Wednesday, June 24, 2015

No. 106: Hank Greenberg's Pyrrhic Victory over the U.S. Government

On June 15, 2015, Judge Thomas C. Wheeler of the U.S. Court of Federal Claims handed down an Opinion and Order ("Opinion") in a lawsuit related to the federal government's bailout of American International Group, Inc. (AIG) in September 2008. The lawsuit was filed by Starr International Co., Inc., a large AIG shareholder. Starr is headed by Maurice R. ("Hank") Greenberg, who was AIG's chief executive officer from 1968 until his retirement in March 2005 during an investigation by then New York Attorney General Eliot Spitzer and then New York Superintendent of Insurance Howard D. Mills, III. The Opinion is a Pyrrhic victory for Greenberg because, although Judge Wheeler ruled in Starr's favor on the "illegal exaction" claim, he ruled that AIG shareholders are entitled to zero damages.

On November 21, 2011, Starr filed two lawsuits against the federal government. One was the claims court lawsuit mentioned above. The other was a district court lawsuit against the Federal Reserve Bank of New York (FRBNY). The latter case was assigned to Judge Paul A. Engelmayer. The government filed motions to dismiss both lawsuits. Judge Wheeler granted the motion in part but denied it in significant part. Judge Engelmayer granted the motion in its entirety. (See Starr v. U.S., U.S. Court of Federal Claims, Case No. 1-11-cv-799, and Starr v. FRBNY, U.S. District Court, Southern District of New York, Case No. 1:11-cv-8422.)

Excerpts from the Opinion
Judge Wheeler's Opinion consists of 75 single-spaced pages. Here are six excerpts from the ten-page introductory section, with the page number indicated at the beginning of each excerpt:
Page 2: On the weekend of September 13-14, 2008, known in the financial world as "Lehman Weekend" because of the impending failure of Lehman Brothers, U.S. Government officials feared that the nation's and the world's economies were on the brink of a monumental collapse even larger than the Great Depression of the 1930s. While the Government frantically kept abreast of economic indicators on all fronts, the leaders at the Federal Reserve Board, the Federal Reserve Bank of New York, and the U.S. Treasury Department began focusing in particular on AIG's quickly deteriorating liquidity condition. AIG had grown to become a gigantic world insurance conglomerate, and its Financial Products Division was tied through transactions with most of the leading global financial institutions. The prognosis on Lehman Weekend was that AIG, without an immediate and massive cash infusion, would face bankruptcy by the following Tuesday, September 16, 2008. AIG's failure likely would have caused a rapid and catastrophic domino effect on a worldwide scale.
Page 2: On that following Tuesday [September 16, 2008], after AIG and the Government had explored other possible avenues of assistance, the Federal Reserve Board of Governors formally approved a "term sheet" that would provide an $85 billion loan facility to AIG. This sizable loan would keep AIG afloat and avoid bankruptcy, but the punitive terms of the loan were unprecedented and triggered this lawsuit. Operating as a monopolistic lender of last resort, the Board of Governors imposed a 12 percent interest rate on AIG, much higher than the 3.25 to 3.5 percent interest rates offered to other troubled financial institutions such as Citibank and Morgan Stanley. Moreover, the Board of Governors imposed a draconian requirement to take 79.9 percent equity ownership in AIG as a condition of the loan. Although it is common in corporate lending for a borrower to post its assets as collateral for a loan, here, the 79.9 percent equity taking of AIG ownership was much different. More than just collateral, the Government would retain its ownership interest in AIG even after AIG had repaid the loan.
Page 3: The main issues in the case are: (1) whether the Federal Reserve Bank of New York possessed the legal authority to acquire a borrower's equity when making a loan under Section 13(3) of the Federal Reserve Act...; and (2) whether there could legally be a taking without just compensation of AIG's equity under the Fifth Amendment where AIG's Board of Directors voted on September 16, 2008 to accept the Government's proposed terms. If Starr prevails on either or both of these questions of liability, the Court must also determine what damages should be awarded to the plaintiff shareholders...
Page 7: Having considered the entire record, the Court finds in Starr's favor on the illegal exaction claim. With the approval of the Board of Governors, the Federal Reserve Bank of New York had the authority to serve as a lender of last resort under Section 13(3) of the Federal Reserve Act in a time of "unusual and exigent circumstances,"... However, Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower's equity as consideration for the loan...
Page 8: A ruling in Starr's favor on the illegal exaction claim, finding that the Government's takeover of AIG was unauthorized, means that Starr's Fifth Amendment taking claim necessarily must fail. If the Government's actions were not authorized, there can be no Fifth Amendment taking claim...
Page 10: ...The end point for this case is that, however harshly or improperly the Government acted in nationalizing AIG, it saved AIG from bankruptcy. Therefore, application of the economic loss doctrine results in damages to the shareholders of zero.
Outline of the Opinion
After the introductory section, the remainder of the Opinion consists of seven sections and an "Appendix of Relevant Entities and Persons." Here are the titles of the sections and subsections:

  Findings of Fact 
The September 2008 Financial Crisis 
AIG's Financial Condition in 2008
September 13-14, 2008"Lehman Weekend" 
September 16, 2008 Loan and Term Sheet 
Development of the September 22, 2008 Credit Agreement 
The Government's Control of AIG
The Creation of a Trust
The Restructuring of AIG's Loan in November 2008
The Walker Lawsuit
Maiden Lane II and III
Reverse Stock Split
The Government's Common Stock
Treatment of [five] Other Distressed Financial Entities 
Expert Testimony [four for each party]
AIG Epilogue
History of Proceedings
JurisdictionSection 13(3) of the Federal Reserve Act
Legal Analysis
The Illegal Exaction Claim
The Fifth Amendment Taking Claim
Summary of Starr's Damages Claim
Economic Loss Analysis
Defendant's Procedural Defense of Waiver

Parties' Statements
Starr issued a statement saying in part it was "pleased that the trial court found that the Federal Reserve acted illegally, discriminatorily, and for improper political purposes in requiring AIG, and AIG alone, to surrender 80% of their equity as compensation for a Federal Reserve loan." Starr also said it "will appeal the ruling that there is no remedy for the Government's illegal conduct, and ask the court of appeals to confirm that the Government is not entitled to keep billions of dollars of citizens' money in its pocket."

The Federal Reserve issued a statement saying in part it "strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective." The Federal Reserve did not indicate whether it will appeal the illegal exaction ruling.

Press Coverage
The Opinion was the subject of page-one articles the next day in The New York Times, The Wall Street Journal, and other media outlets. The rush to report about such a complex ruling can produce errors. For example, a Bestwire article in the late afternoon of the day the Opinion was filed contained a significant error. The fourth sentence of the article said Judge Wheeler "ruled the takeover constituted an illegal taking without just compensation that violated the Fifth Amendment of the U.S. Constitution." He did not make such a ruling. The excerpt from page 8 of the Opinion, as quoted above, shows he ruled that "Starr's Fifth Amendment taking claim necessarily must fail." Subsequent Bestwire articles repeated the error by citing the original incorrect statement.

General Observations
I wrote about the two Starr lawsuits against the federal government in the April 2013 issue of The Insurance Forum. There I expressed agreement with observers who characterized the lawsuits as an attempt to rewrite the terms of the AIG rescue package. I still hold that view.

Several points should be kept in mind. First, during those fateful days in September 2008, those who devised the AIG rescue package had only a few hours to work with, and many other matters were demanding their attention at that hectic time.

Second, Judge Wheeler had nearly four years to study the matter (November 2011 to June 2015). That period consisted of nearly three years of pre-trial filings, a 37-day bench trial spanning two months, a transcript of nearly 9,000 pages, more than 1,600 exhibits, testimony of 36 witnesses (the most prominent were Ben Bernanke, Timothy Geithner, and Henry Paulson), and almost a year of post-trial filings and the writing of the Opinion.

Third, there was no time to seek shareholder approval of the rescue package. Even if there had been time, it is frightening to contemplate what might have happened if the shareholders, led by Greenberg, had voted it down.

Available Material
I am offering a complimentary 81-page PDF consisting of Judge Wheeler's 75-page Opinion, Starr's one-page statement, the Federal Reserve's one-page statement, and the four-page article from the April 2013 issue of The Insurance Forum. E-mail and ask for the Wheeler/Starr/US package.