william c dudley : oversight of the federal government's intervention at american international group testimony of mr william c dudley, president and chief executive officer of the federal reserve bank of new york, before the committee on financial services, us house of representatives, washington dc, 24 march 2009. * * * good morning, chairman frank, ranking member bachus, and other members of the committee. thank you for giving me the opportunity to appear before you today. as you know, on january 27, 2009, i became the president of the federal reserve bank of new york. before i assumed that position, i served as the head of the markets group at the new york fed. i appreciate having this opportunity to discuss the federal reserve bank of new york's involvement with american international group, inc. ( aig ). role of the federal reserve bank of new york at the outset, it is important to note that before the new york fed became involved with aig as a lender on september 16, 2008, the federal reserve lacked any kind of authority to oversee aig. the lack of effective consolidated supervision over aig was a critical contributing factor to the debacle that occurred at the company. the federal reserve made its decision to lend based on a judgment that a failure of aig would cause dramatically negative consequences for the financial system and the economy – consequences worse than what occurred in the aftermath of the failure of lehman brothers. we stand by that judgment today. in the case of lehman, some of the most severe repercussions related to the difficulties in coordinating cross - border insolvency regimes and in coordinating the insolvency regimes among different types of institutions within the organization's corporate structure. in light of aig's unparalleled global footprint – operating in more than 130 countries around the globe – and the multiplicity of different types of financial services entities within its structure – including insurance providers, foreign banks, consumer lending companies and otc derivatives affiliates – the factors that proved unmanageable in the lehman insolvency threatened to be much more severe in aig's case. the fact that no effective emergency resolution procedures exist under u. s. law to reconcile these difficulties heightened the need for quick, effective action by the federal reserve, in consultation with and supported by the u. s. treasury. from the outset, the new york fed has been sharply focused on addressing two overarching goals with respect to aig : ( 1 )

it has been widely adopted in a number of fields and proven to be successful. the tool however is a double edged knife and the financial sector has vindicated such a conviction. 5. one of the causes of the subprime bubble is the pay structure adopted by financial institutions in launching subprime products. during the subprime cycle, most financial institutions pursued a compensation scheme which gave incentives to all personnel involved in the subprime products to chase after high income through risky trading, launching risky products that generally provided higher rates of return. bonus payments for successful and senior investment bankers, including those in the business holding subprime positions, were very substantial. essentially, bonuses were measured against gross revenue after personnel costs, with no formal account taken of the quality or sustainability of those earnings. we have to admit that greed is part of our human nature. in the face of profit, quality of product and hence the revenue derived therefrom could be compromised. the phenomenon was common among institutions and staff involved in the subprime trade, from top management, originators, agents to traders. 6. all enterprises, not confined to financial institutions, should learn from this lesson that, to maintain the sustainable growth of an entity, all compensation schemes should in future adequately reflect performance in the medium and long term as well. as a matter of fact, the compensation schemes for staff involved in the subprime bubble all had a common feature in that there were enormous rewards for deals but there was also a failure to impose penalty symmetrically when losses occurred. to put it in a nutshell, a viable compensation scheme should be well structured and be geared to the long term corporate target and strategy rather than short term profit. 7. i hope my opening remarks on risk management and compensation management will kick off a series of discussions on management of other facets of business. experts and seasoned practitioners from different trades are going to share with us their views, experience and insights to resonate with today ’ s theme “ navigating complex challenges through corporate strategies ”. i am sure the conclusions of this conference will enable the attendees to formulate the correct corporate strategies to navigate through uncharted waters of the contemporary global economy. finally, please accept my best wishes for a huge success of this visionary conference. thank you.