Geithner and AIG: Hard Lessons From the 'Bailout Trial'

The goal of the lawsuit -- to provide even more for AIG's bailed-out shareholders -- seems absurd. But at least this lawsuit, which has already seen testimony from two former Treasury secretaries, is finally giving the American people some hard lessons in the workings of the bailout process and the shortcomings of our current economic system.
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A lawsuit currently being tried in the U.S. Court of Federal Claims argues that AIG shouldn't have been treated any more harshly than Goldman Sachs, Bank of America, or any of the other institutions the government rescued.

There's merit to that argument.

It goes on to assert that AIG deserved the same kind of cushy deal the government gave to the other institutions it rescued.

That's a stretch.

The goal of the lawsuit -- to provide even more for AIG's bailed-out shareholders -- seems absurd. But at least this lawsuit, which has already seen testimony from two former Treasury secretaries, is finally giving the American people some hard lessons in the workings of the bailout process and the shortcomings of our current economic system.

We don't know who'll win in the end. But we probably know who'll lose.

Full Disclosure

A conflict of interest note: I worked for AIG for a number of years (not in the financial division, but as a midlevel manager and technical analyst in the healthcare and risk management divisions), and met then-CEO Maurice "Hank" Greenberg a couple of times

That AIG background may have contributed to my initial reaction when I first read that the notoriously aggressive Greenberg was suing the Treasury Department and the New York Fed. As the Wall Street Journal reported in 2011, he accused them of "wrongly taking control of the insurer and using it as a vehicle to funnel tens of billions of dollars to AIG's trading partners, which included large U.S. and European banks."

I remember reading that sentence out loud to my wife and saying with a laugh, "Look, honey, Hank's fighting for the 99 percent!" (I would not have addressed him as "Hank" when I was employed there.)

The move was a surprise. But Greenberg's shrewdness was not, since even his bitterest rivals acknowledge his brilliance. Still, few people thought the lawsuit had a chance of getting very far. They were wrong. Former Bush Treasury Secretary Hank Paulson testified yesterday, and former Obama Treasury Secretary Timothy Geithner testified today (although Geithner's testimony addressed his actions as President of the New York Fed during the AIG rescue.)

Neither acquitted himself honorably or well - and neither is likely to be held accountable for it.

The Two Mr. Paulsons

Observers report that Paulson's testimony was repeatedly punctuated by decisive statements and "You betchas!"

It was also dripping with hypocrisy. When the former Goldman Sachs CEO was asked why AIG's shareholders were forced to accept an extraordinarily high interest rate of 12 percent per year, Bloomberg News reported that he said, "When companies fail, shareholders bear the losses. It's just the way the system is supposed to work."

"It was important that terms be harsh," Paulson said sanctimoniously, "because I take moral hazard seriously."

Does he? When it came to the banks themselves, Paulson's standards were considerably more lax. He testified yesterday that, where the banks were concerned, he only believed in "fairness to the extent you can have fairness," but that "to me, stability trumped moral hazard."

His moral relativism applied to all the major banking institutions, especially Paulson's alma mater Goldman Sachs. The government was happy to bail out Goldman, and even bent the rules to make a bailout possible. The scandal-plagued outfit was not even a bank when the crisis hit, and was therefore not qualified to receive Fed assistance. But Paulson and Geithner retroactively declared it one so that they could save it.

As for AIG, Paulson acknowledged that the terms of its bailout were "punitive."

Geithner Forgets

Where Paulson was decisive, Tim Geithner was ... a little hazy about the details. Reports filed from the courtroom emphasized the many times that Geithner asserted he couldn't recall critical facts and figures, and other occasions when he was forced to refer to his own autobiography to answer questions.

To be fair, a careful reading of Geithner's memoir suggests that this may not have been an act. But on the fundamental issues, at least, Geithner didn't hesitate to assert himself. His positions tracked closely with Paulson's, and Geithner's attempts to justify himself were as riddled with contradictions as his predecessor's.

The most troubling moment for Geithner seems to have occurred when he was forced to admit that AIG shareholders were "wiped out" by the government's bailout terms -- an assertion which cannot be made about the shareholders of any major American bank. (I don't own any AIG shares now, and didn't then.)

Geithner also testified that "mass panic" would have accompanied an AIG failure. But testimony also revealed that he and Paulson were nevertheless unafraid to confront it with extreme demands, and insist that it capitulate within hours.

And yet Geithner, like Paulson, argued that banks were too critical to the economic system to risk confronting them with any uncomfortable demands, much less "harsh" ones that came with strict deadlines. It's hard to square those two pieces of testimony, although much effort will be expended on that task in the coming weeks.

No Dominoes

Paulson argued that strong moves against American banks would have led to a rush of shortselling against them, creating a domino effect that could bring down the banking industry. Because "I didn't see another insurance company that was vulnerable," said Paulson, he didn't see any reason to go easy on the conglomerate.

Unfortunately, while that argument sounds plausible, it doesn't really wash. At this point AIG's competitors were other financial institutions, because of both its extensive financial portfolio and the blurring distinction between insurance products and risk-based products such as derivatives.

What's more, Paulson's argument fails to explain why the two sets of institutions weren't just treated differently, but radically differently, with draconian rules for one and lavish rescues with no consequences for the other.

This was not a question of dominoes, but of dice -- in the hands of dealers who had friends in the crowd.

Beyond Doomsday

How legal was the decision to retroactively declare Goldman Sachs a "bank" so that it could be rescued? Bizarrely, the full extent of the Federal Reserve's legal powers remains a secret from the public - although the public created it through an act of Congress. Its powers are codified in something called the "Doomsday Book," which sounds a little like a medieval religious tract. The "Doomsday Book" was admitted into evidence today, but at the insistence of Fed officials it was to be kept under seal.

Geithner breezily contended that the book was irrelevant in any case, since "we were operating outside the boundaries of established precedent" -- which apparently means they didn't feel bound by legal restrictions.

Part of Goldman's "unprecedented" rescue came in the form of a $13 billion "backdoor bailout" through AIG, when the government required it to pay 100 cents on the dollar for the payments it owed Goldman and other financial institutions -- even as shareholders and other creditors were required to take substantial losses.

Fair Play

If these bailouts were handled unfairly, what would fairness have looked like? Greenberg argues that AIG would have received a bailout on terms which were as generous as those given the big banks, or that it should have been allowed to close the deal it allegedly had lined up with Chinese investors.

We'll wait for more information on the China deal. But as far as the bailouts are concerned, Greenberg and his attorneys have it exactly backward: AIG shouldn't have received the kinds of deals that Goldman, Citigroup, and the other banks received. The banks should have been given something much closer to the deal AIG got -- including "punitive" measures wrapped in a "harsh" ultimatum.

That doesn't necessarily mean that any shareholders should have been severely punished. As we have learned, senior bank executives have been known to defraud their investors -- including pension funds -- by misleading them on the banks' financial position. But the American people should have received significant rewards from the banks in return for rescuing them. More importantly, the corrupt and incompetent executives who ran those banks should have promptly been forced out, as AIG's chief executive was.

Instead, many of the executives who led America's banks as they committed widespread mortgage and investment fraud remained in place -- and reaped rich rewards from the bailout.

Conclusion: Systemic Failures

We are told that AIG and the big banks were rescued in order to prevent a systemic failure. But there was a systemic failure of sorts. In fact, there were a number of them.

Our regulatory system failed to provide proper oversight to Wall Street, as the result of regulatory capture and a misguided fervor for deregulation. Then it failed to demand accountability from bankers who mismanaged their institutions and should have suffered the consequences.

Our judicial system failed to hold bankers criminally accountable for their massive acts of fraud, negotiating institutional settlements while ignoring the criminal acts that led to those settlements in the first place. (That failure will forever cloud Attorney General Eric Holder's record, obscuring his substantial accomplishments in other areas.)

Our "ratings agencies," which are actually for-profit companies, failed to perform their professional and moral duty when they rated worthless mortgage-backed securities "AAA" in return for financial rewards for themselves and their senior executives -- a failure for which they have not been held accountable.

Accounting firms, which are supposed to abide by a code of professional ethics, also experienced systemic failure. AIG shared an accounting firm with "counterparty" Goldman Sachs -- and that firm failed the public in both cases.

Our political system has failed to hold politicians accountable for the decisions which led to this massive failure. Bill Clinton's fervor for Wall Street and deregulation played a key role. So did the Republican Party's total submission to corporate donors, which gets more extreme every year. And so has Barack Obama's unwillingness to hold bankers criminally accountable or break up the big banks.

Our society has yet to comprehensively address breakdowns in the systems which should protect us from economic catastrophe. The Dodd/Frank financial reform bill was a start, but much remains to be done.

We'll keep following the trial, and we don't know who will win in the end. But until more is done to repair these "systemic failures," we know who will continue to lose: us.

Postscript: Counterparties

An afterthought: What kind of institutions did Hank Paulson and Tim Geithner help when they used AIG as a rescue vehicle, insisting that it pay its creditors in full? The banks wwhich benefited most included Citigroup, Deutsche Bank, UBS, Merrill Lynch, Bank of America, and Goldman Sachs. The following summary undoubtedly omits a number of their misdeeds, and is intended only to provide some insight as to their institutional character:

Citigroup was born during the Clinton administration, which gave the greenlight to the massive merger which created it. Clinton Treasury Secretary Robert Rubin eventually became its CEO. It was considered the worst-managed of all the major banks (which is no small distinction).

Citi eventually reached a $7 billion settlement for fraudulently selling bad mortgage securities, paid $590 for deceiving investors about subprime debt, and paid $285 million for deceiving investors about mortgage bonds -- a figure which was only finalized after a judge rejected the government's deal as inadequate but was overruled.

As is the case with most deals the government struck during this period, the bank was not required to admit wrongdoing.

Deutsche Bank paid more than $550 million and admitted criminal wrongdoing in a tax fraud case which cost the federal government billions in tax losses (where were the deficit hawks when that happened?) It paid $202.3 million to settle a mortgage fraud case. And its home office was raided this year in an unrelated fraud investigation.

UBS has been fined $1.5 billion for LIBOR interest rate fraud, $49.8 million for derivatives-related fraud, and is currently facing tax fraud charges in France.

Merrill Lynch paid $10 million for fraud charges stemming from its misuse of confidential customer information for its own profit. It paid $131.8 million for fraudulent sale of mortgage-backed CDOs.

Bank of America was a party to the $25 billion multi-bank foreclosure fraud settlement. It paid $245 million for securities fraud and mortgage-related investor fraud. It paid $150 million for failing to disclose Merrill Lynch losses to investors before they approved its merger with the troubled institution.

Goldman Sachs, Paulson's former outfit, profited from short-selling its own products in the run-up to the financial crisis -- even as it was selling those products to unwary customers. In 2010 it paid a then-record $550 million settlement for mortgage securities fraud. The SEC gave it a $22 million rap on the knuckles for illegally sharing insider information with preferred clients. Observers were stunned when Goldman CEO Lloyd Blankfein, who clearly appeared to deceive Congress, was not charged with perjury -- and when, unlike AIG's CEO, he was permitted to remain in his lucrative position of leadership. As Hank Paulson might say: You only get fairness to the extent you can have fairness.

You betcha!

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