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Treasury Admits It Could Have Stopped AIG Years Ago

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The idea that deregulation caused the housing and stock market bubbles that popped so explosively has, in some quarters, become an article of faith.

New York Times columnist Paul Krugman says that former Sen. Phil Gramm is a "fervent advocate of financial deregulation" who, with Alan Greenspan, made "this crisis possible." The Huffington Post quoted Harvard University economist Richard Freeman as saying a "deregulation economy doesn't produce growth, it produces disaster." Notorious pessimist Nouriel Roubini and French President Nicolas Sarkozy have offered similar complaints.

But Wednesday's hearing in the U.S. House of Representatives tells a slightly different story. The hearing was titled "American International Group's Impact on the Global Economy: Before, During, and After Federal Intervention," and featured as a witness Scott Polakoff, the acting director of the Treasury Department's Office of Thrift Supervision.

Polakoff's testimony admitted that OTS "focused too narrowly" in some areas of AIG's business, and neglected others. It "did not foresee" how risky credit default swaps would be, he said, and "relied too heavily" on history to judge future risks. (OTS's official mission is "to supervise" certain financial services companies "to maintain their safety and soundness.")

In short, Polakoff seemed to be indicating that the career civil servants at OTS had the expertise, manpower, and regulatory authority during the Bush administration to rein in AIG -- before it engaged in excesses that led to a taxpayer-funded bailout that's $170 billion and growing. If true, that would be an astonishingly expensive example of yet another regulatory failure.

Later in the hearing, Rep. Jeb Hensarling, a Texas Republican, pressed for more details. In the following exchange (which PowerLineBlog.com also noted), Polakoff conceded the Treasury Department made "a mistake."

Keep reading for an excerpt from the transcript:

HENSARLING: I believe I heard in an earlier answer to one of the questions, I believe I heard you say that OTS in 2004 should have stopped the book of business that I think you were alluding to to CDS and the AIG securities lending commitments. Did I understand you correctly?

POLAKOFF: Yes, sir.

HENSARLING: So if you said you should have stopped it in 2004, that implies you could have stopped it in 2004. Is that correct?

POLAKOFF: Yes, sir.

HENSARLING: So there were not limits on your power. Perhaps, there were limits on your knowledge or insight, but there was not limits on your power to stop what you cite, as I believe AIG's liquidity -- I'm reading from your testimony -- was the result of AIG's business lines.

So you did have the power to stop those business lines. Is that correct?

POLAKOFF: Yes, sir.

HENSARLING: I read on your Web site that, quote, OTS has supervisory and enforcement authority over the entire corporate structure. The scope of this authority includes the savings association, its holding company, and other affiliates and subsidiaries of the savings association.

I continue to quote, These supervisory tools allow OTS to obtain a complete picture of the interrelationship and risks throughout the savings and loan holding company enterprise regardless of its size and complexity.

Again, it appears, if this is correct, it was not a lack of supervisory authority that caused you not to take action with respect to these two lines. Is that correct?

POLAKOFF: Yes, sir.

HENSARLING: And I think I also heard you say in your testimony that you did not have sufficient* manpower and expertise. Is that correct?

POLAKOFF: Yes, sir.

HENSARLING: So, again, in retrospect, it wasn't the lack of authority. It wasn't the lack of resources. It wasn't the lack of expertise. You just flat made a mistake. Is that a correct assessment?

POLAKOFF: In 2004, we failed to assess how bad the mortgage economy, the real estate economy would become in 2008. Yes, sir.

HENSARLING: I see my time is expired.

* This appears to be a misstatement or transcription error; Hensarling probably said or meant "insufficient."

Declan McCullagh writes about economics and politics for CBS News' EconWatch and writes a weekly column called Other People's Money. His email address is declan.mccullagh@cnet.com.

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