Wall St. Bankrolls Ex-Executive as He Sues Over A.I.G. Bailout
Ben Protess and Aaron M. Kessler
September 23, 2014
One might call it “chutzpah,” as several irate lawmakers did, or “rubbing salt in the wounds” of the American taxpayer. But to a few Wall Street financiers, a lawsuit that accuses the government of shortchanging the American International Group in its 2008 bailout is something else: a promising investment in a cause they support.
Maurice R. Greenberg, 89, the former A.I.G. chief executive who still holds a large stake in the insurance company, filed the lawsuit on behalf of fellow shareholders. He has now raised several million dollars from three Wall Street companions to help cover the cost of the case. The investors, who are entitled to a cut of any damages Mr. Greenberg collects from the government, contributed about 15 percent of the tens of millions of dollars in legal costs, according to people with knowledge of the arrangement.
Six years after the government saved Wall Street from the brink of collapse, the lawsuit is coming to trial, reopening one of the ugliest chapters in modern financial history. The trial, which begins next week in Washington, will most likely hinge on testimony from the policy makers who orchestrated A.I.G.’s rescue, including former Federal Reserve Chairman Ben S. Bernanke and former Treasury Secretary Timothy F. Geithner.
With the legal bills mounting in the three-year case, Mr. Greenberg sought support from a certain breed of investor — those who have misgivings about the government. Kenneth G. Langone, the former director of the New York Stock Exchange who spent years fending off accusations from the New York attorney general’s office, contributed to Mr. Greenberg’s legal fund, the people said. Steven A. Cohen, whose hedge fund was indicted on charges of insider trading last year, considered investing, too, but ultimately declined.
The investments from Mr. Greenberg’s friends — their decisions and the details of their arrangement have not been previously reported — have breathed new life into a case that the government thought would never reach trial. After all, by the government’s reckoning, A.I.G. had only one alternative to the bailout: bankruptcy.
The lawsuit, which seeks more than $40 billion from the government, does not dispute that A.I.G. needed a $182 billion lifeline to survive the financial crisis. It instead challenges the onerous nature of the rescue. The government took what became a 92 percent stake in the company — a step it did not pursue with other bailed-out Wall Street giants — imposed a steep interest rate and steered billions of dollars to the insurer’s trading partners. Those decisions, the suit says, cheated A.I.G. shareholders and violated the Fifth Amendment, which prohibits the taking of private property for “public use, without just compensation.”
Mr. Greenberg also contends that the Fed lacked the legal authority to demand a stake in A.I.G. That argument stems partly from past rulings, including a Supreme Court case that challenged President Truman’s takeover of the steel industry during the Korean War.
The case thrusts A.I.G. into a fight that the company itself does not support. For the insurer, which has since repaid the bailout and regained its footing, Mr. Greenberg’s case is a reminder of a time when it was synonymous with the excessive risk-taking that nearly imploded the economy.
The trial, at the United States Court of Federal Claims in Washington, will also place an unwelcome spotlight on the government, forcing Mr. Bernanke and Mr. Geithner to justify their unconventional policies. The government, which turned a $22.7 billion profit on the A.I.G. bailout, senses a broader public policy threat from the case as well, warning that a verdict in Mr. Greenberg’s favor could set a precedent that Wall Street firms are legally entitled to bailouts on their own terms. Mr. Greenberg’s lawyers dispute that notion.
At times, the case has pitted one government agency against another. The Treasury Department, dismayed that the case made it to trial, briefly considered hiring Neil H. MacBride, a prominent former prosecutor now at the law firm Davis Polk, to supplement the Justice Department lawyers assigned to the case, according to people with knowledge of the matter. That idea irritated some Justice Department officials, the people said, particularly since the law firm Debevoise & Plimpton was already advising the government. Ultimately, Mr. MacBride was not retained.
For his fight, Mr. Greenberg hired David Boies, the litigator who led the Justice Department’s antitrust trial against Microsoft and later helped overturn California’s ban on same-sex marriage.
Mr. Boies, 73, has become de facto counsel for Mr. Greenberg, steering him through accusations of accounting impropriety during his tenure as chief executive and handling his litigation with A.I.G. after his departure. Their ties extend to Yale Law School, where professorships are named for both men. Mr. Boies, an alumnus, and his wife, Mary, financed the professorship in Mr. Greenberg’s name.
In the A.I.G. case, Mr. Greenberg is sparing no expense. His legal team, which has taken over nearly an entire floor of a downtown Washington hotel near the courthouse, also includes the Wall Street law firm Skadden, Arps, Slate, Meagher & Flom.
To help finance the fight, Mr. Greenberg turned to his friends on Wall Street, putting a personal twist on so-called litigation financing, a growing industry for hedge funds and specialty firms.
His pitch resonated with Mr. Langone, a close friend and vocal supporter of Mr. Greenberg. J. Christopher Flowers, a private equity executive who happened to warn the Treasury Department in September 2008 that A.I.G. was careering toward collapse, also invested in the legal fund, the people with knowledge of the financing arrangement said. The identity of the third investor could not be learned.
Mr. Greenberg’s effort came to light in a report by Fox Business Network in June. While it is unclear whether that report scared off some potential investors, Mr. Cohen, the hedge fund manager, declined to invest. Peter G. Peterson, an outspoken fiscal conservative who served in the Nixon administration and helped found the giant private equity firm the Blackstone Group, also turned down Mr. Greenberg.
Mr. Greenberg delivered his pitch to the investors at a meeting in his office this March, according to the people with knowledge of the financing arrangement. He also made personal appeals. Mr. Greenberg was seen having lunch with Mr. Cohen at the Four Seasons restaurant in Manhattan in April.
The trial is the latest front in Mr. Greenberg’s long campaign to keep a finger on A.I.G., a company he presided over for nearly 40 years and fashioned into the most valuable insurer in the world. Since his resignation in 2005 in the face of accounting investigations — he settled an S.E.C. action in 2009 and is going to trial next year in a 10-year-old lawsuit from the New York Attorney General’s Office — Mr. Greenberg has fought to maintain his influence.
The bailout presented a threat to that power. When the government took what became a 92 percent equity stake, it diluted the value and voting rights of shares belonging to existing stockholders, including Mr. Greenberg’s company, Starr International. At the time of the bailout, Starr was A.I.G.’s largest investor.
Mr. Greenberg, a veteran of two wars who continues to lift weights well into his 80s, registered his complaint with Mr. Geithner, who was president of the Federal Reserve Bank of New York before becoming Treasury secretary. He called Mr. Geithner at least six times, according to Treasury Department calendars, and met him in 2010 to suggest restructuring the bailout.
Unsatisfied, Mr. Greenberg filed suit a year later. Initially, the case hit a dead end. A federal judge in Manhattan dismissed the case, a decision that a federal appeals court upheld.
Now, however, Mr. Greenberg’s legal team could benefit from trying the case before the claims court in Washington, which typically hears more obscure lawsuits over issues like tax rebates and government contracts. Recently, the court has become a go-to site for Wall Street to pursue its grievances with the government, including hedge funds that filed claims over the bailout of the mortgage finance companies Fannie Mae and Freddie Mac.
Driving Mr. Greenberg’s case is the argument that the government singled out A.I.G. to receive the harshest of bailouts.
For one, it initially paid more than 14 percent interest on a line of credit from the government, which the lawsuit contends was “an extortionate interest rate.” The decision to use taxpayer and A.I.G. money to repurchase soured mortgage deals that the company insured for big banks in the form of credit-default swaps amounted to a “backdoor bailout” of Wall Street, the lawsuit says. And the government’s equity stake “took control of A.I.G. away from its shareholders.”
The final straw, according to the lawsuit, came when the government “deliberately ignored and evaded” a shareholder vote against an increase in shares that would accommodate the government’s equity stake. A.I.G. created a reverse stock split, the lawsuit claims, that effectively allowed the company to circumvent that vote.
The government has dismissed that argument as a “conspiracy theory.” And government lawyers note that A.I.G.’s board accepted the terms of the bailout, which they argue benefited Mr. Greenberg in the long run, saying that “the common shareholders’ 20.1 percent equity stake in A.I.G. after the rescue was worth more than their 100 percent equity stake before the rescue.”
“Neither the Constitution nor the Federal Reserve Act required American taxpayers to rescue A.I.G. and cushion the fall of its shareholders, much less to do so on terms even more favorable to Starr,” the government said in court papers.
Michael Corkery, Jessica Silver-Greenberg and Andrew Ross Sorkin contributed reporting.
Fed’s $85 Billion Loan Rescues Insurer
By EDMUND L. ANDREWS, MICHAEL J. de la MERCED and MARY WILLIAMS WALSH
WASHINGTON — Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.
The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.
With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.
What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.
If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.
“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”
Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse and the bankruptcy of Lehman Brothers, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the United States on Tuesday. Asian stock markets opened with strong gains on Wednesday morning, but the rally lost steam as worries returned about the extent of harm to the global financial system.
Still, the move will likely start an intense political debate during the presidential election campaign over who is to blame for the financial crisis that prompted the rescue.
Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, said Mr. Paulson and Mr. Bernanke had not requested any new legislative authority for the bailout at Tuesday night’s meeting. “The secretary and the chairman of the Fed, two Bush appointees, came down here and said, ‘We’re from the government, we’re here to help them,’ ” Mr. Frank said. “I mean this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.”
House Speaker Nancy Pelosi quickly criticized the rescue, calling the $85 billion a "staggering sum." Ms. Pelosi said the bailout was "just too enormous for the American people to guarantee." Her comments suggested that the Bush administration and the Fed would face sharp questioning in Congressional hearings. President Bush was briefed earlier in the afternoon.
A major concern is that the A.I.G. rescue won’t be the last. At Tuesday night’s meeting. lawmakers asked if there was any way of knowing if this would be the final major government intervention. Mr. Bernanke and Mr. Paulson said there was not. Indeed, the markets remain worried about the financial condition of major regional banks as well as that of Washington Mutual, the nation’s largest thrift.
The decision was a remarkable turnaround by the Bush administration and Mr. Paulson, who had flatly refused over the weekend to risk taxpayer money to prevent the collapse of Lehman Brothers or the distressed sale of Merrill Lynch to Bank of America. Earlier this year, the government bailed out another investment bank, Bear Stearns, by engineering a sale to JPMorgan Chase that left taxpayers on the hook for up to $29 billion of bad investments by Bear Stearns. The government hoped at the time that this unusual step would both calm markets and lead to a recovery by the financial system. But critics warned at the time that it would only encourage others to seek bailouts, and the eventual costs to the government would be staggering.
The decision to rescue A.I.G. came on the same day that the Fed decided to leave its benchmark interest rate unchanged at 2 percent, turning aside hopes by many on Wall Street that the Fed would try to shore up confidence by cutting rates once again.
Fed and Treasury officials initially turned a cold shoulder to A.I.G. when company executives pleaded on Sunday night for the Fed to provide a $40 billion bridge loan to stave off a crippling downgrade of its credit ratings as a result of investment losses that totalled tens of billions of dollars.
Fed’s $85 Billion Loan Rescues Insurer
But government officials reluctantly backed away from their tough-minded approach after a failed attempt to line up private financing with help from JPMorgan Chase and Goldman Sachs, which told federal officials they simply could not raise the money given both the general turmoil in credit markets and the specific fears of problems with A.I.G. The complexity of A.I.G.’s business, and the fact that it does business with thousands of companies around the globe, make its survival crucial at a time when there is stress throughout the financial system worldwide.
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It’s the interconnectedness and the fear of the unknown,” said Roger Altman, a former Treasury official under President Bill Clinton. “The prospect of the world’s largest insurer failing, together with the interconnectedness and the uncertainty about the collateral damage — that’s why it’s scaring people so much.”
Under the plan, the Fed will make a two-year loan to A.I.G. of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80 percent ownership of the insurer, if the existing shareholders approve. All of the company’s assets are being pledged to secure the loan. Existing stockholders have already seen the value of their stock drop more than 90 percent in the last year. Now they will suffer even more, although they will not be totally wiped out. The Fed was advised by Morgan Stanley, and A.I.G. by the Blackstone Group.
Fed staffers said that they expected A.I.G. would repay the loan before it comes due in two years, either through the sales of assets or through operations.
Asked why Lehman was allowed to fail, but A.I.G. was not, a Fed staffer said the markets were more prepared for the failure of an investment bank. Robert B. Willumstad, who became A.I.G.’s chief executive in June, will be succeeded by Edward M. Liddy, the former chairman of the Allstate Corporation. Under the terms of his employment contract with A.I.G., Mr. Willumstad could receive an exit package worth as much as $8.7 million if his removal is determined to be “without cause,” according to an analysis by James F. Reda and Associates.
A.I.G. is a sprawling empire built by Maurice R. Greenberg, who acquired hundreds of businesses all over the world until he was ousted amid an accounting scandal in 2005. Many of A.I.G.’s subsidiaries wrote insurance of various types. Others made home loans and leased aircraft. The diverse array of companies were more valuable under a single corporate parent like A.I.G., because their business cycles offset each other, giving A.I.G. a relatively smooth stream of revenue and income.
After Mr. Greenberg’s departure, A.I.G. restated its books over a five-year period and instituted conservative new accounting policies. But before the company could really rebuild itself, it became embroiled in the mortgage crisis. Some of its insurance companies ended up with mortgage-backed securities on their books, but the real trouble involved the insurance that its financial products unit offered investors for complex debt securities.
Its stock tumbled faster this year as first the debt securities lost value, and then the insurance contracts, called credit default swaps, came under a cloud.
The Fed’s extraordinary rescue of A.I.G. underscores how much fear remains about the destructive potential of the complex financial instruments, like credit default swaps, that brought A.I.G. to its knees. The market for such instruments has exploded in recent years, but it is almost entirely unregulated. When A.I.G. began to teeter in the last few days, it became clear that if it defaulted on its commitments under the swaps, it could set off a devastating chain reaction through the financial system.
“We are witnessing a rather unique event in the history of the United States,” said Suresh Sundaresan, the Chase Manhattan Bank professor of economics and finance at Columbia University. He thought the near brush with catastrophe would bring about an acceleration of efforts within the Treasury and the Fed to put safety controls on the use of credit default swaps.
“They’re going to tighten the screws and say, ‘We want some safeguards on this market,’ ” he said of the Fed and the Treasury.
The swaps are not securities and are not regulated by the Securities and Exchange Commission. And while they perform the same function as an insurance policy, they are not insurance in the conventional sense, so insurance regulators do not monitor them either.
That situation set the stage for deep losses for all the countless investors and other entities that had entered into A.I.G.’s swap contracts. Of the $441 billion in credit default swaps that A.I.G. listed at midyear, more than three-quarters were held by European banks.
“Suddenly banks would be holding a lot of bondlike instruments that were no longer insured,” Mr. Sundaresan said. “They would have to mark them down. And when they marked them down, they would require more capital. And then they would have to go out and raise capital in these markets, which is very difficult.”
Mr. Sundaresan said that for a new market arrangement to succeed, it would have to create a clearinghouse to track swaps trading, and daily requirements to post collateral, so that a huge counterparty would not suddenly find itself having to come up with billions of dollars overnight, the way A.I.G. did.
Edmund L. Andrews reported from Washington. Michael J. de la Merced and Mary Williams Walsh reported from New York. David M. Herszenhorn contributed reporting from Washington and Eric Dash from New York.