More on the AIG Case

I finally got around to reading U.S. Court of Claims Judge Thomas Wheeler’s opinion in the class action suit led by Maurice (Hank) Greenberg against the United States concerning the terms of the bailout of AIG. Nothing in it changes my opinion about Steven Pearlstein’s article in the Washington Post about this case, which I found to be incredibly biased for a news story.

I am no expert on the applicable law in this case, but Judge Wheeler’s opinion seems quite reasonable. In short, he held that the Federal Reserve exceeded its authority by demanding a controlling equity interest in AIG as condition for a loan that would keep AIG for filing for bankruptcy, but he found that AIG’s stockholders were not due any payment from the government for this action, since the alternative, bankruptcy, would have left them in a worst position economically. In a less noticed part of the opinion, the judge found that AIG’s reverse stock split in a ratio of twenty-to-one was done in order to keep AIG share price over $1.00 so as not to be delisted from the New York Stock Exchange. The judge found no evidence that it was done to avoid a stockholder vote on the government exchanging preferred stock for common stock. In other words, on this issue, the plaintiffs lost.

The judge’s descriptions of the events leading up to the AIG loan do not portray anyone in a very favorable light. In particular, one gets the impression that certain of the actors reveled in acting as the tough guys in the way they acted towards AIG. Left unexplained is why the terms of the AIG loan which involved the effective nationalization of AIG and a very high interest rate were so much tougher than what the government demanded of the banks. As I’ve indicated, the excuse that Pearlstein and Andrew Ross Sorkin proffer, i.e., the government did not regulate AIG, is questionable, since the Office of Thrift Supervision did have supervisory authority over AIG as a thrift holding company. Also the judge mentions, without much comment, that the Federal Reserve decided that AIG’s credit default swap counterparties would be paid the full amount they were owed, even though AIG was in financial distress but for the government backup. This seems to have been a way to help the banks.

As to the legal authority to take an equity interest in AIG, particularly telling is an email from a Davis Polk lawyer who was acting as the New York Fed’s outside counsel. In this email, the lawyer said that the government “is on thin ice and they know it. But who is going to challenge them on this ground?” Well, we know the answer to this question. How Mr. Greenburg feels about winning his case after paying a very expensive legal team led by David Boies but not receiving any payment in spite of this win is unclear, except that he is not satisfied. According to The Wall Street Journal, he plans to appeal Judge Wheeler’s decision on damages and an earlier decision to dismiss claims related to the “backdoor bailout” of banks by making them whole on the CDS contracts with AIG.

Also, of course, AIG is hardly blameless. The company took excessive risk by taking on the mortgage risk that the banks did not want to hold through credit default swaps. It is also true that the government actions led to AIG continuing in business.  Given the pressures of the time, the government officials were making the best decisions they could, and mistakes were inevitable. In retrospect, many think that the biggest mistake was letting Lehman Brothers fail. While Treasury and Federal Reserve officials claim that they did not have sufficient authority to save Lehman, this is not widely believed given their resourcefulness in other matters, including AIG.