Maybe the idea of suing the US government over the terms of a gargantuan bailout isn’t such a winning move for AIG.
That’s what the directors of American International Group concluded in a Wednesday meeting. The insurance company’s board was reviewing legal action by another firm, Starr International, calling on AIG to join a lawsuit arguing that the terms of the 2008 rescue trampled on shareholder rights.
Starr is run by former AIG chief Maurice “Hank” Greenberg, and had been a major shareholder of AIG.
“The AIG Board has determined to refuse Starr’s demand in its entirety, and will neither pursue these claims itself nor permit Starr to pursue them in AIG’s name,” AIG said in a statement released late in the day.
The company said it had been legally bound to weigh the best interests of shareholders. By inference, it concluded that the damage to its public image – hinted at in a firestorm of public criticism this week over the possible legal action – outweighed any potential benefits of joining the lawsuit.
But the uproar over the proposed lawsuit has served up a reminder that goes beyond the details of AIG: Debate over the role government should play in the nation’s financial system during times of panic is far from over.
AIG’s rescue defined a pivotal point in the financial crisis.
The investment bank Lehman Brothers had just collapsed, and there was uncertainty about whether AIG and then others would fail next. The Federal Reserve promptly moved to the aid of AIG, extending an $85 billion loan in exchange for 80 percent ownership in the troubled firm.
The goal was not merely to save the troubled company, but to quell worry of a relentless domino effect in the intertwined world of finance, where the failure of one firm results in losses at others.
But the rescue left a big question in its wake: Isn’t there a better way?
AIG’s bailout was controversial not just because it was a big handout from the Fed and later from taxpayers. It also allowed large banks to avoid any losses on risky investments made with AIG. Much of the bailout money simply passed through AIG to those banks, paying them in full on investment contracts known as “credit default swaps.”
Mr. Greenberg alleges another problem with the bailout as well. His lawsuit via Starr International argues that the AIG rescue represented an illegal taking of private property without just compensation. Greenberg isn’t arguing that AIG needed no help. But the lawsuit, at a minimum, underscores that setting the terms of a bailout can be an imprecise and controversial art.
The Starr lawsuit against the US government and the Federal Reserve Bank of New York now appears set to go forward, but without AIG’s willing participation.
AIG aims to prevent Starr from prosecuting any claims on AIG’s behalf, but on Tuesday it characterized Starr as “likely to challenge” such an effort.
To outsiders, the idea that AIG, the recipient of a highly unpopular bailout, might turn around and sue its benefactor seemed the height of insensitivity.
On Tuesday, AIG’s chief executive, Robert Benmosche, sought to navigate the delicate situation.
“AIG has paid back its debt to America with a profit, and we mean it when we say thank you to the American people,” he said in a statement on the lawsuit. “At the same time, the Board of Directors has fiduciary and legal obligations to the Company and its shareholders to consider.”
The board reached a decision quickly. The company must still file a formal statement of its position in court in coming weeks.
Some finance experts argue that the AIG rescue, while disappointing in many ways, represented a generally successful response in a dire predicament. Rightly or wrongly, the terms deal did evolve over time, with more bailout money being added and the interest rate on loans falling from the initial 14 percent that Greenberg has called “punitive.”
To the surprise of many, the government recouped the money it put into AIG, posting a profit on the final sale of stock announced last month.
Sheila Bair, who headed the Federal Deposit Insurance Corp. during the crisis, argues in a recent book that AIG and some large banks were insolvent, but that their risk to the financial system couldn’t practically be addressed through bankruptcy at the time.
“The Lehman experience demonstrated that bankruptcy was not an option for the orderly resolution of large, interconnected financial institutions,” she writes.
The Dodd-Frank financial reform law tried to remedy that problem. The law tries to set up a framework in which the FDIC could take over a large financial firm on the brink of failure, like AIG. It seeks to impose losses on creditors of the failing firm, rather than letting them be paid in full.
But finance experts disagree about how well such a process will work – including on the important matter of staving off a meltdown in financial markets – during the next crisis.