The United States Court of Federal Claims in Washington will hear an unusual case today brought by Hank Greenberg, former chairman of the insurance giant AIG. The case, which has already taken three years and cost tens of millions of dollars, pits Greenberg’s company, Starr International, against the federal government, particularly the key policymakers at the Federal Reserve and Treasury Department who engineered the $182 billion rescue of AIG during the depths of the financial crisis. According to the lawsuit, the government’s bailout terms for AIG were discriminatory, punitive, and unconstitutional. Greenberg will seek $40 billion in compensation for shareholders.
Greenberg’s claim is mostly insane, as it assumes that a failing company is entitled to a bailout with kid-glove treatment. Nevertheless, his court case represents our best opportunity to assess, under penalty of perjury, the government’s actions during the bailout, and the favoritism it showed certain financial institutions. Making that information public may give policymakers pause in the next crisis, knowing that their actions can have consequences well into the future.
Greenberg’s case, Starr International v. U.S., which was dismissed in district court in New York but continues in Washington, alleges that the government denied AIG access to discounted federal loans that would have enabled the company to pay off creditors. Instead, AIG was forced to pay a high interest rate and hand the government an 80 percent equity stake in the company, without shareholders like Starr International (which had a 12 percent stake in the firm) receiving “just compensation,” as required by the Fifth Amendment. “Financial emergencies do not eviscerate this Constitutional protection,” reads the original complaint.
Greenberg’s lawsuit claims that the reason the government took this “unprecedented” action, against the wishes of shareholders, was to facilitate a “backdoor bailout” of AIG’s counter-parties—including major investment banks like Merrill Lynch and Goldman Sachs. The government famously paid them in full for $62.1 billion in credit default swaps, when they would have otherwise received significantly less.
The complaint is a highly selective narrative of the AIG bailout, which is probably why AIG itself chose not to join the case with its former chairman. First of all, terms imposed by the government for a bailout should be punitive. After all, AIG would have gone under without government support. But while AIG may not have gotten the same deal as, say, Citigroup, the lawsuit ignores all the goodies AIG did receive during the bailout. The initial AIG deal was for $85 billion; eventually, another $97 billion would get loaned out in three separate restructurings. The government asked for little in exchange for the subsequent windfall. It never put AIG through bankruptcy or forced the board to resign.
The government also created an exemption to allow AIG to retain $35 billion in operating losses, which Andrew Ross Sorkin called “a gift from the U.S. government.” AIG used this to offset its tax bill, make large profits, and prop up their stock price. Finally, the government famously allowed AIG to pay $165 million in bonuses to its employees, just months after the bailout.
Needless to say, this isn’t the government’s alibi: It can’t tell the judge “actually, we gave AIG as sweetheart a deal as we did for everybody else!” Instead, the government cites AIG’s catastrophic circumstances that required immediate action, the AIG board’s acceptance of the bailout terms, and the eventual profit shareholders made on the deal, despite the reduced stake. (This idea that the bailout “made money” requires you to ignore all the largesse AIG and insolvent banks were basically given to pay back the government.)
The problem for the government is that there are very real, well-documented concerns with the way it handled AIG, and the suit will put them on display. For example, the backdoor bailout is pretty simple to understand, and has been laid out by the Congressional Oversight Panel, the Special Inspector General for TARP, and the Government Accountability Office.
The Federal Reserve Bank of New York, in 2008 under the direction of future Treasury Secretary Timothy Geithner, created a vehicle to purchase AIG’s credit default swaps (CDS) from their big bank counter-parties, which were all in trouble at this time. The New York Fed’s negotiations with the counter-parties for a discount on the CDS were half-hearted at best, and some were never consulted. Even though at least one bank offered to take less, eventually every one got paid out at 100 percent.
GAO found that the New York Fed lied to Congress about the attempts to negotiate concessions, and its claim that French law prohibited discounted payments was denied by French banking officials. Emails from the New York Fed show that it forced AIG to omit disclosure of the counter-party payoff from Securities and Exchange Commission documents, a violation of securities law. And the Fed tirelessly worked to hide this history from public view.
Greenberg may not be able to prove that the government took an equity stake in AIG specifically to enrich private banks. But the counter-party payout certainly cast the government in an unfavorable light, secretly and selectively preventing bank losses while the economy imploded and millions suffered. “You scalped the folks at Bear Stearns—two cents on a dollar, they got,” said Rep. Stephen Lynch in a Congressional hearing in 2010. “The folks at Goldman Sachs got a hundred cents on a dollar. That is just unacceptable."
Geithner and other top officials have answered these charges before, in testimony before Congress. But they’ve never had to face hostile questioning from the likes of David Boies, lead counsel on Greenberg’s case. Boies is a legendary cross-examiner who recently helped win the Supreme Court case over California’s same-sex marriage ban. The prospect of Geithner, former Fed Chair Ben Bernanke, or ex-Treasury Secretary Henry Paulson, being questioned under oath by Boies on the occasionally distasteful details of the AIG bailout should make for great theater.
But there’s more at stake here than just schadenfreude. Boies’ legal team has received 16 million documents from the government, deposing Bernanke and others. They’re bankrolled by prominent Wall Street financiers, and willing to pursue this case as long as it takes. Judge Thomas Wheeler, who is hearing the case, has already rejected a motion to dismiss, arguing that the complexity of the issues involved “strongly point to the need for a trial.” So even if unsuccessful, the case will likely produce the most conclusive fact pattern of what the government did to rescue AIG, with all the dirty laundry that implies.
If the judge consents to unsealing trial records, they are likely to be deeply embarrassing to the government. And that will have long-lasting implications. Future policymakers will have to keep the AIG case in mind when determining how to save troubled firms. They will maybe not attempt a backdoor bailout, or demand the same rigid, penalizing terms on everyone who beseeches them for aid.
Greenberg may not have much of a case. But he’s doing the country a public service. Institutions like the Fed and the Treasury Department should face excruciating scrutiny whenever they put taxpayer dollars at risk to protect financial institutions. They should have to take into account how both history and the legal system will view their actions. That’s likely to lead to fairer outcomes that holds failed businesses and their executives accountable.