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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 transaction’s “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. “That’s just the way our system is supposed to work, that when companies fail, the shareholders bear the losses.”

What makes Paulson’s testimony remarkable is a tale that can be pieced together through a court document, the Plaintiffs’ Corrected Proposed Findings of Fact, and the ex–Treasury secretary’s 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 People’s Republic of China, approached the Treasury Department directly and was eager to make an AIG investment — an offer that one or more officials in Paulson’s office in September 2008 believed was sufficient to meet the insurer’s 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 CIC’s 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.

Paulson’s 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 else’s 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 hadn’t been the American taxpayer.”

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 America’s 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 York–based Goldman Sachs Group, where Paulson served as CEO from 1999 to 2006, before being appointed Treasury secretary.

“It’s sinister or cynical,” fumes James Cox, a professor at Duke Law School. “It’s 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 ex–New 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 wasn’t 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 reigned.

New York–based AIG’s 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 AIG’s 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 AIG’s 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 outraged.

A key point of contention was the New York Fed’s 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, Paulson’s 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 that’s 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 Investor’s Sovereign Wealth Center.

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 GIC’s $6.9 billion investment in New York–based 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 Holding’s $4.4 billion investment in the firm the previous month. Temasek took an additional $3.4 billion slug in July 2008, just months before Merrill’s disastrous acquisition by Charlotte, North Carolina–based 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 2007–’08 were largely interpreted as 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 access.”

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