(Bloomberg) -- Former Treasury Secretary Henry Paulson’s testimony that American International Group Inc. received harsher terms than other institutions getting government bailouts in the financial crisis set the stage for today’s examination of a second architect of the rescue.
Timothy Geithner, the head of the Federal Reserve Bank of New York in 2008, was cited in earlier testimony as being responsible for setting what a Starr lawyer called “an extortion rate” of 14 percent. He took the stand this morning in a Washington federal court trial over claims by Maurice “Hank” Greenberg’s Starr International Co. that the government illegally took equity in AIG.
Several copies of Geithner’s book, “Stress Test,” some with pages marked with Post-it notes, lay on the plaintiff and defense tables, fodder for questioning ahead. Greenberg’s lawyer David Boies used a similar tactic yesterday, focusing on key pages in Paulson’s book, “On the Brink,” in questioning the former treasury secretary. Ben Bernanke, the former chairman of the Federal Reserve, is scheduled to take the stand tomorrow.
Paulson testified that regulators wanted to send a message to markets that government help would cost them.
“It was important that terms be harsh because I take moral hazard seriously,” Paulson said yesterday in federal court in Washington, referring to the economic term for consequence-free risk-taking.
Starr, AIG’s largest shareholder at the time of the bailout, claims the government punished the insurer by demanding equity and imposing a far higher interest rate than other bailout recipients, such as banks, had to pay. Starr, whose chief executive officer Greenberg led AIG for almost 40 years, is seeking at least $25 billion in damages for shareholders.
Paulson said he valued stability above all else in regulating markets, followed by the need for market participants to be responsible for the consequences of their actions.
“When companies fail, shareholders bear the losses,” Paulson testified under questioning from Joshua Gardner, a Justice Department lawyer. “It’s just the way our system is supposed to work.”
Greenberg, who built AIG into the world’s biggest insurer, claims the government trampled shareholders’ rights. The government didn’t have the legal authority to take an 80 percent equity stake in consideration of an $85 billion loan to AIG, Starr alleges. That equity demand wasn’t made of any other financial institution getting government rescue loans, according to the lawsuit.
In his testimony, Paulson drew a distinction between AIG’s treatment and that of Citigroup Inc., which he acknowledged received better terms than the insurer.
AIG had to be rescued because if it failed “the country faced a real disaster,” Paulson said under questioning by Boies.
Boies is lead attorney of at least seven lawyers and aides representing Starr in the plain, brown-paneled court room, flanked by four bookcases, each holding six rows of white- labeled evidence binders. The government has an equal number of lawyers and aides, with a similar bookcase on its side of the court room.
The government avoided punitive terms for Citigroup because it feared doing so would encourage shortsellers to attack other banks, further destabilizing the economy, said Paulson, who was CEO of Goldman Sachs Group Inc. before being named Treasury secretary by Republican President George W. Bush.
There was no similar risk of a domino effect in the insurance market, according to Paulson. “I didn’t see another insurance company that was vulnerable” and posed a risk to the entire economy as AIG did, he said.
Paulson said he advocated “fairness to the extent you can have fairness,” but “to me, stability trumped moral hazard.”
In brief follow-up questioning, Boies sought to portray the harsh terms of the AIG rescue as driven by political considerations.
AIG had become “a scapegoat for Wall Street and all of the bad practices people were angry about,” Paulson told Boies.
Paulson also acknowledged telling both major presidential candidates, Republican Senator John McCain of Arizona and Obama, then a Democratic senator from Illinois, that they shouldn’t be unhappy about the AIG bailout because shareholders had been treated harshly.
Paulson said he “wanted to minimize political opposition to what we were doing,” which included appealing to Congress for more money to shore up struggling institutions, including the second half of the $700 billion initially authorized for the Troubled Asset Relief Program.
In particular, Paulson testified, he was concerned that a $40 billion injection of capital into AIG in October 2008 “would so enrage the American public and Congress” that it would make it more difficult to get the last $350 billion.
Paulson said earlier in the day that he talked with China about helping bail out financial firms in 2008.
In AIG’s case, Paulson said he didn’t think the Chinese would be interested in a deal without a government guarantee.
“The government couldn’t provide that assurance,” Paulson said. “The Chinese were very, very nervous” about investing in U.S. firms at the time, he said.
Boies didn’t draw much out of Paulson regarding how the government arrived at the terms for bailing out AIG. Paulson said repeatedly he didn’t recall many of the details of the rescue package when questioned about it.
Boies was slated to question Paulson for six hours. The former Treasury secretary was finished and off the stand in fewer than two.
To fill the hole in the schedule, lawyers recalled Patricia Mosser, a former senior vice president of the New York Fed, who had begun testifying on Oct. 3.
Mosser, under questioning from Boies yesterday, described loan programs the Fed cobbled together in 2008 to address the crisis.
In an effort to show how much cheaper those loans were than the one to AIG, Boies asked Mosser to list the interest rate for each program.
The highest rate cited by Mosser was for the Commercial Paper Funding Facility, which charged 3 percent above the target short-term interest rate, which was estimated in earlier testimony to be “in the neighborhood of 1.5 to 2 percent.”
The case is being heard by U.S. Court of Federal Claims Judge Thomas Wheeler without a jury.
The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).
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