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Government Cheese: AIG and the Fed

“How far that little candle throws his beams! So shines a good deed in a weary world,” Shakespeare wrote.1 The United States government is now thinking twice about performing a good deed at a weary time.

Former AIG CEO Maurice Greenberg and his firm Starr International2 filed a class action lawsuit on behalf of fellow AIG shareholders against the U.S government claiming that the U.S. government violated the equal protection, due process and taking clauses of the U.S. Constitution when the government took control of AIG in September 2008, at the thick of financial crisis.3 Mr. Greenberg and Starr International are seeking more than $40 billion in compensation, despite the fact that AIG itself refused to join the case.4

At the time of its near failure in 2008, AIG provided more than $400 billion dollars in credit-default swaps to banks and other financial institutions.5 A credit default swap is an insurance that “transfer[s] the credit exposure of fixed income products between parties.”6  A purchaser swap makes periodic payments to an insurer and in turn the insurer “agrees to pay off a third party debt if this party defaults on the loan.”7

Greenberg and Starr International alleged that AIG’s problem in 2008 was “not one of solvency, but temporary liquidity.”8 They claim that the government took 80% of shareholder equity without just compensation.9 Whereas the government loaned other financial institutions money, it took an ownership interest in AIG, singling AIG for “differential—and far more punitive—treatment,”10 and used its stake in AIG as a “backdoor bailout” of other financial institutions.11 AIG further alleges that the government treated it differently by refusing to provide it loans while it was providing loans to other institutions, including foreign banks and some insurance companies.12 Had the government guaranteed AIG’s obligations instead of taking equity in the company, AIG would have been fine.13

While the complaint recognizes and applauds the government’s action to “protect the United States economy and rescue the country’s financial system,” it alleges that government “could not and did not justify” the means which it went about it.14

What the complaint didn’t mention was that if it were not for government intervention, AIG would have naturally collapsed and any equity that Mr. Greenberg and Star International had in AIG would have been wiped out.15 With the best interest of AIG in mind, AIG’s directors approve the bailout fearing that without the bailout that AIG was going to collapse, after AIG failed to raise $75 billion from private sector banks.16 “Just compensation” means the full monetary equivalent of the property taken.17 However what economic loss Mr. Greenberg suffered, seeing that AIG was going bankrupt, is unclear.  If the guiding principle of just compensation is reimbursement for property interest taken, and that the owner is entitled to be put in as good a position as if his property had not been taken, but is not entitled to more18—then Mr. Greenberg should be lucky that he at least retained some value in AIG stock when the government bailed AIG out. If it was not for government action, there will not any value in the AIG stock Mr. Greenberg retains today.

The government’s strategy to take an ownership interest in AIG was not due its want to “backdoor bailout” the banks, but because AIG served as a linchpin of the financial sector, and hence the entire U.S. economy. AIG provided billions of dollars in credit-default swaps to several banks19, who themselves were at the verge of bankruptcy. The underlying loans (owned by several banks and several institutions) that AIG insured were failing and AIG did not have the cash to pay for loan defaults that were mounting.20   Several banks were going to fail;21 AIG was going to fail; and money-market funds, which invested in securities insured by AIG, were going to fail.22 With AIG being at the center of the financial crisis—insuring a vast amount of credit-default swaps—saving AIG, would in turn save the whole financial system—and the hence, the U.S. economy. As was noted at the time of the bailout, “[i]n bailing out AIG, the Federal …[Government] appeared to be motivated in part by worries that Wall Street’s financial crisis could begin to spill over into seemingly safe investments held by small investors….”23 The government did not bail out AIG because it wanted to, it did it because it had to.24

Even if the government did intend to treat AIG differently25, “Greenberg’s claim is mostly insane, as it assumes that a failing company is entitled to a bailout with kid-glove treatment.”26 There was no legal obligation for the government to bail AIG or any other institution out. If the government refused to bailout AIG and let it fail, would Greenberg still have a claim? Should Lehman Brother’s shareholders have a claim against the government because the government did not bail them out? The method the government used to save the financial sector—whether taking equity in the company or guaranteeing AIG’s loans—should be left to the government’s discretion. Moreover, that the government allowed AIG to retain $35 billion in operating losses–which AIG used to offset billions of dollars in taxes—shows that government did not treat AIG all that badly.27

However, this case raises a bigger issue. In times of distress, the government has to balance the need to protect and rescue the country from the need to not interfere with individual rights.  Alas, there is no way for the government to act swiftly when the country is faced with the collapse of a vital industry.  The Federal Reserves statutory mandate is to “maximum employment, stable prices, and moderate long-term interest rates”28—not to act as a fail-safe for systemic economic failure. When faced with such a systemic failure, history shows that the government is usually acting extemporaneous, as President Theodore Roosevelt by forcing coal miners and mine owners to negotiate the end of the Coal Strike of 1902.29 In times of war, our government can suspend habeas corpus.30  However, in times of severe economic collapse, our government is left with little tools to work with.  Dodd Frank provides a framework for winding banks when they face insolvency.31 However, there is no general framework for government intervention in times of unconventional economic crisis.  If the tech industry, or the electricity industry, or the insurance industry faces some sort of systematic collapse, how can the government intervene? Whether AIG wins or not, they have shown that we need a better system to deal with systematic industry failure—or else, someone will question the legitimacy of government action if the government takes action in the face of systemic failure. We need a better beam to weary times ahead.

  1. William Shakespeare, The Merchant of Venice act 5, sc. 2, available at 

  2. Andrew Ross Sorkin, A.I.G. Bailout, Revisionists’ Version, N.Y. Times (Oct. 6, 2014), 

  3. Original Compl. ¶168-78, Starr International Co. v. United States, No. 1:11-cv-00779-TCW (Fed. Cl. 2011). 

  4. David Dayden, Don’t Laugh Off Hank Greenberg’s Ridiculous AIG Lawsuit, THE NEW REPUBLIC (Sept. 29, 2014), 

  5. Compl. ¶107. 

  6. Credit Default Swap – CDS, INVESTOPEDIA, ( last visited Oct. 13, 2014, 10:23 AM). 

  7. Id. 

  8. Compl. ¶3. 

  9. Compl. ¶ 4 & 8. 

  10. Compl. ¶ 5. 

  11. Compl. ¶ 9 &103-11. 

  12. Compl. ¶ 42-54. 

  13. Compl. ¶ 48. 

  14. Compl. ¶13. 

  15. Adam Davidson, How AIG feel apart, REUTERS (Sept.18, 2008),;  Mathew Karnitschnig et al., U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as Credit Dries Up,  Wall St. J. (Sept. 16, 2008),

  16. Mathew Karnitschnig et al., U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as Credit Dries Up,  Wall St. J. (Sept. 16, 2008),

  17. U. S. v. Reynolds, 397 U.S. 14, 15 (1970). 

  18. U. S. v. Virginia Elec. & Power Co., 365 U.S. 624, 633 (1961). 

  19. Adam Davidson, How AIG feel apart, REUTERS (Sept.18, 2008),

  20. Id. 

  21. See Andrew Ross Sorkin, A.I.G. Bailout, Revisionists’ Version, N.Y. Times (Oct. 6, 2014), 

  22. Mathew Karnitschnig et al., U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as Credit Dries Up,  Wall St. J. (Sept. 16, 2008),

  23. Id. 

  24. See Aaron M. Kessler, Bernanke Testifies That He Was Reluctant to Lend Money to AIG, N.Y. Times (Oct. 10, 2014),; see also Aaron M. Kessler, Geithner Testifies That Government Had Right to Avert A.I.G. Bankruptcy, N.Y. Times (Oct. 8, 2014), 

  25. Aaron M. Kessler, Paulson Testifies That “Punitive’ A.I.G. Terms Were Also Necessary, N.Y. Times (Oct. 6, 2014), 

  26. David Dayden, Don’t Laugh Off Hank Greenberg’s Ridiculous AIG Lawsuit , THE NEW REPUBLIC (Sept. 29, 2014), 

  27. Id. 

  28. What are the Federal Reserve’s objectives in conducting monetary policy?, THE FEDERAL RESERVE, (last visited Oct. 13, 2014, 2:03 PM). 

  29. The Coal Strike of 1902 – Turning Point in U.S. PolicyThe Coal Strike of 1902 – Turning Point in U.S. Policy, DEP’T OF LABOR, (last visited Oct. 13, 2014, 2:05 PM). 

  30. See Habeas Corpus Suspension Act, 12 Stat. 755 (1863). 

  31. Resolution Plans, THE FEDERAL RESERVE,, (last visited Oct. 13, 2014, 2:03 PM).