Was AIG’s High Bailout Loan Rate Forced by Regulators?

A “crazily high” interest rate levied on American International Group Inc.’s $85 billion bailout loan may have been forced on the Federal Reserve Bank of New York by other regulators, according to evidence presented at a trial over the government’s taking stock of the insurer.

Timothy Geithner, the bank’s former head who is testifying in a trial accusing the government of cheating AIG shareholders, said yesterday that he was responsible for setting the rate and stuck by that statement during his second day on the witness stand.

Maurice “Hank” Greenberg’s Starr International Co., which was the insurer’s largest shareholder before the 2008 bailout, accuses the government of illegally taking equity in consideration for the loan and seeks more than $25 billion in damages. Starr’s lawyer contends AIG was charged an “extortion rate” of 14 percent interest on the loan.

Geithner was presented today with an October 2008 e-mail from a New York Fed vice president, Meg McConnell, describing a “crazily high” rate “that was forced on us (meaning FRBNY) by people that have long since punted on all the hard things that came about as a result of the decision to lend that all of us knowingly made together.”

Asked by Starr’s lawyer, David Boies, who McConnell was referring to, Geithner pointed to the Federal Reserve, then led by Chairman Ben Bernanke, or the U.S. Treasury Department.

“She must be referring to people either at the Board of Governors or Treasury,” Geithner said.

Boies concluded his questioning of Geithner without asking further questions to reconcile any discrepancy as to who was responsible for setting the rate for the initial AIG bailout on Sept. 16, 2008. The government lowered the rate weeks later.

Responding to questions later from a Justice Department lawyer, Geithner said it wasn’t clear to him whether the New York Fed could help AIG until about the time of the Sept. 15, 2008, collapse of Lehman Brothers Holdings Inc.

Geithner said he discussed the “core conditions” for the AIG bailout with Bernanke and Donald Kohn, then the Fed’s vice chairman. He said the rate wasn’t forced on the New York Fed and repeated his earlier testimony that he was ultimately responsible for setting it.

He said the higher rate was to protect the government for its risk in providing the loan and to avoid “moral hazard” by making the terms “tough enough that they were not viewed as attractive.”

Earlier today, Geithner testified that “the scale of AIG’s financial needs, the potential losses relative to those facing other firms at the time, were a result, by definition, substantially of the management decisions by the company.” Greenberg was AIG’s chief executive officer until 2005.

When asked by Boies about whether any detailed analysis had been done to determine the causes of AIG’s financial problems, Geithner said he was “not sure you could analyze the extent to which that might be the case.”

After Boies introduced a draft article by Geithner stating that the government forced losses on AIG shareholders proportional to the mistakes of the firm, he asked him whether other companies needing government assistance, such as Morgan Stanley, were similarly punished.

Geithner said they were. He said requiring Morgan Stanley and other banks to raise more common equity relative to their capital needs was punishment proportional to the penalties imposed on AIG.

Geithner’s testimony so far has been marked by careful answers and a lack of recollection about the details of the financial rescue he helped oversee. Bernanke, the former chairman of the Federal Reserve who had been set to begin his testimony Wednesday, is now scheduled to testify Thursday.

Yesterday, Geithner backed away from two of his more provocative assessments of AIG’s 2008 bailout and shed little new light on how he set the interest rate for AIG’s rescue loan.

Responding to Boies’s questions yesterday, Geithner acknowledged, “Ultimately I was the one responsible for setting that rate.” He testified that it was modeled in part on a contemplated though never completed private rescue of AIG to be led by JPMorgan Chase & Co. and Goldman Sachs Group Inc.

Boies asked Geithner if he ever saw anything in writing describing a rationale for the rate.

“I don’t believe so. We were moving kind of quickly,” Geithner said.

He responded “I don’t know” or “I don’t recall” to a series of questions about who drafted the proposed terms for AIG, whether he had ever seen a term sheet from private lenders and whether the terms were shared with AIG.

Geithner said his information about the proposed terms for AIG was conveyed to him verbally by “someone I deemed authoritative” at the New York Fed whose name he could not recall.

Geithner was named Treasury Secretary by President Barack Obama, a Democrat, in January 2009, serving until January 2013. He currently is president and managing director of Warburg Pincus LLC.

Starr claims the government punished AIG, which Greenberg led for almost 40 years, by demanding 80 percent equity and imposing a far higher interest rate than other bailout recipients, such as banks, had to pay. That stake later rose to as much as 92 percent after further government assistance.

Geithner attempted to take back a statement he’d made earlier about AIG shareholders being “effectively wiped out” by the bailout.

“It’s true I used the phrase,” Geithner told Boies. “It wasn’t completely accurate” because shareholders were provided with a substantial benefit as a result of the rescue, he said.

Geithner also backtracked slightly from a comment he made that the government takeover of AIG gave it the power to “carve up, dismember, sell or restructure” the insurer.

“It’s not the most precise language,” he said.

A failure of AIG, the world’s biggest insurer, would have caused “mass panic on a global scale,” Geithner testified. Letting the company fail “would have been catastrophic for the broader economy,” he said.

An AIG failure would have been “even more damaging” than the Lehman Brothers collapse, he said.

The case is being heard without a jury by U.S. Court of Federal Claims Judge Thomas Wheeler.

Speaking at Fortune’s Most Powerful Women Summit in Laguna Niguel, California, billionaire Warren Buffett said yesterday that he gave Geithner an appraisal of AIG just before its rescue.

Geithner asked “was there enough in the way of value there to warrant such an $85 billion loan” to AIG, Buffett said. “I thought that if they had staying power and, if there weren’t things there that I didn’t know about, it could be. Probably the underlying subsidiaries would bring $85 billion in a normalized market. And that was that.”

The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).
–With assistance from Laura Davison and Zachary Tracer in New York.