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AIG: Audacity is Good, Acceptance is Good

January 18, 2013

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The Fifth Amendment to the Constitution prevents the federal government from taking private property without just compensation. In its most basic construction, this means that if the government  isgoing to take your family farm to build a highway, your property will be appraised and you will be compensated accordingly. It gets tricky when what’s being taken isn’t literal property such as real estate. What if the government were to take control of, say, 79% of your company’s equity? Not the most absurd idea to find its way into the American legal system.

Unless that “taking” was actually the government stepping in and saving your company, which happens to be the nation’s largest insurer, from going bankrupt and shattering an already suffering economy.

Last week American International Group’s board of directors had to consider whether or not it would join a lawsuit mounted by ex-CEO Hank Greenberg against the U.S. government for what he believes amounts to an unconstitutional taking.

So much for Thank You, America?

 

BACKGROUND

In 2008 the American financial system was falling apart right before everyone’s eyes. Banks began issuing credit, particularly mortgages, like it was going out of style. Running roughshod over the concepts of “creditworthiness” and “ability to repay,” these institutions created mountains of subprime loans on the idea that they could bundle them into muddled, confusing securities and eventually sell them off to unsuspecting investors.

Major investment banks bought into the profitability of these securities and began buying them up. To mitigate their risk, they then bought a type of insurance on these risky securities known as a credit default swap. When the original loans began to default, the securities tanked, and the insurers (namely AIG) were left to make payments to the holders of the credit default swaps.

AIG, in turn, didn’t have the liquidity to be able to make these kind of payouts and faced imminent bankruptcy. This is when the federal government stepped in. Claiming the “systemic risk” that AIG held and the damage that its bankruptcy would cause the U.S. economy, the government bought out a majority stake in AIG for $182.3 billion.

By 2012, the government sold out all its shares of AIG, recovering its $182.3 billion in full, and then some. American taxpayers ended up making a $22.7 billion profit on its “investment” (bailout) of AIG.

 

THE LAWSUIT

Mr. Greenberg, the former CEO of AIG now leads a group of AIG shareholders called Starr International. It is Mr. Greenberg, through Starr, who purports to sue the federal government for an unconstitutional taking.

Last week, he went to AIG’s board and presented them with the opportunity to join the lawsuit on behalf of all its shareholders not represented by Starr. The board eventually produced a statement in which they formally distanced themselves from Starr’s lawsuit and forbade Starr from pursuing any claims in AIG’s name.

 

BITING THE HAND

Despite their ultimate disapproval, the very idea of the lawsuit drew severe criticism on AIG’s behalf.

“It shows that some of the former masters of the universe — those who were bringing this idea forward — have no shame,” said Democratic Senator Jeff Merkley, of Oregon.

Thank You, America messages seem to carry little weight when AIG is contemplating thanking Americans in person, in court. Some critics, still bitter about AIG’s role in the financial crisis, expect them to accept the bailout with a sense of humble gratitude.

Others speculate on the potential future implications of the suit. Will the government be more hesitant to step in and rescue a “too-big-to-fail” firm with this knowledge in mind? “You’re not going to have a bailout story that doesn’t have AIG in it,” says corporate reputation adviser Bill Haynes.

 

TAKING A STAND

So does Mr. Greenberg just have one of the most twisted senses of humor in the United States? Surely there must be some underlying reason behind this lawsuit. In fact, Mr. Greenberg may in fact have a legitimate claim with AIG shareholders’ best interests at heart.

By providing AIG with the liquidity it needed to make all its payouts, the U.S. government eliminated a lot of the losses that could have resulted from the risky lending and mortgage-backed securities. Mr. Greenberg alleges that the bailout of AIG was a “covert, inequitable backdoor bailout for Goldman Sachs and AIG’s other bank counterparties.” This, he claims, is the real reason that the government forced the AIG board to allow the fed’s supermajority stake in the company without just compensation for the equity.

Where those counterparties were able to benefit from the bailout, Mr. Greenberg claims that AIG’s shareholders may in fact have benefited more from a more traditional Chapter 11 bankruptcy. That’s not easy to say, but given the chance to litigate, the judicial system could certainly reach an agreement on that issue.

 

CONCLUSION

This issue, like most others revolving around the 2008 financial crisis, is quite convoluted. At this point, it really is hard to tell who is in the right here. As seen by the public’s reaction to the suit, AIG probably made the right decision by staying out. Joining the suit would have really undermined their Thank You, America campaign and would have been a big setback in attempting to gain favor with lawmakers and regulators. The public relations claims just might eke out the legal claims here.

However, none of that is to say that the suit is without merit. Starr International should by all means carry on with the suit and force judgement on whether or not the federal government really had AIG and the American peoples’ best interests in mind. This suit provides an opportunity for the courts to seriously explore questions about the authority the federal government exercised in response to the financial crisis. While it is certain that AIG would have lost in the court of public opinion, the same can’t be said for certain about the court of law. There’s more than one side to this story and its important to consider all of them before forming an opinion.

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