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What you need to know about the AIG trial

Scott Tong and Sally Herships Oct 7, 2014
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There’s a star witness in a big trial today.

You’ve heard of him: Timothy Geithner. The case: AIG shareholders, including former CEO Maurice R. Greenberg, are suing the Feds, saying they feel cheated by the terms of the bailout in 2008.

Didn’t Henry Paulson testify yesterday?
Yup. Then-Treasury Secretary Paulson testified. He said the AIG bailout deal was “punitive.” AIG made risky bets, he said, and its shareholders deserved to be punished for them. The key was to send a message to Wall Street: “Just so you know, we are not the Santa Claus of easy bailouts. If you come and ask for one, the terms will be harsh.” Okay, that’s a made-up quote.

So why does this testimony matter?
Because Paulson was not the key player in regards to details of the AIG bailout. Geithner, then-head of the NY Fed, was. He’s the big witness this morning, says Columbia law professor John Coffee, and the guy Greenberg’s lawyer (one David Boies) really wants to grill.

Oh yeah, the bailout.
Recall: in the fog of the banking crisis, the Feds realized AIG was in big money trouble. Why? AIG was the insurance company for banks that bought risky subprime loans. If those loans defaulted, AIG was on the hook. (five-dollar word: credit default swaps).

What’s the AIG shareholder beef?
The Feds were overly mean, they say, and they punished us too harshly. Or, in legal-speak, they took control of AIG without “just compensation” – a Constitutional no-no.
The details:

  •  In return for $192 billion in loans, we got hit with a 14 percent interest rate. Beltway loan sharks.
  •  The feds took an 80% stock share in the company.
  •  We got these harsh terms, but the banks got paid back 100 cents on the dollar for their risky investments. How come only we sat in the barber chair for the haircut?

What do AIG shareholder want?

Led by former CEO Greenberg, they are suing for $40 billion in compensation.

What’s the counter-argument against AIG?
We needed to punish you, because you took bad risks. But we needed to save the banks because the financial system was on life support. That’s the job of the Federal Reserve.

What role did Geithner play?
He ran the NY Fed, which engineered the details of the whole bailout.

Geithner argues – in his recent book, “Stress Test” – that the government had no choice. If they hadn’t bailed out AIG, it would be ruined the economy. His NY Fed has also been accused of hiding the terms of the 100% payments to the banks that bought AIG default insurance.

How could Geithner’s testimony impact?

“If the evidence that comes out in the case shows that there was a big misfire at the fed, then congress may react and change the way that the Fed does business,” says Georgetown finance professor Jim Angel.

Public reaction to the government’s bailouts of large financial institution during the financial crisis was so negative says Angel, that when congress passed Dodd-Frank it reduced the fed’s ability act. New restrictions, he says, could be key in a future crisis.

Why do we care, again?

In litigation, there’s this thing called discovery where each side has to “open its kimono” to the other.  Lawsuits are all about getting to the bottom of things. And observers are hoping that this lawsuit could get to the bottom of the financial crisis. Angel says “There’ve been a lot of studies of the financial crisis, but do we really know what happened?”

His answer: not really. He hopes this lawsuit could reveal facts that we don’t know, we don’t know about how the crisis and the bailout of AIG occurred, as well as a potential answer to the “Watergate question” –  what the Fed knew and when it knew it.

That sounds pretty exciting, but John Coffee, director of Columbia Law School’s Center on Corporate Governance, isn’t so sure he agrees with Angel.

“I don’t think you’re going to learn dramatically new information,” he says. “You may hear snippets, emails anecdotes that support both sides.” 

There are two opposing points of view on how the government handled AIG’s bailout, notes Coffee.

“One side said it was done to prevent financial contagion and panic. The other side says it was done to achieve a backdoor bailout of large banks you wouldn’t dare to fund directly and publicly,” he says. 

Coffee’s opinion: the court won’t decide to oversee or restrain financial regulators. Those new regulations, he says, already exist – thanks to Dodd-Frank. But Georgetown’s Angel takes a different view.

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