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Former AIG CEO Suing Treasury and Fed Over AIG Bailout

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Hubris knows no bounds. AIG’s former CEO Hank Greenberg, who was a significant shareholder of AIG stock via C.W. Starr (which was basically an executive enrichment vehicle) is suing the Treasury and Fed over its rescue of AIG. He has hired litigation heavyweight David Boies, who famously made Microsoft CEO Bill Gates squirm when he put him on the stand in the Microsoft antitrust case.

based on the report from Gretchen Morgenson, the argument seems to be that AIG got less good terms that Citigroup did, ergo the bailout “discriminated” against AIG.

While the public might similarly enjoy the spectacle of Timothy Geithner, Hank Paulson, and Ben Bernanke through the wringer, and I’m looking forward to reading the actual claim, but this reads like a stretch. The government stepped into a rescue when private sector rescue efforts failed. A team headed by Bob Scully of Morgan Stanley had put together a term sheet and tried raising funds for the floundering insurer, but they could not secure enough money. If my recollection of the Sorkin book Too Big to Fail is correct (I’m on the road and don’t have a copy here), the Fed and Treasury used the same termsheet as the private sector deal (although, as I recall, the amount to be funded also rose as AIG revealed late in the game that it needed an additional $20 billion dollars in addition to its guesstimated $40 billion in CDO losses due to problems in securities lending portfolio). Note also that the AIG CEO came to the government, provided the collateral for the initial loan, and AIG proved to be in worse shape than it initially told the authorities. It’s hard to argue either coercion or unjust enrichment. As we wrote, it was outrageous that the deal was retraded repeatedly, with the terms becoming more favorable each time.

A big issue, per the Sorkin account, was the embarrassingly bad state of AIG’s records. The Wall Street firms involved in the failed rescue were alarmed at was the fact that AIG did not have a good handle at all on its financial exposures. Similarly, your truly saw a huge red flag in a disclosure in the first edition in Sorkin’s book:

Readers of TBTF may recall that the book gives the travails of Lehman center stage, with the AIG unravelling a secondary but parallel story. Sorkin drops in the proximate cause for the AIG rescue: the magnitude of its credit default swaps portfolio: $2.7 trillion notional, with $1 trillion of that concentrated among 12 financial institution (p. 236). We get a flavor of how badly run the place is: management admits to having “antiquated systems” (p. 364) and is not able to get a estimate its cash needs (p. 365). Amazingly bankers poring over its financials in the course of trying to raise funds discover a $20 billion sinkhole that was somehow overlooked by the AIG top dogs, the result of losses in its securities lending business. That increased the amount of money needed at that juncture from $40 billion to $60 billion (p. 337). Ouch.

So the story thus far is that AIG is a great big mess that will bring everyone down if it goes. Got that. Geithner accepts that picture, persuades Bernanke. AIG is on the verge of bankruptcy, according to Sorkin, mere “minutes away” (p. 399). The Fed agrees to extend a $14 billion loan to get it through the trading day but it wants collateral. Collateral? From a broke company? How is that going to happen?

Then we get this bit:

Wilmustad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing bonds – tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the cabinets, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping bonds on hand was a disconcerting but welcome throwback. (p. 400)

WTF? This is a company about to go out of business, then it suddenly remembers it has a secret stash….worth at least 1/6 of the initial government rescue commitment? $14 billion was only what they coughed up to satisfy the Fed. How much more was left in those cabinets?

And more important, WHO SUPPOSEDLY OWNED THIS PAPER? This wasn’t held by the subsidiaries; otherwise, AIG would not have been able to pledge it to the Fed. And if it was a parent company holding, why wasn’t it repoed or sold earlier? What entity took the semi-annual interest payments? Take the $14 billion we know about, and assume a 5% interest rate. That’s $700 million. Where did it go? Was it reinvested? Disbursed?

The language further suggests that bonds in this secret trove, while mainly accumulated under Greenberg, had more recent additions, presumably under Martin Sullivan, perhaps Wilmustad. This “unofficial vaults” designation strongly implies this was a secret, off balance sheet cache that threw off a hefty amount of annual income by virtue of its staggering size. That would mean it could be used by the CEO at his sole discretion, for anything from bribes to unreported executive payments that might then be used to open foreign bank accounts or pay for personal or business expenses.

And these “unofficial reserves” continued AFTER Greenberg was ousted over accounting improprieties. Business Week gave a short summary:

Investigators believe that AIG may have goosed its financial performance with dubious transactions and improper accounting. Last fall, the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. for deals it structured for outside clients that allegedly violated insurance accounting rules, although AIG admitted no wrongdoing. The company also came under the glare of New York Attorney General Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos. (MMC ), which led to the ouster of Hank’s son Jeffrey as CEO there. AIG admitted no wrongdoing, but two of its executives plead guilty and left the company.

This time, investigators initially focused on two transactions involving Berkshire Hathaway’s (BRK ) General Re Corp. unit. The deals essentially amounted to a $500 million loan that was dressed up on the books as premium revenue. That allowed AIG to boost its sagging reserves at a time when investors thought they were too low. The problem: AIG never assumed any of the risk associated with insurance underwriting. On Mar. 30, the company acknowledged that “the transaction documentation was improper” and should never have been classified as insurance premiums.

Since then, AIG ‘s problems have escalated. In its Mar. 30 release, the company itself identified several problem areas. They include transactions with supposedly independent companies that were in fact controlled by AIG; bond transactions that may have allowed it to claim gains without actually selling the bonds; misclassified losses; and questionable estimates on deferred acquisition costs. Investigators and state regulators are looking into some 60 transactions involving these and other possible accounting shenanigans. “Greenberg strived for a steadily rising stock price,” says a source in Spitzer’s office. “He used mechanisms now being revealed as deceptive and improper.”

Perhaps there is an innocent explanation for this huge stash. However, but in all my years in financial services (and having had billionaire clients who would be completely within their rights to run their enterprises as personal cookie jars to the extent the law allows), I have never heard of anything remotely this suspect.

Sorkin contends (based on phone calls prompted by the focus on this paragraph) that the securities pledged to the Fed were the share certificates in the subsidiaries and changes his account to reflect that in later editions of his book. Maybe. But even so, that’s a hugely irregular practice at a company as big as AIG, and also flies in the face of the idea of an “unofficial vault”.

In addition, AIG was known to be in thick with the CIA. Its huge sprawl of offices around the world made it the perfect entity to give employment cover to agents.

This obvious lack of adequate controls would seem to set up a major defense to the suit: AIG was not regulated in any meaningful way by the Federal government, unlike Citigroup. To expect it to rescue an entity where it had effectively no oversight and therefore had no insight into the adequacy of its records is bollocks. It should properly ask for completely different and more punitive terms for rescuing a pig in the poke. And as we commented at the time, we approved of the first AIG rescue. It was along classic Bagehot lines: lend freely, against good collateral, at penalty rates.

But the premise of the first AIG bailout was proven false. The collateral wasn’t so hot. That was why the deal had to be redone repeatedly. AIG had been highly confident this was just a liquidity problem, that it could sell various subsidiaries and come out just fine. But it was only able to monetize a few of its best operations.

In keeping, I’ve been told AIG was and is DEEPLY insolvent at the subsidiary level from former state insurance regulators. Since you get the money up front and pay out later, insurance is the perfect vehicle for fraud. This is extremely significant, since if true, it means AIG was rotten to the core, not merely insolvent at the parent company level. The alleged problems are in its US property and casualty operations, which have an extraordinary number of cross guarantees, and also make use of the highly suspect “finite reinsurance” with each other, the same sort of dubious practice cited in the Business Week article above. But it is brutally difficult to prove (I had a team of four people waste the better part of a month on statutory filings. They are FULL of red flags, but even one major sub’s filing run to nearly 300 pages, and you need to go through tons of analysis across subs to get anywhere).

But any Federal case is not going to touch the issue of problems at the sub level confirming their initial call; this would call into question the quality of what is left of AIG when the Federal government still has more of that garbage barge to unload on the public.

The intent of this case is clearly to embarrass the officialdom into paying Greenberg to go away quickly. Many of their best defenses cannot be revealed due to their conflict of interest by being a continuing owner of AIG and keen to present the bailout as a success (remember the continuing “paid off the TARP” meme). And Greenberg does have a point in his favor: the way AIG was used as a vehicle to provide funding to other insolvent companies (the now notorious paying off of the Maiden Lane III credit default swaps at par, the payouts on the securities lending portfolio, and the less widely noted way in which entire portfolios of levered credit risks were unwound, purported to provide the big banks with badly needed profits in the first quarter of 2009).

Paulson is interestingly off the hook as the Treasury secretary, since the Treasury secretary was put outside the law in TARP legislation. So I’d assume the Treasury will be able to get itself removed from the case. The Fed will probably seek to have the case sealed. If it succeeds, it might pull out all the dirty laundry on what a mess AIG really is.

I love the notion of a Microsoft anti-trust-suit-like spectacle, but I don’t see that in the offing. Boies is shooting at much bigger targets at this time, and he may not realize the fact set is pretty poor (Greenberg is smart and famously persuasive). But the flip side is this is probably an effective extortion game, since senior government officials won’t be keen to spend the time needed to make an adequate defense, or go a few rounds of discovery to let Boies know they would have good case if they went to the mat. After all, one thing Greenberg has observed that the easiest course of action is to roll the taxpayer. He just wants his share.

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36 comments

  1. LeonovaBalletRusse

    Yves, you connect all the dots to the end. Now, is Greenberg set to blow the whistle on AIG as dealer in *money disappeared disappeared into black ops*? How much information in defense will be *classified*?

    Is it Iran-Contra in Emperor’s clothing? Sounds like Greenberg is in the catbird seat. O, this is very hard ball.

    Thank you for your superlative report and interpretation.

  2. Just Me

    I’m not sure I would call David Boies a litigation heavyweight. He was the legal “brains” behind The SCO Group’s anti-Linux lawsuits. You can read all the gory details and most of the legal pleadings at http://www.groklaw.net. He is also the attorney who argued and lost Gore vs. Bush.

    I wouldn’t hire Mr. Boies to fight a parking ticket.

    1. EH

      Yes, Boies is like the country’s most famous loser (add DOJ v. Microsoft to your list), but well-paid. I’m not confident enough to cast odds based on his record, though.

    2. LeonovaBalletRusse

      Just Me — Greenberg should get serious and team up with Geoffrey Robertson QC, author of “The Tyrannicide Brief: The Story of the Man Who Sent Charles I to the Scaffold” (2005) and “THE CASE OF THE POPE: Vatican Accountability for Human Rights Abuse” (2010). In the former he is said to be “a leading human rights lawyer and United Nations war crimes judge.” The latter book tells us: “He has appeared in the courts of many countries as counsel in leading cases in constitutional, criminal and international law….”

      After all, “AIG…CIA–Poppy’s baby in a bathtub

    3. Yves Smith Post author

      First, Boies at Cravath was one of the most feared corporate litigators. He fought the Federal government to a standstill on its IBM anti trust case (and this was in the days when the government was competent at that sort of thing, witness the AT&T breakup).

      Second, you are wrong re Microsoft. Boies won a resounding victory before Judge Thomas Penfield Jackson, who was clearly ready to throw the book at Microsoft. But Jackson snatched defeat from the jaws of victory. He spoke to a reporter about the case BEFORE he rendered his sentence. During appeals, his findings of fact stood, but he was removed from the case,. It was assigned to a remarkably clueless judge, Coleen Kolar-Kotelly. (BTW appeals are different than trials, and my recollection is that another firm joined the case for the appellate pleading).

      1. Just Me

        Thanks for your reply, Yves. Please note that I didn’t criticize Mr. Boies’ handling of DOJ vs. Microsoft. He actually won that case. I’m well aware of what happened regarding Judges Jackson and Kolar-Kotelly.

        As a Linux enthusiast, my animosity towards Mr. Boies stems from his role in the “SCO vs. The World” lawsuits documented in excruciating detail at Groklaw. That whole affair soured my low opinion of lawyers. They’re like prostitutes – they’ll “do it” for anyone who pays them.

        If that isn’t enough, here is another example of Mr. Boies’ antics.
        http://articles.sun-sentinel.com/2003-03-20/news/0303191362_1_david-boies-florida-bar-palm-beach-county

        From that article:
        “March 20, 2003|By Peter Franceschina Staff Writer

        The Florida Bar again is reviewing the actions of a nationally known courtroom powerhouse, David Boies, after a Palm Beach County circuit judge called into question his firm’s financing of a six-year legal battle in a dispute between two lawn-care companies.

        Boies, 61, the celebrated litigator who represented Al Gore in the contested Florida 2000 election, is a longtime friend and business partner of Amy Habie of Boca Raton. Habie is a wealthy businesswoman who bought a lawn-service company that serves Palm Beach’s manicured estates from Scott Lewis in 1996 for $800,000.

        Lewis, 46, started up another company months after the sale, and each side accused the other of violating the contract.”

        And further:
        “Lewis represents himself in court, but West Palm Beach attorney Jack Scarola represents his wife and company. Habie was represented personally by Boies — who has a family trust with a 25 percent interest in Habie’s company — in the early days of the case, and she has had the benefit of the vast resources of his national firm without having to pay anything.”

        Apparently Mr. Boies was fought to a standstill by a pro se litigant. But wait, there’s more:

        “This case is sad commentary on the inability of the legal system and the courts of our state to resolve a simple contract dispute, when one is willing to litigate without regard to costs,” [Circuit Judge David] Crow wrote in his Feb. 20 order. “The civil-justice system is intended to resolve disputes, but it can be abused when used only to flame the fire of disagreement.”

        I wouldn’t hire Mr. Boies to fight a parking ticket because I don’t want to be in the same room as him.

    1. LeonovaBalletRusse

      Kid, thanks for the link. #9 is the *smoking gun* – the “back door” bailout of *Old Europe* banks daisy-chained with Greek sovereign debt and GS compound derivates.

      Where did the money go? Where did it go in the S&L scandal (Bush’s Silverado: see Singer’s “Funny Money”; where did it go with Bush’s Enron? Where did it go with Bush’s Wars? Where did it go with TARP? Where, O where does the money go?

      The Bushes so far are *sacred cows*. Will this continue? Let’s see what *hush money* Greenberg gets out of this.

    2. Thorstein

      KD or Yves,

      “Between March 2005 and December 2005… AIGFP wrote approximately … 220 CDSs…. [M]ost of these new CDSs referenced, not corporate debt, but subprime mortgage debt.” (sec 29, p. 9.)

      “In late 2005, senior executives at AIGFP concluded that writing CDSs on CDOs dependent on subprime mortgage debt was unacceptably risky, and in December 2005, AIGFP decided to stop writing new CDSs for CDOs backed by subprime mortgage debt. However, the CDS contracts AIGFP had already written remained on its books.” (sec 33, p. 10.)

      Question: What was the expected lifespan of the CDSs that FP wrote in 2005 — ~7 years, shorter?

      What did FP receive for assuming the risk, Libor plus 30bps?

  3. 'Gwailo

    Like an orphan begging for sympathy after murdering his parents, Hank Greenberg knows how to spell c-h-u-t-z-p-a-h.

  4. bob

    CIA? Maybe now, but the founder was most likely working for British intelligence, IMO. Their massive activity and losses in London back this.

    1. LeonovaBalletRusse

      Dulles, Bush, CIA, MI6, MI5, is there a difference?

      Carroll Quiqley: “THE ANGLO-AMERICAN ESTABLISHMENT.”

      1. bob

        More or less my point. In 1919, when Starr started selling insurance in Shanghai, GBP was king, not the newly minted $.

        1. LeonovaBalletRusse

          Ah, the clout of the *right* DNA. The name Starr lives on in spooksville under Academic cover at Johns Hopkins.

  5. stevelaudig

    Boies isn’t that sharp. He turned Gore into a loser with his faulty litigation strategy and pusillanimous tactics. He is a weak sister.

    1. barrisj

      Too right…better Mr Greenberg retains Theodore Olson as chief counsel – Olson WON Bush v Gore, for God’s sake, and got Ray-gun off the hook in the Iran-Contra debacle. He prolly bills less than Boies too.

      1. LeonovaBalletRusse

        Alas, his specialty is defense, not prosecution.

        Geoffrey Robertson is the man for Greenberg, if Greenberg would rather be the winner *David* vs. Goliath, and won’t settle for *hush money*.

        How about it, Mr. Greenberg? Want to go down in history as the world’s savior and Leading Mensch?

    2. Yves Smith Post author

      No court was going to overturn the election on hanging chads. This was an uphill battle, big time.

      The information to back the better argument (systematic scrubbing of black voters from the rolls, using the resemblance of their names to convicted felons. At least 100,000 black voters denied access to the polls x 30% black turnout x 90% propensity to vote Dem = 27,000 lost votes to Gore) didn’t come out till later.

      1. YankeeFrank

        Maybe the stats didn’t, but many of the stories were there or were apparent even before the election.

    3. scraping_by

      You’re assuming he was working for the best interest of his client. You apparently haven’t hired a lawyer.

      Where I’m from, your opponent can hire your lawyer without your knowledge at a rate far above what you can pay. This isn’t defined as bribery. No, really.

      In the bigger world, a lawyer always knows there’s life after each case. Al Gore could pay so much, the Bush family and their allies in the 1% could pay infinitely more.

      And supporting the right for the sake of the right?

      HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA HA!!!!!

  6. Brett

    Maybe this will backfire and push the government to try to put Greenberg in jail. They let him off the hook originally, but as this proves once again, the government babies these Masters of the Universe to its own detriment. If an aggressive push had been made from the start to make them pay and put them in jail, they’d not be suing the government for bailing out their fraudulent companies (and they wouldn’t be trashing Obama publicly given how he’s let them get away with huge crimes and keep all their stolen loot — their only punishment so far has been to be publicly called “fat cats” one time).

  7. Winston Smith

    The scenario I proposed in an ironic comment on this blog last April which was intended to be as ridiculous as possible is looking more likely:

    And I’d like to see a reverse class action lawsuit brought by the financial industry against taxpayers for making them feel guilty about bailouts.

    Life parodies art parodies life.

  8. LeonovaBalletRusse

    Yves, will you please take the *overtime* to read and comment on the link below. This appears to be a just solution, lost in the fog of financial history. We could undo the damage done by Harry Dexter White:

    http:www.monbiot.com/2008/11/18 – This was ignored in 2008.

    We do really appreciate your genius and your exhaustion. But this is an international emergency waiting for an American to redeem ourselves somewhat.

  9. Hugh

    Greenberg is a megalomaniac. He still thinks AIG should have remained his to loot. I agree with those who characterize this as a shakedown. Greenberg is 86. If this went to trial and appeal, he would be dead and in the ground years before it finished.

    1. Yves Smith Post author

      I’m told by people who know him from McKinsey that he expects to live to be at least 110. So he assumes he’ll be able to live long enough to get through the appeals.

  10. ep3

    yves, could this be some sort of ruse to by the ministry of truth to make the gov’t look like the bad guy (as popularity in Occupy wall street is making action against the banks more popular).
    So this 1% clown comes out of hiding, as this opportune time, and cries “oh, how awful, the evil gov’t meddled in our private affairs. If only the gov’t would have left us alone, we could have survived on our own.” Several articles on google had this as headlines or subheadlines, or within the first paragraph. That this was a fascist power grab by the gov’t to get involved in wall street and…draw your own conclusion (hint hint, that meddling caused the crisis).
    back to reading.

  11. shineOn

    These scumbags have clearly gone through life blackmailing, stalling and squalling every step of the way — starting from infancy. These huge egos are still emotionally two years old.

Comments are closed.