New York (HedgeCo.Net) -   After handing AIG another $30 billion in taxpayer-funded, government bailout funds, U.S. Federal Reserve Chairman Ben Bernanke defended the decision, with the worn-out argument that the insurer’s failure may trigger an economic domino effect.

“We know that failure of major financial firms in a financial crisis can be disastrous for the economy,” Bernanke said in a testimony to the senate Budget Committee on Tuesday.  “We really had no choice.”

So far, the government has come to AIG’s rescue four different times, pumping over $160 billion into the insurance giant.  In an attempt to appease furious lawmakers who disagree with the latest handout, Bernanke said, "If there’s a single episode in this entire 18 months that has made me more angry, I can’t think of one (other than) AIG."

AIG reported an industry wide record $61.7 billion quarterly loss this week, attributing that to losses on their credit default swaps; worthless pieces of paper that “guarantee” mortgage-backed securities.    AIG sold these credit default swaps, which supposedly insured about $440 billion in bonds.  In reality, AIG did not have the funds to cover these investments.  When the securities inevitably plummeted in value, AIG couldn’t cover what they promised.  Unfortunately, credit default swaps, which were invented in the late 90’s by several employees at J.P. Morgan Chase as a means to make quick cash, are not regulated by the U.S. government. 

Many feel AIG has acted irresponsible, and that no amount of government funds will turn the poorly run business around.  AIG even “cleverly attached a hedge fund to their insurance company, taking advantage of a gap in federal and state oversight,” Bernanke added.

In exchange for the funds, the government will receive $26 billion in preferred stock in two AIG subsidiaries – American Life Insurance Co. and American International Assurance Co.  AIG will not have to pay interest on the outstanding loan.

Julie Scuderi
Senior Editor for HedgeCo.Net
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Bloomberg – Federal Reserve Chairman Ben S. Bernanke said American International Group Inc. operated like a hedge fund and having to rescue the insurer made him “more angry” than any other episode during the financial crisis.

“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke told lawmakers today. “AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company.”

Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul. The U.S. government has had to deepen its commitment to prevent AIG’s collapse three times since September as the company accumulated the worst losses of any U.S. company.

The company “made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system,” Bernanke said. At the same time, officials “had no choice but to try and stabilize the system” by aiding the firm.

AIG is getting as much as $30 billion in new government capital and relaxed terms on its bailout announced yesterday.

In another sign of tighter regulation to come, Bernanke said supervisors should have authority to bar new financial products that may be destabilizing to markets.

Bernanke made the AIG comments in response to a question from Senator Ron Wyden, an Oregon Democrat, at a Senate Budget Committee hearing today in Washington.

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