Corporate Governance

The Government Bailout of AIG and the Failure of a Theory of Regulation

By J. Robert Brown

When Secretary of Treasury Paulson entered office, he was on a mission to scale back regulation.  It was only a little over a year ago that he criticized the existing regulatory framework as having gone too far and, indeed, indicated that the administration was considering "a more business-friendly approach to regulation."   And, in addition to reducing the regulatory burden, he wanted to restrict shareholder lawsuits.  As John Holcomb wrote on this Blog:

• Treasury Secretary Henry Paulson has expressed continuing fears about the impact of regulation on the capital markets and instigated the formation of a Committee on Capital Markets Regulation, with leading corporate CEOs as members. The Committee has called for limits on the liability of accounting firms, targeting of individual executives rather than firms for prosecution, and the scaling back of shareholder lawsuits.
  

He likewise didn't care for at least some aspects of SOX, having formed a panel to look into the "problem" of too many restatements.  In other words, he was antagonistic towards regulation, targeted the areas that were mostly designed to protect shareholders and investors, had an inflated view of the power of the market to correct all evils with government (and plaintiffs) best kept out of the process. 

With this in mind, we consider the extraordinary steps taken by Paulson with respect to AIG.  The deal involved an $85 billion loanand the acquisition by the federal government in return for a 79.9% ownership interest in the form of warrants called equity participation notes.  His anti-regulatory philosophy has been entirely jettisoned.  How big is AIG?  Big.  At the end of 2007, it was the 23rd largest company in the Fortune Global 500.  As for insurance business, the "holding company with its scores of subsidiaries is the second-largest insurer in the United States in direct written premium and the largest in the world when measured by its approximately $1 trillion in assets."  

There are a myriad of questions that the transaction raises.  Does government ownership mean an implicit guarantee of AIG's business, giving the company an unfair advantage in the private insurance markets?  Will the federal government exercise effective control and oversight over the board of directors?  But mostly what is shows is that Paulson's judgment when it comes to regulatory reform is not to be trusted.  This is also true with the attempt to "reform" the securities markets through additional restrictions on shareholder litigation, a theme recently reiterated by the Chamber of Commerce.  The views deserve the same weight as Paulson's earlier positions on the need for regulatory reform.

Full post as published by The Race to the Bottom on September 17, 2008 (boomark / email).