Bernanke Tells Judge He Wasn’t Looking to Punish AIG

Former Federal Reserve Chairman Ben Bernanke said he wasn’t looking to punish American International Group Inc. for mismanagement when the board of governors authorized an emergency loan to the distressed insurer at a steep interest rate and with a demand for equity in 2008.

Bernanke yesterday finished his testimony in a lawsuit accusing the U.S. of imposing illegally harsh terms in the bailout of AIG, capping a week of testimony in Washington from the architects of the insurer’s 2008 rescue. Maurice “Hank” Greenberg’s Starr International Co., AIG’s biggest shareholder before the bailout, is seeking at least $25 billion in damages.

Called as a witness by Starr lawyer David Boies, Bernanke said he didn’t set out to punish AIG when the Fed considered a rescue. It’s potentially critical testimony at a trial where a key issue is whether the Fed acted outside its authority by penalizing AIG, as Starr claims, instead of acting as merely a lender of last resort.

“I did not make any personal judgments at the time about the quality of management at AIG, but I did know of course that AIG was having difficulty making contractual payments,” Bernanke said. “The company was on the brink of failure.”

Geithner Stance

Bernanke’s stance differed from that of Timothy Geithner, then president of the Federal Reserve Bank of New York, who, during his own testimony this week, was confronted with a draft article he wrote stating that the government forced losses on AIG shareholders proportional to mistakes of the firm.

Former Treasury Secretary Henry Paulson testified that he supported harsh terms for AIG to send a message to markets that government assistance would come only at a stiff price.

All three financial regulators told the court that the bailout was an extraordinary intervention they backed to prevent wider damage to the economy.

Yesterday, Bernanke acknowledged that in September 2008, others at the Fed, in particular vice chairman Donald Kohn, may have had a harsher view of AIG’s conduct.

Kohn “seemed to be concerned about the clarity of the firm’s plans to deal with its problems,” Bernanke testified.

When Boies asked whether colleagues thought AIG mismanaged its business or took on too much risk, Bernanke, citing trading losses, said, “I think a number of my colleagues were inferring that based on margin calls.”

Two Days

Bernanke testified over parts of two days in the U.S. Court of Federal Claims, where Judge Thomas Wheeler is hearing the case without a jury.

Bernanke defended the 14 percent interest rate on AIG’s $85 billion rescue loan, saying it kept shareholders from reaping a windfall from an action designed “to prevent the collapse of a systemic firm.”

Bernanke testified that the Fed authorized Geithner to make the bailout loan, giving him latitude to set the interest rate.

During testimony earlier in the week, Geithner told the court he was responsible for setting the rate, putting it higher than was contemplated by an aborted private-sector rescue of the insurer.

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.

The AIG loan included a demand for 80 percent of the company’s equity, an unprecedented condition for an emergency Fed loan and one that Starr argues is illegal.

‘Additional Compensation’

“What the Federal Reserve was doing was taking some additional compensation” to give taxpayers potential upside, Bernanke said.

Bernanke told the court that the Fed’s emergency lending authority provided “wide discretion” to set the terms of the loan and he “relied on legal counsel to confirm that.”

Starr argues that the Fed singled out AIG for uniquely severe terms, demanding equity so it could control the company to conduct a “back door bailout” of the insurer’s trading partners.

Boies asked whether the Fed could use its wide discretion to set different conditions for loans to Democrats and Republicans.

“It’s a silly example,” Bernanke replied. Still, he testified, the law “does give wide discretion to the lender.”

Little Emotion

Bernanke showed little emotion on the witness stand during questioning by Boies, responding to his pointed questions in a matter-of-fact tone.

He grew more animated yesterday during cross-examination by Kenneth Dintzer, a U.S. Justice Department lawyer. Abandoning the reserve he displayed with Boies, Bernanke spoke so quickly that the court reporter asked him to slow down.

At AIG, executives didn’t seem to grasp the approaching disaster, he recalled.

“There is a disconnect,” Bernanke wrote in a Sept. 13, 2008, e-mail to Kohn, which he reviewed during his testimony. “We think they are days from failure. They think this is a temporary problem.”

He elaborated in court.

“I was dismayed by the range of reports I was getting” that gave differing accounts of AIG’s efforts to find capital, sell assets and take other steps to remedy its funding shortfall, he said.

Final Hours

As late as the day before the bailout began, “there was still a lot to be learned about what kind of loan would be needed, whether there was still a private-sector solution, what would the terms be, what would the collateral be and would this be the right choice,” he said.

Until the final hours, the Fed didn’t want to bail out AIG partly for fear that “every company in America would call us up and ask us for a loan,” he said.

Bernanke testified that the Fed made only two emergency loans tailored to individual companies: the one to AIG and another to JPMorgan Chase & Co. for its takeover of Bear Stearns in March 2008.

Many other financial institutions got low-interest loans through credit facilities set up by the central bank to add liquidity to markets during the economic crisis, he said.

The central bank rejected some company-specific requests for loans, including one from Thornburg Mortgage Inc., he testified. Thornburg, of Santa Fe, New Mexico, filed for bankruptcy in May 2009.

Bagehot Lesson

Bernanke, a former Princeton University professor, said his actions were guided during the crisis by an axiom from 19th-century British economist Walter Bagehot for quelling financial panic.

“Lend freely against good collateral to solvent firms at penalty rates,” said Bernanke.

Bernanke said Bagehot defined “good collateral” as marketable securities. Of the “thousands of loans” made by the central bank during the crisis, the one to AIG was the only one not issued in accordance with Bagehot’s principle, he said.

The former fed chairman told Wheeler of the Fed’s historic role in promoting stable markets and how it was hobbled during the financial crisis by a dearth of tools to address the near-collapse of companies like AIG, whose failure threatened the health of the financial system.

The Fed “had to use powers in an ad hoc way,” he said.

The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE