Never underestimate the greed of a billionaire. But I have to say separately that I will thoroughly enjoy the pigfight between former AIG chief Hank Greenberg’s C.V. Starr (now the biggest shareholder in AIG) versus the Federal government over the rescue of AIG. Any cost and embarrassment that the Administration suffers will be the direct result of the Bush-Obama policies of being concerned only about saving financial players rather than meting out any punishments, and for being incompetent negotiators.
The media and even some Congressmen exploded over the notion that AIG might join Greenberg in a suit against its rescuer, the US government, meaning ultimately the American taxpayer. For instance, Elijah Cummings, ranking member of the House Committee on Oversight and Government Reform, wrote:
The idea that AIG might sue the government is an unbelievable insult to our nation’s taxpayers, who cleaned up the mess this firm created. I understand that AIG’s board has a fiduciary duty to consider this action, but the simple fact is that AIG did not have to accept these terms — it could have entered bankruptcy. This is like suing the paramedic who just gave you CPR because he didn’t give you a pillow. The American taxpayers were a lifeline to this firm, and for certain shareholders to now criticize the terms of the rescue is utterly ridiculous.
The fact that AIG has launched a PR salvo thanking America for its rescue no doubt heightened the negative response; AIG has tried to feign gratitude to reverse the stigma of the bailout. Its board would have to be smoking something strong to join Greenberg in this lawsuit. It would suffer considerable reputational damage to chase a low-odds payoff. MarketWatch, hardly a bastion of radicalism, suggested, “How about charging AIG with treason?” As for the possible upsides, a Federal judge in the Southern District of New York already dismissed the parallel case against the New York Fed with prejudice and issued a blistering ruling; Starr is appealing.
Neil Barofsky explained on Bloomberg why AIG’s board will probably choose to dodge this bullet:
The flip side is the AIG directors and its CEO Benmosche have been consistently intransigent in their dealings with the government (see here and here, for instance); this is one of the few boards that might be loopy enough to sign up for Greenberg’s scheme.
But all this uproar misses what I consider more interesting, and had gone under the radar until now: that the judge in the case against the government is letting the case proceed (procedurally, the cases needed to be filed in different courts). Discovery has already begun; the New York Times reports that Starr has demanded 16 million pages of documents and the DoJ has not only tasked a dozen attorneys to this case but has also been forced to hire experts.
While a few observers argue Greenberg’s suit has merit, it’s really hard to see that, at least if the detailed account of the AIG rescue in Andrew Ross Sorkin’s Too Big to Fail is remotely accurate. The Starr lawsuit tries to claim that the government discouraged sovereign wealth funds and other investors from taking a stake in AIG, meaning effectively that the government somehow preferred that AIG get in trouble and then took advantage of it. Huh? The Bush Administration wanted no part of bailouts; they clearly hoped to leave the whole credit mess in Obama’s lap but events conspired against them. In fact, as with Lehman, the Administration was trying to get a private sector rescue in place up to the last possible minute. But as the mortgage backed securities market kept collapsing, the losses in AIG’s securities lending portfolio ballooned to $20 billion (on top of a then-estimated $50 billion hole in the credit default swaps portfolio). They couldn’t raise enough money in the post Lehman panic (quelle surprise!).
The suit apparently makes the related claim that the terms imposed on AIG were punitive. First, that is what they are supposed to be, the Bagehot rule is “lend freely, at a penalty rate.” Second, punitive does not mean exploitative. Sorkin has said the terms on which the government lent were the same that the insurer was offering to private investors. Now get that: management and/or the board had to have approved those terms. If they were soliciting funding on those terms, voluntarily, from private parties, how can Starr claim the deal was extortionate? And even if the Sorkin account somehow missed key points that would complicate the picture, the board accepted the government deal because the alternative was bankruptcy, which would have wiped out the shareholders, including Starr.
The other part the fulminating misses is how many times the deal was redone, each time to make the terms more generous to AIG.
he original financing was $85 billion, secured by all of AIG’s assets, with a interest rate of 8.5% over Libor, which translated into 11.5%, From the Fed’s press release:
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers…
The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.
Now as readers of Andrew Ross Sorkin’s Too Big Too Fail may have noticed, there was a stunner in how this came about. Wall Street (namely, the god of syndicated lending, Jimmy Lee) has determined he could raise $50 billion on the terms outlined above, which fell short of what AIG needed. (There is another amazing vignette, when AIG needs a $14 billion overnight loan from the Fed, and Geithner demands collateral. CEO Wilmustad wonders how they will come up with that “in the next few minutes” and someone remembers “the unofficial vaults.” In the same office, AIG had “tens of billions” of physical bonds, apparently not recorded on the balance sheet. WTF? What kind of organization is about to run completely out of money, and then remembers it has “tens of billions” sitting around? Obviously someone DID know, and chose to keep that little fact secret.)
So why did the NY Fed suddenly decide to fund all on its own? Why didn’t the Fed just lend along side the other firms on the same terms? I’d much rather have a bunch of Wall Street SOBs overseeing AIG than the half-hearted minders at the Fed.
Sorkin apparently corrected the second edition of his book; the claim is that what he called bonds in the first version of his book were the stock certificates of all the AIG subs. Even if true, that’s astonishingly irregular. But the point here is that Starr’s claims are barmy. The suit apparently asserts the interest rate was 14% (I’d like to see how they come up with that) and that AIG was disadvantaged by the loss of private investors. But they were going to come in on exactly the same terms that the government funded the deal at. So no financial harm was done. The only reason I can fathom for the NY Fed taking up the entire loan is that it thought it would take too long to close the deal. But the flip side is this was an $85 billion lending facility; AIG was still free to close a deal with private investors if it wanted to and use it to partially pay down the Fed loan.
Moreover, as indicated above, the original loan was only for two years. The whole idea was to have a high interest rate to force AIG to sell assets and pay the loan back. The belief was that AIG was a hugely valuable company that was suffering a holding company insolvency. If it sold its subsidiaries, surely it would have more than enough to repay the loan.
That’s not how it played out. AIG was shortly back to the well, for another $37.8 billion. It needed to have the maturity of the loan extended, since it couldn’t sell enough units (in part due to the fact that some were garbage barges; I’m told by a former state insurance examiner that Treasury was having monthly conference calls with the state insurance regulators in the 19 states in which AIG has insurance subs pressuring them not to pull the plug on them).
And remember, AIG was coddled during this process. As we wrote earlier:
Look at the list of terms above. The government has the right to seize absolutely everything of value AIG has until it pays off the loans, hold virtually all of the equity, and can veto many key actions (the senior position with respect to the assets gives it more rights than those listed above). Think of AIG as a felon: until it pays its debts to society, it has virtually no rights….
Now given AIG’s liquidity needs, and the object of this exercise (not to have AIG go under) the second loan was presumably necessary, but the efforts to dress it up as as a loan against collateral is an amusing fiction (all this second loan does is degrade the collateral against the original loan. There are no free lunches here, except, of course, for AIG). Again, if we go back to the felon metaphor, the state had budgeted X for his care, but it turns out he has a really nasty disease that really has to be treated or it will infect the entire prison population and the guards too, so the cost of his incarceration has gone from X to X + Y.
But now we get to the heinous part. AIG should have no rights at this point. Zero. Zip. Nada. The government already on the hook for an open-ended liability. Yet the Fed is treating AIG as a party that has rights and is negotiating with them, as opposed to dictating terms. This is staggering.
But what did the Feds do? They kept making the terms easier, and got nothing back, not even symbolic items like formally putting the company through bankruptcy to allow management contracts to be voided, firing the board, or at least demanding their resignation letters, along with those of C level managers, so the Feds could throw them out with no hassle if deemed necessary, or even indemnification, a no-brainer whose omission is what is allowing AIG to contemplate suing Uncle Sam. A basic rule is you never give a free concession in negotiations. You get something back, and the fact that AIG kept coming back to the well (three additional times) gave the Feds plenty of time to ponder if there was anything they had missed in their earlier dealmaking. But their priority was not to protect the interest of the public, it was just to salvage AIG with as little effort on their behalf as possible.
How Starr can claim to have been victimized by a sugar daddy that kept shoveling more and more money at it? It got stealth bailouts too, such as Treasury going through hoops to preserve the value of $26.2 billion in net operating losses plus $9 billion of “unrealized loss on investments” that Sorkin called “a tax benefit, er, gift, from the United States government”
These aren’t the only claims that Starr makes, but they all flow from the idea that AIG was somehow snookered and abused in doing the initial bailout or that the government exercised undue control when it did one of its later restructurings in a manner that disadvantaged shareholders. Given that all these retrades amounted to corporate welfare, this is remarkably strained.
So why am I nevertheless looking forward to seeing this ridiculous lawsuit play out? Greenberg may be deluded enough to think he has a case, but he’s seasoned and legally sophisticated, so he may be operating on a different theory. I’ve mentioned before that there are two ways to prevail in litigation: by having a winnable case or by having one that can get past summary judgment in which you can inflict a ton of pain on the other side in discovery and the trial process. And remember also, Starr’s counsel David Boies cut his teeth on the IBM antitrust suit, which lasted the better part of a decade. He’s been through extremely protracted, complex litigation before.
So what might Greenberg and Boies be planning? Well if I were in their shoes, I’d try to make this case o embarrassing to the government that they are willing to pay to make it go away. Merely making it costly (like 16 million page document requests) probably is not sufficient in and of itself. If Starr can persuade the judge to keep the records unsealed, and gets embarrassing material about how the government handled the rescues into the public domain, this could be great theater, and would also let us see how much of what has been fed to folks like Sorkin was accurate. That means keeping it in the spotlight during Obama’s term, since his successor wouldn’t suffer from any revelations.
And just imagine, if this goes to court, Boies will almost certainly seek to put Paulson, Geithner and Bernanke on the stand. I don’t see how Geithner, as a private citizen, could refuse; if Bernanke is reappointed, he might escape (judges tend to show some deference in calling top executives and officials to testify if less senior people have enough knowledge to appear in their place).
Put it another way: if you thought Geithner squirmed when Elizabeth Warren grilled him, you haven’t seen anything till Boies has a go at him. That alone is reason to look on this suit with more sympathy than it otherwise deserves: it will lead any successor bailouter in chief to be a lot more careful and demanding when he shovels out cash to wards of the state.