Court Casts a New Light on a Bailout (AIG)
The New York Times
SEPT. 27, 2014
By GRETCHEN MORGENSON
“I think by the time we get finished with this case and we have our trial, we’re going to have the full picture on everything that occurred regarding the government’s rescue of A.I.G.,” said Thomas C. Wheeler, a federal judge. “Why did they do it the way they did here?”
With that remark made in a July hearing, Judge Wheeler got to the heart of a mortgage crisis dispute scheduled for trial in his Washington courtroom on Monday. The lawsuit contends that the United States’ bailout of the American International Group, the giant insurer that collapsed in mid-September 2008, was so punitive that it amounted to an improper taking of private property by the United States under the Fifth Amendment.
For its part, the government argues that A.I.G. entered into the arrangement voluntarily and that its shareholders benefited.
The case was filed in 2011 by Starr International — an insurer headed by Maurice R. Greenberg, former chief executive of A.I.G. — once A.I.G.’s largest shareholder. Starr is seeking $40 billion in damages.
Maurice R. GreenbergCredit Mark Lennihan/Associated Press
It may sound outrageous to argue that the government should pay $40 billion because it offered $182 billion in assistance to a company on the precipice. Shouldn’t the shareholders be grateful?
But the A.I.G. deal was, fundamentally, a rescue of A.I.G.’s trading partners. Those partners included the big banks whose toxic mortgage securities had brought on the financial crisis. The insurer had guaranteed the securities against default.
Starr’s argument is most compelling when it details the confiscatory aspects of A.I.G.’s bailout and compares it with the easy-money programs bestowed on banks.
The court filings connect the dots on the deal with some new material and some old. Starr’s lawyers deposed all the decision makers in the bailout, including Ben S. Bernanke, the former chairman of the Federal Reserve; Timothy F. Geithner, then president of the Federal Reserve Bank of New York; and Henry M. Paulson Jr., the Treasury secretary at the time.
The United States government persuaded the court to keep these depositions confidential. Still, tidbits are trickling out in Starr’s filings. All three men will testify in the case, which will take place in an open courtroom in Washington.
Shedding sunlight on this transaction will be a good thing; from the moment the New York Fed orchestrated the A.I.G. deal, the government has worked hard to keep its full picture from coming into view.
In 2008, for example, the Fed refused to let A.I.G. identify the trading partners that received full payment on their mortgage bets insured by A.I.G. After an outcry over the secrecy, the company identified the bailout recipients in March 2009; they included Société Générale, Goldman Sachs, Deutsche Bank and Merrill Lynch.
Some segments of the depositions in the Starr case certainly support the notion that the A.I.G. deal was punitive. In one interview, Thomas C. Baxter Jr., general counsel at the New York Fed, said the interest rate extracted from A.I.G. was “loan sharky.” In another, Mr. Paulson acknowledged that the federal aid given to Citigroup posed greater risks to taxpayers than the A.I.G. loan. Yet, he said, Citigroup received far more favorable terms from the government.
It is striking to compare the A.I.G. transaction with the federal assistance provided to the banks. Too striking, perhaps — the government asked to exclude from the trial “testimony and documents offered to show that other financial institutions received government assistance on terms different from A.I.G.” Judge Wheeler indicated that he was not granting that request.
Here are a few of those differences.
Normally, when a bank gets into trouble, the Fed lends at an interest rate that will not create an additional burden on the borrower. Not so with A.I.G. Even though the loan was fully secured by its high-quality assets, the A.I.G. loan carried a rate of 14 percent initially. The initial deal also charged A.I.G. 8.5 percent on loan amounts it did not draw. (The terms were eased later.)
Banks tapping the government’s Troubled Asset Relief Program, by contrast, paid only 5 percent interest. Banks lucky enough to borrow from the Fed’s Primary Dealer Credit Facility — available only to institutions that were deemed trading partners of the Fed — paid just 2.25 percent on their loans. These fortunates received another perk: The Fed vastly loosened its collateral requirements, letting institutions post high-risk securities in exchange for cash.
But A.I.G. was not a primary dealer and was barred from that facility. Court filings show three Federal Reserve Bank officials discussing the idea that A.I.G. would benefit from being let into the dealer club.
There’s more. In the A.I.G. deal, the government received a 79.9 percent equity stake in the insurer that came with voting rights. In no other bank assistance offered by the Fed did the government receive stock that carried voting rights. Once the federal government received its controlling stake in A.I.G., Starr contends, it continued to hobble the company. For example, when the government paid A.I.G.’s trading partners in full, the insurer was required to release those banks from future legal liability arising from the transaction. This meant A.I.G. couldn’t sue those banks for misleading it about the quality of mortgage securities it had guaranteed. Other plaintiffs — even A.I.G. itself — have successfully mounted such cases, reaping rich settlements.
In spite of this punishment, A.I.G. repaid the loan in January 2011. I am not arguing that A.I.G. was an innocent in the economic debacle of 2008. But unlike its trading partners, it neither created garbage mortgage securities nor peddled them to unsuspecting investors. Its error — a whopper for sure — was not recognizing that it was the patsy at the poker table when it insured those troubled securities. Which brings us back to Judge Wheeler’s question: Why did the government do what it did in the A.I.G. deal?
An answer emerges from the material presented by Starr. Perhaps A.I.G. was treated differently because the government saw an opportunity in the insurer’s liquidity crisis: It could become an enormous taxpayer-funded piggy bank from which the government could funnel billions to a throng of teetering banks. Remember, taxpayers were growing increasingly outraged by bank rescues in fall 2008. So claiming to bail out a rogue insurer while quietly rescuing Wall Street allowed the government to channel that anger toward A.I.G. and away from the deal’s real beneficiaries.
Starr may not prevail, but it has trained the spotlight on the government’s dealings with A.I.G. in the crisis. That alone is a public service.
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