I have just noticed this little snippet in a Financial Times blog:
“AIG, which could have single-handedly destroyed the global economy, was allowed to choose a small regulator in Delaware to regulate its trillion-dollar operations. No one in Washington batted an eyelid.”
Now I wrote at length about Delaware in Treasure Islands: a tiny jurisdiction where financial players could come around the table with a few in positions of power and hammer out new legislation quickly, operatinng essentially in a smoke-filled room closed to outsiders, and with no accountability to those, elsewhere affected by those laws. In fact, that is in a sense the whole point of offshore: to sever those lines of accountability, as I’ve explained several times before.
So what’s with Delaware and the calamity of AIG? I don’t think the FT quote above is quite right. But still, there is something to this story. I mentioned in Treasure Islands the the big black box that blew AIG up was a smallish office in the City of London, which had been set up specifically to escape financial controls elsewhere. (Regulatory escape has long been one of London’s selling points.) Federal Reserve Chairman Ben Bernanke called the London unit
“a hedge fund, basically, attached to a large and stable insurance company.”
(Read The Big Short to get a good handle of the madness in AIG’s derivatives game. In brief, people took risky gambles, then paid small premiums for insurance against things going bad; AIG was single-handedly and merrily writing a large chunk of those insurance premiums, and when things did turn bad, it went bust and had to turn to the U.S. taxpayer for a rescue.)
Now I have dug up a New York Times article from 2010, which reveals that its swaps business wasn’t just focused on this one London black hole. It had another unit, albeit of less systemic importance, in . . . . my old favourite regulatory black hole of Delaware. And they were all too happy to welcome this AIG unit, and not to check on any dangers:
“Insurance regulators said Delaware did not consider credit-default swaps to be insurance.
“I don’t think an insurance commissioner should tread on the toes of the banking industry,” said Karen Weldin Stewart, the commissioner in Delaware. “This started out as a bank product.”
And they came up with some dodgy reasoning for this reluctance to regulate: technically, these swaps look more like options than like insurance products. But of course the point of a regulator’s job should not be to assess merely the form of an instrument, but its substance. And in this case, the substance was a transfer of risk, like an insurance product.
It was still pretty small beer, when compared to the London black hole. But it all goes to underline the points I make in Treasure Islands, about Delaware and its like.
P.S. while looking at this story, I came across another Delaware AIG insurance story, from 2008, unrelated to this one. It’s by Lucy Komisar, and it’s fascinating. I hadn’t twigged this particular aspect of offshore captive insurance, and I guess I should have.
P.P.S. I wrote something else about U.S. state-level offshore shadow insurance industry a while back, which is also unrelated, and also fascinating and worrying.