In all the recent brouhaha over American International Group, very few have pointed out that AIG is not just an insurance company but also a thrift holding company. AIG first emerged from an insurance agency established in Shanghai, China, in 1919. It moved its headquarters to New York in 1949 with the rise of Mao, and soon expanded internationally. The company went public in 1969, but the critical date is December 1999, when AIG chartered AIG Federal Savings Bank in Wilmington, Delaware. It subsequently acquired other thrifts, such as Wilmington Finance, Inc., and American General Finance.

This put AIG under the regulatory umbrella of the Office of Thrift Supervision (OTS). The Federal Reserve has regulated all multi-bank holding companies since passage of the Bank Holding Company Act of 1956 and all single-bank holding companies after the act was amended in 1970, whereas the Office of the Comptroller of the Currency (OCC) regulates all nationally chartered banks. After the S&L crisis, when OTS was set up in the Treasury Department alongside OCC to give thrifts a parallel regulatory structure, OTS became the regulator of all nationally chartered thrifts. But in one of the many byzantine inconsistencies in U.S. regulations, thrift holding companies also fall under OTS rather than the Fed. And many of the other early failures in the current financial crisis were of OTS regulated institutions, providing an intriguing historical link to the S&L crisis.

But more important, the fact that AIG was a thrift holding company meant that several of its subsidiaries were, of course, receiving the deposit-insurance subsidy. I have frequently suggested (here and here) that deposit insurance has played a bigger role in causing the current crisis than is generally acknowledged, and this just reinforces my suspicion. Not only might the moral hazard from leaking deposit insurance have encouraged excessive risk taking on the part of AIG itself. But this is probably one reason that AIG's counterparties put so much confidence in its credit default swaps.

Although neither bank nor thrift holding companies qualifies for deposit insurance directly, the FDIC or Fed had often bailed them out along with their depository subsidiaries prior to the current crisis. Thus, when Continental Illinois National Bank and Trust Company was essentially nationalized after its failure in 1984, the regulators covered the holding company's debt as well. (On the other hand, when Charles Keating's Lincoln Savings and Loan finally went under in 1989, the government chose not to reimburse the bondholders of Lincoln's holding company, American Continental Corporation, but that was before the creation of OTS.) Then in 1998, when Alan Greenspan came to the rescue of Long Term Capital Management, which was neither a depository nor a depository holding company, but merely a private, unregulated hedge fund, he inevitably reinforced the impression that more regulated bank and thrift holding companies were protected.

Bear in mind that the swap contracts AIG wrote were over-the-counter derivatives in which AIG agreed to provide additional collateral both if the insured securities looked more likely to default or if the financial condition of AIG itself weakened. Thus, after AIG's credit rating was downgraded in September of 2008, the necessity to post further collateral provoked a liquidity squeeze that led to the first Fed intervention. As James Hamilton recently put it at Econbrowser:"Could AIG's counterparties have been thinking that their payments would come not from AIG but from the Federal Reserve and taxpayers? . . . To the extent that the buyer and seller of the CDS were making a bet for which the taxpayers were implicitly picking up the downside, the CDS market, rather than helping institutions effectively manage risk, would have been a factor directly aggravating systemic risk." For useful details about AIG, check out this report from the Congressional Research Service.