Bernanke Defends AIG Bailout Terms; Judge Opens Fed’s ‘Doomsday Book’

Former Federal Reserve Chairman Ben Bernanke defended the sterner treatment of American International Group Inc. in the 2008 bailout compared with how investment banks were handled, saying the rescue of the insurer had a different purpose.

Maurice “Hank” Greenberg’s Starr International Co. claims in a lawsuit that the government illegally took equity in AIG and that a 14 percent interest rate on the rescue loan was extortionate. Starr is seeking at least $25 billion in damages.

An $85 billion loan to AIG at a steep interest rate “was intended to prevent the collapse of a systemic firm” while keeping its shareholders from reaping a windfall, Bernanke testified today in Washington federal court.

Low-interest lending to banks and other institutions was meant to “get funds out into the system” to improve liquidity, even though it was understood that the action might lead to a windfall for their shareholders, Bernanke testified.

“There were offsetting considerations,” Bernanke told the court under questioning by David Boies, an attorney for Starr.

Earlier testimony and documents in the trial, which began Sept. 29, showed that banks paid less than 4 percent interest on their loans from the Fed.

Bernanke testified that at the time of the bailout, he didn’t know the basis for what a New York Fed official called a “crazily high” interest rate the government charged the insurer.

“I have since learned something about it, but at the time I didn’t know,” Bernanke said. “I understand the overall goal was to minimize the windfall to the stockholders of AIG from being bailed out, but I couldn’t go term by term and explain them.”

His testimony is slated to continue tomorrow.

Bernanke was preceded on the witness stand this week by former treasury secretaries Henry Paulson and Timothy Geithner. Geithner headed the New York Fed at the time of the bailout.

The three men were considered the architects of the U.S. response to the financial crisis.

Like Bernanke, Geithner and Paulson defended AIG’s tougher rescue package and testified that a failure by the insurer would have been catastrophic for the economy.

Bernanke showed little emotion on the witness stand in the U.S. Court of Federal Claims, in contrast to Geithner, who grinned frequently during his testimony. Bernanke responded to Boies’s pointed questions in a matter-of-fact tone.

At one point, when Boies pressed for specifics about prevailing interest rates at the time of the crisis, Bernanke said, “I don’t think it’s worth splitting hairs on this one.”

Bernanke offered little clarity on how the Fed and the Federal Reserve Bank of New York arrived at the terms of the bailout loan, including the key issue of how the central bank determined it had authority to demand equity as a consideration for the lending.

Bernanke said he didn’t recall whether there was any discussion during a September 2008 Board of Governors meeting about whether Fed emergency lending provisions allowed the terms to include taking equity.

Information about the terms came “only implicitly in the presentation of the proposal by the general counsel,” he said.

In testimony that ended this morning, Geithner said he was ultimately responsible for setting the rate, after being authorized to do so by the Fed.

Geithner testified that he wanted the interest rate and other terms of the loan to be “tough enough that they were not viewed as attractive” to other companies that might seek a government bailout.

After Bernanke, 60, took the stand at midday, Boies asked him if the Fed’s powers to set interest rates for loans to troubled financial institutions included a right to demand equity.

“I don’t recall thinking about it,” said Bernanke, now a fellow-in-residence at the Brookings Institution.

Lawyers at the Fed and New York Fed differed on the scope of that power, according to a May 2008 e-mail introduced earlier in the trial.

A note from Thomas Baxter, the general counsel of the New York Fed, to Geithner stated that “we in New York” have a more expansive view of what the central bank can do under an “incidental powers” section of the law but that some officials at the Federal Reserve Board of Governors “see our conduct as loophole lawyering.”

Baxter testified earlier in the trial that those “incidental powers” included the ability to authorize demands for equity as a condition of emergency lending.

Shortly before Bernanke began his testimony, lawyers for both sides discussed ground rules for Starr’s access to a Fed volume dubbed the “Doomsday Book,” a compendium of confidential legal opinions about what the central bank can do in crisis situations.

U.S. Court of Federal Claims Judge Thomas Wheeler, who is trying the case without a jury, said he was inclined to grant Starr broad access to opinions about emergency lending that might bear on demands for equity, even those generated decades ago.

“I think all of that is relevant,” Wheeler said. He ordered lawyers for Starr, the Justice Department and the Fed to work out a system that would give the plaintiffs broader access to the information.

Starr was AIG’s biggest shareholder when the financial crisis struck. It claims the government punished AIG, which Greenberg led for almost 40 years, by demanding 80 percent equity and imposing the higher interest rate.

The government’s stake later rose to as much as 92 percent after further government assistance.

The initial loan of $85 billion grew to $182 billion. AIG returned to profitability and repaid the assistance in 2012, leaving the government with a $22.7 billion profit.

Bernanke testified that AIG “actually did worse than I anticipated,” because it required the infusion of funding beyond the initial $85 billion loan.

Geithner, in contrast, said he was pleasantly surprised by how well AIG eventually performed.

Near the end of his testimony, Boies asked Geithner, who earlier acknowledged that he rebuffed efforts by Greenberg to participate in bailout discussions, about an encounter with the Starr CEO in December 2010.

Boies asked whether Geithner had told Greenberg: “You are the only one who was right about the value of AIG.”

Geithner disputed that wording of his comments, but said “to my surprise, events unfolded in a way that allowed us to realize a positive return.”

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.