Judge seems skeptical of government's AIG bailout terms

WASHINGTON — A federal judge on Wednesday appeared openly skeptical toward the government's claim that it had the authority to take a majority stake in American International Group (AIG) in exchange for a bailout at the height of the 2008 financial crisis.

Judge Thomas Wheeler repeatedly challenged a government lawyer's argument that the Federal Reserve's decision to take an 80% interest in the insurance giant was not an illegal taking of property and was justified because it rescued the firm from bankruptcy.

"All of the company's people who had been running the operation….were gone and the government is running the show, completely," Wheeler told Justice Department lawyer Kenneth Dintzer. "How can it be there wasn't some sort of illegal (taking) for that to happen?"

His remarks came in the closing arguments of former AIG CEO Maurice Greenberg's lawsuit accusing the government of illegally taking controlling ownership of AIG without "just compensation."

Starr International, Greenberg's investment firm and AIG's largest shareholder in 2008, is seeking $40 billion to compensate him and other shareholders for stock losses and the unusual 14.5% effective interest rate the government charged AIG for the $85 billion loan. Greenberg, 89, stepped down as AIG chief in 2005 after four decades at the helm.

The case, argued in the U.S. Court of Federal Claims, could set limits on the kinds of compensation the government can seek when it rescues a teetering firm.

Dintzer said AIG would have gone bankrupt without the loan. AIG sold insurance for tens of billions of dollars in securities tied to subprime mortgages that it couldn't cover when the real estate market crashed, threatening the global financial system.

"Whatever injuries they allege, the benefits exceeded that," Dintzer said of the government's equity stake."Absent the equity element, there is no deal at all and the company goes bankrupt."

But Wheeler responded, "One view of the case is the government took the stock, didn't pay anything for it and then pocketed revenue from the sales. I mean, come on." The government earned about $16 billion in profits when it sold the AIG shares and another $7 billion or so in interest.

Starr's lawyer, David Boies, argued that federal law allows the Fed only to charge a market-based interest rate for a loan during a crisis. He noted that no other financial firm bailed out in the crisis was forced to surrender equity. "The government made a political scapegoat (of AIG)" and "demonized" the company.

Dintzer said AIG's terms were more onerous in part because it was an insurance company not regulated by the Fed. He also noted that other firms, including Lehman Bros., received no loans.

Wheeler, however, said he remained "perplexed" by the government's treatment of AIG. "It doesn't really justify interest (rate) four times as high (as other firms) and an 80% stake," the judge said. "I mean nobody got that."

While acknowledging that AIG's board voluntarily approved the government takeover, Boies said that did not make it legal. "They had no real alternative," he said.

By law, he said, the Fed should have allowed AIG shareholders to vote on the equity stake, noting "there was plenty of time" for that.

Dintzer said the law gave the government broad authority to set "limitations and restrictions" on a loan, suggesting those could include an equity stake. And he said AIG's board had the power to act on behalf of shareholders in approving the government takeover.

But Wheeler said the evidence shows Fed board members didn't necessarily believe that. "They were very intense on maneuvering through this process so (AIG) never had a shareholder vote."

Dintzer also contended that the government didn't illegally take property, in part because no shareholders lost any stock.

Boies, however, said the issuance of new shares to the government had the same impact because it diluted the shares of existing stockholders.

"The economic effect is exactly the same as if they walked into AIG's vault and took four out of five shares," Boies said.

Wheeler compared the predicament to allowing a homeowner to keep "a nice house in the country," but adding, "We're going to make you live in the master bedroom."

At the outset of the case, experts gave Greenberg little chance of convincing a judge that the government somehow harmed AIG shareholders by saving a company that had taken risky bets on subprime mortgages. But Wheeler's questions suggest he at least has a a reasonable chance.

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