When former Treasury secretary
Henry (Hank) Paulson Jr. testified in a suit last month
about the U.S. government takeover of American International
Group, his words were mostly numbingly familiar.
Explaining the punitive terms set for the September
2008 bailout, he referred again to the transactions
moral hazard a term of art Paulson has
invoked to describe the notion that companies should not rely
on Uncle Sam when they foul up. I take moral hazard
seriously, he said.
In the deal, a hemorrhaging AIG got an $85 billion backstop
that eventually ballooned to $182.3 billion in U.S. taxpayer
funds, and Treasury got 79.9 percent of the insurer. It
did indeed punish the shareholders, Paulson said.
Thats just the way our system is supposed to work,
that when companies fail, the shareholders bear the
What makes Paulsons testimony remarkable is a tale
that can be pieced together through a court document, the
Plaintiffs Corrected Proposed Findings of Fact, and the
exTreasury secretarys own foggy recollections.
Despite talk of moral hazard, it turns out that at least one
alternative to the taxpayer rescue was readily available.
Specifically, China Investment Corp., the big sovereign
wealth fund of the Peoples Republic of China, approached
the Treasury Department directly and was eager to make an AIG
investment an offer that one or more officials in
Paulsons office in September 2008 believed was sufficient
to meet the insurers needs at the time.
According to the court document, Treasury officials, after
consulting with Paulson, told CIC that its help was not wanted.
The secretary did not return CICs phone call, as
requested by the Chinese government. A Treasury colleague was
dispatched to tell the fund, in effect, to go away. A seperate,
indirect entreaty from CIC was rebuffed as well.
Paulsons brush-off of CIC is proof, critics say, that
at the very least there were unexplored rescue options for AIG.
There were other solutions that did not require
taxpayers or anybody elses money, says
longtime investor Jim Rogers, a former partner of Soros Fund
Management and a critic of the AIG bailout. In the end,
somebody did pay, and I just wish it hadnt been the
The disclosure prompts two gob-smacking questions: Was the
taxpayer bailout of AIG, the biggest in U.S. history, really
necessary? And what would have happened if the main sovereign
wealth fund of Americas biggest geopolitical rival had
rescued it instead?
Alas, we may never know, but the revelation bolsters the
arguments of those who view the bailout as a giant payoff to
banks that were on the hook for tens of billions of dollars if
AIG went belly-up including New Yorkbased Goldman
Sachs Group, where Paulson served as CEO from 1999 to 2006,
before being appointed Treasury secretary.
Its sinister or cynical, fumes James Cox,
a professor at Duke Law School. Its protecting the
big banks against the yellow peril.
The suit, Starr International Co., Inc. v. United States
of America, effectively pits Maurice (Hank) Greenberg, CEO
of Starr, among the largest shareholders of AIG, against
regulators including former Federal Reserve chairman Ben
Bernanke and exNew York Federal Reserve Bank president
Timothy Geithner, who have also testified. Starr alleges
the government violated its constitutional rights as well as
those of other AIG investors by appropriating their property
without just compensation. Filed in the U.S. Court of Federal
Claims in Washington D.C., the suit also asserts that the terms
of the bailout were unfair, citing in particular the interest
rate of more than 14 percent on the credit line that was part
of the deal.
Starr, based in Zug, Switzerland, is seeking more than $40
billion in damages. And in hiring David Boies of Boies,
Schiller & Flexner, who represented former vice president
Al Gore in Bush v. Gore and has worked on other noted
cases, the 89-year-old Greenberg has lined up some high-gauge
legal firepower. AIG itself is a nominal defendant in the suit,
meaning it is included for technical reasons. The suit is
ongoing, with a ruling not expected until next year. An AIG
spokesman declined to comment.
As for Greenberg himself, he was forced out as CEO of AIG in
2005 amid fraud allegations by Eliot Spitzer that the former
New York State Attorney General never proved. Greenberg
maintained control of Starr, whose business was closely
intertwined with that of AIG.
AIG wasnt the only financial firm to run into trouble
in September 2008 as credit markets froze and stock prices
plunged. Fannie Mae and Freddie Mac, two government-sponsored
mortgage companies, were placed in conservatorship on September
6, 2008, as the value of their loan portfolios collapsed.
Merrill Lynch & Co., losses mounting, agreed on Sunday,
September 14, to be acquired by Bank of America Corp. At 1:45
a.m. the following Monday, September 15, Lehman Brothers
Holdings filed for bankruptcy, after a plan for London-based
Barclays to buy it was nixed by the U.K.s then-chancellor
of the Exchequer
Alistair Darling. That forced the venerable Reserve Primary
Fund, a money market fund that held Lehman commercial paper, to
break the buck, the value of its shares falling
from $1 to 97 cents. Redemptions were suspended. Panic
New Yorkbased AIGs financial situation had been
deteriorating for months. The company was bleeding cash,
largely because of the rising cost of insurance it had written
on $62.1 billion of toxic collateralized debt obligations
(CDOs). On September 15, the same day Lehman filed for Chapter
11, major rating agencies downgraded AIGs long-term
credit outlook, triggering further collateral calls by its bank
counterparties. The downgrades would almost certainly have
bankrupted the insurance giant.
We know what happened next. As part of the bailout, the New
York Fed, on behalf of the U.S. government, took control of
AIGs management and directed it to pay off the banks that
had bought insurance on the CDOs despite the fact that
these counterparties, including Goldman Sachs, Frankfurt-based
Deutsche Bank, Merrill Lynch and Société
Générale of Paris, had largely underwritten or
managed these cratering securities themselves. The public was
A key point of contention was the New York Feds
insistence that AIG pay the banks 100 cents on the dollar for
the insurance, which was in the form of credit default swaps,
even though AIG had been negotiating discounts on the
insurance. That made Goldman Sachs, Paulsons alma mater,
whole on its $14 billion in CDO protection and the other banks
whole on theirs. The CDOs were shunted into a special-purpose
vehicle called Maiden Lane III, named after the street where
the New York Fed keeps a back door through which it can sneak
people without undue attention. (Perhaps thats another
reason to call the rescue a backdoor bailout.) A spokeswoman
for the New York Fed declined to comment, while the Treasury
Department did not respond to phone calls.
The suit speaks to the changes in
sovereign wealth funds themselves since the crisis a
period in which the state-owned investors have mushroomed,
hitting an estimated $5.3 trillion in assets under management
in 2014, up from just $2.4 trillion in 2007, according to Institutional Investors Sovereign Wealth
The funds have evolved, becoming more sophisticated stewards
of their nations wealth and less likely to serve as
bottomless sources of liquidity in times of trouble. Before and
during the financial crisis, they were pouring money into
foundering U.S. and European banks with abandon.
Among the biggest deals, according to Sovereign Wealth
Center data, was GICs $6.9 billion investment in New
Yorkbased Citigroup in January 2008 and a $10.3 billion
deal with Zurich-based UBS that May. In November 2007 the Abu Dhabi Investment Authority had sunk
$7.5 billion into Citigroup. Korea Investment Corp. and the Kuwait Investment Authority each plowed $2
billion into Merrill Lynch in January 2008 following Temasek Holdings $4.4 billion
investment in the firm the previous month. Temasek took an
additional $3.4 billion slug in July 2008, just months before
Merrills disastrous acquisition by Charlotte, North
Carolinabased Bank of America, which was completed, under
U.S. government pressure, on January 1, 2009. The Qatar Investment Authority ponied up a
total of $7.7 billion for two 2008 investments in Barclays. The
fund also sank a total of $4.4 billion into two deals with
Zurich-based Credit Suisse. The list goes on.
There were multiple motivations back then, says
Rachel Ziemba, director of emerging markets at Roubini Global
Economics in London. One was to gain access to assets at
a discount, two was trying to leverage their own financial
institutions and partner with the firms they were investing in,
and three was some feeling they would be thanked there
was a desire to build up political capital. Some of the
sovereign funds would come to regret their munificence.
The investments of 200708 were largely
sovereign wealth funds coming to the rescue of the Western
financial system, says Sven Behrendt, founder of
Geneva-based consulting firm GeoEconomica. There was an implicit
understanding of a political quid pro quo based on financial
engagement for broader nondiscriminatory market