The Office of Thrift Supervision took responsibility for its failure
as AIG’s primary regulator to prevent the company’s accumulation of
extreme risk in the years before its collapse.   

As CQ reports:

“It’s time for the OTS to raise their hand and say they
have some responsibility and accountability here,” acting Director
Scott M. Polakoff said at a Senate Banking, Housing and Urban Affairs
Committee hearing, part of a broader effort to overhaul financial
industry regulations this year.

…Polakoff said his office did not fully assess the extent to
which AIG’s complex financial instruments — including collateralized
debt obligation and credit default swaps — were susceptible to declines
in market value or downgrades in the credit ratings of the company. No
one anticipated the amount of funds that AIG would need to meet
collateral calls and cash demands on its credit default swaps once
rating agencies downgraded AIG in September, he said.

By the time AIG’s Financial Products division stopped selling the
securities in 2005, the toxic products already posed a significant risk
to the overall company. “We in 2004 should have taken an entirely
different approach than we wound up taking,” Polakoff said.

OTS became the primary regulator of AIG’s holding company after AIG
bought an S&L in the 90s. (An example of a company choosing its regulator – Look how well that turned out.) Even Treasury says it
was the financial regulators, not the insurance regulators (as some House members argued in a separate hearing going on as Polakoff testified), that failed
to keep AIG in check.

New York Insurance Chief Eric Dinallo made the same argument in his testimony, that you can read here.

Some have tried to use AIG’s problems as an argument for an optional
federal charter for insurance companies. I am open to a federal role in
regulating insurance and the non-insurance operations of large
financial services groups such as AIG. I have said as much in prior
testimony to other Congressional committees.

But an optional federal charter is the wrong lesson to learn from AIG for two very clear reasons.

One, when you permit companies to pick their regulator, you create
the opportunity for regulatory arbitrage. The whole purpose of
financial services regulation is to appropriately control risk. But
when you allow regulatory arbitrage, you increase risk. Because you
create the opportunity for a financial institution to select its
regulator based on who might be more lenient, who might have less
strict rules, who might demand less capital.

…Two, what happened at AIG demonstrates the strength and effectiveness of state insurance regulation, not the opposite.

The only reason that the federal rescue of AIG is possible is
because there are strong operating insurance companies that provide the
possibility that the federal government and taxpayers will be paid
back. And the reason why those insurance companies are strong is
because state regulation walled them off from non-related activities in
the holding company and at Financial Products.