Americans were angry when Wall Street’s greedy and risky behavior triggered a global financial crisis in 2008. They were angrier still when the government had to borrow and spend hundreds of billions of dollars to rescue mortgage giants Fannie Mae and Freddie Mac, the largest banks and the insurance company AIG. They were outraged when they found out that executives at those enterprises were continuing to receive big salaries and bonuses.
So just imagine how it outrageous it would be if some Wall Street sharpies went to court to argue that they didn’t benefit enough from the bailouts and that taxpayers should pay them tens of billions of dollars more.
In fact, they did. And, according to legal observers, they just might prevail.
“Lawsuits of the Rich and Shameless” is how the comedian Jon Stewart dubbed it.
“An absurdist comedy . . . worthy of the Marx Brothers or Mel Brooks,” wrote John Cassidy, the New Yorker’s economics correspondent.
For taxpayers, it looks to be another example of the old adage that no good deed goes unpunished.
In two separate cases, the government now stands accused of overstepping its authority when it took extraordinary measures to prevent a financial meltdown in the fall of 2008. The Wall Street figures who are suing say their property was seized without compensation, in violation of the Constitution. One case was brought by Maurice “Hank” Greenberg, the legendary former chief executive of AIG who built it into the world’s largest insurer. Filing the other case is a group of hedge funds that bought Fannie and Freddie stock for pennies per share after the companies were put in government conservatorship.
Federal district court judges in Washington and New York initially dismissed both challenges. Their opinions noted, somewhat pointedly, that the Wall Street plaintiffs were not only unharmed but actually came out better off as a result of the government rescues. Yet both groups have now found a more sympathetic hearing a stone’s throw from the front gate of the White House, at a little-known brick courthouse called the U.S. Court of Claims.
There, Greenberg is asking the court to award him and other AIG shareholders at least $23 billion from the Treasury. He says that’s to compensate them for the 80 percent of AIG stock that the Federal Reserve demanded as a condition for its bailout. Judge Thomas Wheeler has repeatedly signaled his agreement with Greenberg. A decision is expected any day.
In the Fannie and Freddie case, the decision is further off, with the trial set to begin in the fall. The hedge funds are challenging the government’s decision to confiscate all of the firms’ annual profits, even if those profits exceed the 10 percent dividend rate that the Treasury had initially demanded. This “profit sweep” effectively prevents the firms from ever returning the government’s $187 billion in capital and freeing themselves from government control.
Earlier this year, Judge Margaret Sweeney refused to dismiss the case and gave lawyers for the hedge funds the right to sift through the memos and e-mails of government officials involved. Within weeks, Fannie and Freddie shares, which had been trading at about $1.50, started trading as high as $3 based on rumors that the documents revealed inconsistencies in government officials’ statements. The hedge funds are asking for the return of as much as $100 billion in profits and an end to the Treasury-imposed profit sweep. In her comments, Sweeney has shown sympathy with their argument that the government can’t hold them indefinitely in a legal limbo in which they have no claims to assets of the company they ostensibly own.
When these cases were filed, many legal observers thought they were a long shot, even frivolous. But from their procedural rulings and comments from the bench, said David Zaring, a professor of legal studies at the Wharton School of Business, both judges have indicated they are at least open to the plaintiffs’ legal theories and willing to hold the government accountable for what it did during the financial crisis.
“I think people’s views have changed,” Carl Tobias, a professor at the University of Richmond Law School, said of the AIG case. Greenberg’s lawyers, he said, “were able to present evidence and persuade the judge that there were some serious issues here. It’s possible the judge could rule in their favor in some way.”
AIG’s Hank Greenberg: Victim or ingrate?
Even before the final papers for AIG’s bailout were signed, in September 2008, one shareholder was already agitating against it.
Hank Greenberg had been forced out as chairman and chief executive in 2005 after state and federal regulators uncovered that the company had been engaged in sham transactions that allowed AIG and its corporate customers to manipulate reported earnings, avoid taxes, evade regulatory requirements and hide risks and liabilities from shareholders. Ever since, Greenberg has been on a mission to restore his reputation and regain control of the company that he had ruled over with an iron hand for 37 years.
Even in exile, Greenberg remained AIG’s most important shareholder, controlling 20 percent of the company’s stock. He successfully sued some AIG executives in court and recruited away others to build his own rival insurance company. He also agreed to pay $15 million to settle civil charges brought against him by the Securities and Exchange Commission, though he refused to acknowledge any wrongdoing.
Greenberg has repeatedly claimed that if he’d still been in charge, AIG would never have gotten into the mess it did. But that is impossible to know.
What is known, however, is that when Greenberg was in charge, he ran the company “as if it were a feudal state . . . disdainful of modern concepts of internal controls and regulatory compliance,” according to one person with intimate knowledge of the company’s management. After his firing, AIG paid $1.6 billion to settle multiple counts of accounting fraud brought by the SEC.
What is also known is that the two lines of business that were the source of AIG’s major problems during the 2008 crisis were launched on his watch. He helped to create their risky business models and strategies, which were based on playing one regulator off another and engaging in complex financial arrangements between regulated subsidiaries and a largely unregulated parent company. And both business lines took root in the same clever rules-bending corporate culture that had always been Greenberg’s trademark.
“The AIG which came begging to the Fed’s doorstep was the AIG that Hank Greenberg built,” said James Millstein, the Treasury official who oversaw AIG’s restructuring. “It’s capital structure was opaque, it was heavily dependent on short-term funding, with a highly leveraged financial products subsidiary that had been organized to evade effective regulatory oversight.” Greenberg, he said, “ran the parent company like a hedge fund with a triple A rating.”
As the financial crisis unfolded, AIG’s fundamental flaws were finally exposed. On the same week Lehman Brothers collapsed, desperate executives went to the Treasury and the Federal Reserve looking for a loan. Dozens of Fed officials were dispatched to AIG headquarters on Pine Street in lower Manhattan. Within days, they were convinced that without a substantial cash infusion, AIG would be forced to file for bankruptcy, threatening the solvency of a number of big banks in Europe and the United States.
To avoid such a meltdown, the Fed agreed under its emergency authority to act as a lender of last resort, lending AIG an initial $85 billion. The terms were to be the same as AIG’s investment bankers had offered the previous week, without success, to private lenders — a 14 percent interest rate and ownership of 80 percent of the company. With lawyers sitting in the next room ready to file a bankruptcy petition, AIG directors reluctantly agreed to the terms.
In his current suit against the government — which has generated 300 docket items, 70 depositions, 4,600 exhibits, 36 million pages of documents and testimony from two former Treasury secretaries and the former Fed chairman — Greenberg has relied on the legal advice and representation of super-lawyer David Boies. Boies gained his megawatt status in the 1980s successfully defending IBM against the government’s effort to break it up, and in the 1990s prosecuting the government’s case to break up Microsoft. He also represented Al Gore in the Supreme Court case over the contested 2004 election. But few clients have been as lucrative as the litigious Greenberg, whom he has also represented in earlier disputes: Disputes with the New York attorney general. Disputes with the SEC. Disputes with AIG itself. Even a slander suit against former New York attorney general Eliot Spitzer. Published estimates of Boies’s legal fees in all these cases run to well over $100 million.