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Oversight of the Federal Government's Intervention at American International Group
|March 24, 2009|
William C. Dudley, President and Chief Executive Officer
Testimony before the Committee on Financial Services, U.S. House of Representatives
Good morning, Chairman Frank, Ranking Member Bachus, and other members of the Committee. Thank you for giving me the opportunity to appear before you today. As you know, on January 27, 2009, I became the president of the Federal Reserve Bank of New York. Before I assumed that position, I served as the head of the Markets Group at the New York Fed. I appreciate having this opportunity to discuss the Federal Reserve Bank of New York's involvement with American International Group, Inc. (AIG).
Role of the Federal Reserve Bank of New York
The Federal Reserve made its decision to lend based on a judgment that a failure of AIG would cause dramatically negative consequences for the financial system and the
From the outset, the New York Fed has been sharply focused on addressing two overarching goals with respect to AIG: (1) the stabilization of the company so that it no longer poses a disruptive threat to our financial system and economy and (2) obtaining full repayment of the government funds that have been extended to AIG. In light of the exceptional size and scope of AIG's operations, with over 110,000 employees in more than 130 countries, spanning hundreds of legal entities, it was clear from the beginning that the New York Fed—which had never been engaged in any regulatory oversight of the company—was not in a position to exert day-to-day management control over the company. Rather, the New York Fed's actions have consistently been directed at securing its objectives as lender. As any lender in our position would do, the New York Fed has put into place a loan agreement that contains covenants designed to help ensure ultimate repayment of the loan—but these creditor's rights do not create an ability to manage AIG.
Responsibility for AIG's day-to-day affairs continues to rest with AIG's chief executive officer, Edward Liddy, under the oversight of AIG's board of directors. Mr. Liddy, who has only become involved with AIG in a public-spirited attempt to resolve its troubled affairs, has made strides in dealing with AIG's opaque corporate structure, lack of centralized controls and complex risk exposures, but much remains to be done.
In light of the inherent conflicts that would arise from either the U.S. government or the Federal Reserve exerting ownership control over the world's largest insurer, the Federal Reserve, with the support of the Treasury Department, directed in the loan agreement that an approximately 77.9 percent equity interest in AIG be issued to an independent trust established for the sole benefit of the United States Treasury. The trust, which now holds that controlling equity interest, is overseen by three independent trustees who are of the highest integrity and who have considerable experience leading major companies. These trustees have a legally binding obligation to exercise all of their rights as majority owner of AIG in the best interests of the U.S. taxpayer, with the proceeds of any ultimate sale of shares going directly to the Treasury of the United States.
Efforts to Reduce Risk at AIG Financial Products
With respect to the retention awards owed to FP employees under their pre-existing contracts, we believe that Mr. Liddy weighed a number of factors in deciding not to attempt to prevent payment, including:
In conducting our oversight as lender, the New York Fed did not see reason to disagree with Mr. Liddy's judgment from a risk perspective. Equally important, we did not think it was legally permissible—or within the proper role of the New York Fed—to attempt to substitute our judgment for that of Mr. Liddy in this circumstance, even though we found the payment of the retention awards extremely distasteful.
The broad public disapproval of sizeable retention payments being directed toward the unit most responsible for last fall's downfall of AIG is understandable. Americans naturally feel outraged when confronted with news of such payments to an entity that worsened the financial crisis and that is dependent on taxpayer funds to stay out of bankruptcy court where these contracts would not have been fully honored. Moreover, the payments occurred during a time when so many Americans are struggling to find jobs, seeing their wages reduced or watching their retirement savings plummet as a result of a crisis they had no hand in creating. This feeling of outrage underscores the urgent need to reform the system of compensation at our financial institutions to more closely align the incentives of executives, owners and taxpayers. Congress saw fit to impose appropriate compensation restrictions on recipients of Troubled Asset Relief Program (TARP) funding, and we think it is crucial for Congress and the U.S. Department of the Treasury to continue to craft effective and sensible policies in this area.
Although oversight of TARP-related compensation matters rests with the Treasury Department, the New York Fed has played a role since September in reviewing the adequacy of AIG's corporate governance procedures. This review has helped to identify longstanding deficiencies with respect to compensation committee governance, compensation benchmarking and lack of centralized control over compensation policy. We will continue to work with our colleagues at Treasury and the independent trustees to ensure that AIG's management properly addresses these deficiencies.
Ongoing Involvement with AIG
In all that we have done, we have been motivated by two goals: to preserve the stability of the U.S. economy and to protect the U.S. taxpayer. The threat of a major systemic risk event has been averted by honoring all of AIG's contractual obligations around the globe—from insurance policy obligations owed to individuals, municipalities and businesses across the U.S., to the posting of collateral under credit default swap arrangements with the full range of counterparties recently disclosed. As unattractive as certain aspects of this treatment may be, these negative aspects have followed unavoidably from the decision to avert a systemically destructive bankruptcy. I look forward to your questions today and, in the longer term, to working with you and your staffs on the broader public policy questions—such as formulation of a resolution regime for institutions like AIG and consideration of the appropriate supervisory structure for OTC derivatives—that are posed by the events at AIG.