Chicago Tribune reports. “If the credit markets fail, no one will lend money to anybody, and the system won’t work.”

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