Thursday, March 30, 2023 | Back issues
Courthouse News Service Courthouse News Service

Judge Sees Fed Overreach in 2008 Bailout of AIG

(CN) - The Federal Reserve had no authority to demand 80 percent of AIG's equity as a condition of its $85 billion bailout in 2008, a federal judge ruled.

"There is no law permitting the Federal Reserve to take over a company and run its business in the commercial world as consideration for a loan," U.S. District Judge Thomas Wheeler said in a 75-page opinion.

When the Federal Reserve bailed out American International Group, it took 79.9 percent of the company's equity in exchange for a loan of $85 billion to prevent the company's collapse.

AIG had entered into credit default swaps to insure $441 billion worth of securities originally rated AAA. But $57.8 billion of these swaps were back by subprime loans that were unmasked as worthless in the 2008 financial crisis.

As a result, AIG's credit rating was downgraded, and it faced a liquidity crisis that would have doomed the company if the Federal Reserve had not acted to save the insurance giant.

Over the next three years, AIG required more funds from the government to stay afloat as its losses widened. The government loaned a total of $182.3 billion to the company, which paid back a total of $205 billion by the end of 2012.

But former AIG chief executive Maurice Greenberg, who remains major shareholder of the company through his Starr International, filed a shareholder class action claiming that the Federal Reserve overstepped its authority when it demanded equity as a condition for the bailout, and effectively became its majority owner.

Wheeler found for Greenberg on Monday, ruling that the Fed's actions constituted an "illegal exaction under the Fifth Amendment."

"It is one thing for FRBNY [Federal Reserve Bank of New York] to have made an $85 billion loan to AIG at exorbitant interest rates under Section 13(3), but it is quite another to direct the replacement of AIG's Chief Executive Officer, and to take control of AIG's business operations," the judge wrote.

Even so, the judge declined to award Greenberg any damages, because the Fed's actions did not injure shareholders - rather, the bailout preserved some of their equity, when AIG's alternative was bankruptcy.

The former CEO sought at least $40 billion from the government.

"The inescapable conclusion is that AIG would have filed for bankruptcy, most likely during the week of September 15-19, 2008. In that event, the value of the shareholders common stock would have been zero," Wheeler said. "By loaning AIG $85 billion under the September 22, 2008 Credit Agreement, the government significantly enhanced the value of the AIG shareholders' stock."

So even if the Fed's actions were illegal, the government did not cause shareholders any economic loss, the court concluded.

After all, "[twenty] percent of something [is] better than [100] percent of nothing," the court said quoting government witness John Studzinski.

In a statement, the Federal Reserve said it "strongly believes that its actions in the A.I.G. rescue during the height of the financial crisis in 2008 were legal, proper and effective."

"The court's decision today in Starr International Company, Inc. v. the United States recognizes that A.I.G.'s shareholders are not entitled to compensation for that decision, and that the Federal Reserve's extension of credit to A.I.G. prevented losses to millions of policyholders, small businesses and American workers who would have been harmed by A.I.G.'s collapse during the financial crisis," the statement continued.

Wheeler's ruling holds no immediate policy repercussions, as the Dodd-Frank Act, passed in 2010, now prohibits the federal government from bailing out a swaps entity such as AIG in the future.

Read the Top 8

Sign up for the Top 8, a roundup of the day's top stories delivered directly to your inbox Monday through Friday.