AIG is suing the Government. At first it seems highly ungrateful for AIG to sue its “White Knight” who swooped in to rescue it in its time of need. But when we look a bit deeper we may find that all is not as it seemed at the time. Republican Senator Jim Bunning of Kentucky, says that he has seen documents which show Bernanke overruled recommendations from his staff that he not bail out AIG. In other words, some of Bernanke’s people didn’t think the decision to bail out AIG was necessary. And in today’s article we’ll see that in addition to being unnecessary, Bernanke may have had ulterior motives that had nothing to do with what was good for AIG or the the country.
Here at Financial Trend Forecaster we believe that the less the government is involved in the market the better it operates and that in this and all other cases in the long run the best outcome is to allow the market to handle these issues. There might be some initial pain but in the long run it is best for people and companies to have to take responsibility for their own actions. But as you’ll see in today’s article when the government gets involved market forces are by-passed and those who benefit may not be the ones who should. There is some evidence that others would have stepped up t the plate to bail out AIG if the government had let them. And just like the Mafia it is possible that Bernanke made AIG “an offer they couldn’t refuse,” even though it ended up costing shareholders 92% of the company.
AIG is Right to Sue the Government
Life isn’t as simple as people would like. AIG’s old boss Hank Greenberg is still a large AIG shareholder. He thinks his ox was gored by the onerous terms of the government’s rescue. He actually has a great point. AIG was one of many companies that could have found better buyers on the free market had the government been willing to let the market work in 2008.
AIG management wasn’t in a good negotiating position when the credit-default swap poop was hitting the fan in the meltdown. The government wanted what would eventually become 92% of the company. The managers at the time, thinking about their wives and mortgages, said, “Sure, why not?”
John Carney points out in a piece for NetNet:
“The government deprived shareholders of billions of dollars and violated the Fifth Amendment’s ban on the government seizure of property without just compensation to the owners, Greenberg[‘s] lawsuit claims.
“But can seizing control of a company that was on the brink of failure really be seen as an illegal taking? A judge on the federal claims court ruled last summer that if what Greenberg argues is true, the government may really have acted illegally.”
Greenberg’s legal beagles say the government elbowed out some sovereign wealth funds and other foreigners that would have recapitalized the company. When AIG couldn’t raise any dough, the vultures started circling. The ratings agencies started finding other letters in their alphabet soup with which to rate the company.
In the end, the company was stuck getting bear-hugged by Uncle Sam.
The AIG thing happened pretty fast. Obtaining a permit, or something similar, from the federal government takes months, years, sometimes decades. The nationalization of AIG? A matter of days. ProPublica provides a timeline, including:
- “Aug. 6, 2008: In its second-quarter filing, AIG ups its unrealized loss in 2008 from the credit-default swaps to $14.7 billion, for a grand total loss of $26.2 billion. It also discloses another impressive number: It’s posted a total of $16.5 billion in collateral
- “Sept. 15, 2008: Standard & Poor’s cuts AIG’s credit rating due to ‘the combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses.'”AIG is forced to raise another $14.5 billion in collateral due to the rating downgrade. The company faces collapse
- “Sep. 16, 2008: The Federal Reserve Board saves AIG by pledging $85 billion. As part of the deal, the government gets a 79.9% equity interest in AIG.”
At that point, the government was given preferred shares for the $85 billion. And as Carney explains, in 2009, the government went to convert the preferred into common stock, taking 79.9% ownership. This was done by means of a reverse 20:1 stock split.
Why the reverse split? The company line said it was so the stock wouldn’t be delisted for trading at such a low price. The real reason is not enough shares were authorized to accommodate the government’s investment. “So when the government converted to common, it was issued unauthorized common stock,” Carney explains.
The company went to the existing shareholders for the required approval to authorize the additional shares that would greatly dilute their holdings. The shareholders, including Greenberg, voted no. So in a bit of boardroom trickery:
“another vote was held about the reverse split of all issued stock — including the government’s unauthorized shares. This time, the government got to vote its 79.9% stake on this question because its unauthorized shares were also affected. And so the measure prevailed. After the split, the total number of shares outstanding no longer exceeded the number authorized in AIG’s charter, so the government’s shares were now officially authorized.”
Greenberg’s lawyers claim this slight of ballot “was engineered to circumvent a Delaware court order meant to protect the rights of the common shareholders when the government took over the company.”
The courts had ruled that AIG shareholders couldn’t be diluted except by their consent. The judge that has upheld Greenberg’s right to sue said that “the government appears to have violated the spirit, if not the letter, of the order by not holding a common shareholder vote on the reverse stock split, which led to the dilution of the common shareholders’ equity and voting interests.”
Greenberg also questions AIG using buyout funds to pay par value for the CDOs insured by the company. Surely, they could have bought the paper at a discount in those troubled times. Carney is not terribly keen on that argument.
However, Neil Barofsky’s book Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street lends support to Greenberg’s argument. According to Barofsky, the special investigator general for TARP, the New York Fed, under Tim Geithner, authorized $60 billion to buy bonds from AIG’s counterparties “that were worth less than half of that amount.”
Barofsky’s audit determined that Geithner never attempted to negotiate a discount, even when one of the banks had offered it upfront. When asked about it, the New York Fed’s general counsel insisted that banking laws required the payment of full price.
Carney points out that Greenberg’s claim that foreign white knights were on their way to save the company is unsubstantiated. They’ll figure that out in discovery. However, it’s turned out AIG is a profitable business, making billions since the bailout even after paying back Uncle Sam.
Surely, someone could see the potential as the company was circling the drain. Instead, government stepped in. Why would they, if there were private investors?
Perhaps what the Greenberg suit will reveal is that the AIG bailout was not to bail out the insurer after all. The private equity investors looking at investing in AIG likely had no intention of paying Goldman Sachs, for instance, 100 cents on the dollar for their CDOs. Is it possible that Hank Paulson and Tim Geithner knew that they couldn’t leave bailing out Goldman and others to the private equity market?
The AIG board has folded to the public pressure and passed on joining in Greenberg’s suit. That’s too bad. We’re rooting for Greenberg, or at least rooting against Uncle Sam.
Let this be a model and a lesson for the future. No bailouts ever! If something is valuable, markets will take possession of that value. Government rescues are ruses and snares.
Laissez Faire Club
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- Interview with David Stockman
Resources from Amazon:
- End the Fed
- The Case Against the Fed
- The Creature from Jekyll Island: A Second Look at the Federal Reserve
- The Secrets of the Federal Reserve
This article was originally published by Laissez Faire Today and is reprinted by permission under a Creative Commons Attribution 3.0 Unported License. The original article appeared here.