Geithner Redux: More Will be Learned From Starr International Co., Inc. v. United States, Case No. 11-00779(C) (Fed. Cl.)

by Elliott Morss, Morss Global Finance

Introduction

We have not heard much from Tim Geithner since leaving his post at Treasury for the Presidency of Warburg Pincus. Financial firm presidents of don’t get the press that Treasury Secretaries get, but the pay is better. But Geithner did get some press when his book was published. And on Monday, the Starr case against the US government went to court. What is this all about? I start by reviewing Geithner’s performance as a public servant.

The IMF to Treasury Transition

I first heard of Geithner at his Senate hearing to be confirmed as Treasury Secretary. It did not go smoothly. It came out that he owed significant back taxes to the IRS for a period when he worked for the International Monetary Fund. The Fund pays a “tax allowance” to US citizens but citizens are responsible for paying their own taxes. Sounds complicated? It is not. The Fund provides staffers with very clear instructions on what they are responsible for after receiving its “tax allowance”. After IRS notification, Geithner voluntarily paid $16,732 to the IRS for taxes due for the years 2003-04. But he still owed the IRS $42,702. And he did not pay this until shortly before his Senate hearing. It was as if the upcoming hearing prompted him to pay the remaining amount. The IRS is located in the Treasury, and I wondered how it would look to have a Treasury Secretary with such a problematic tax background. But there were more fundamental problems with Obama’s senior financial appointments.

The Geithner – Paulson – Summers Team

Obama’s senior financial appointments were extremely troubling – all having come from the financial industry. Geithner had already worked for the IMF and the Federal Reserve Bank of New York; Paulson had been head of Goldman Sachs and Summers had combined consultancies for financial firms with assignments at Harvard. Since these appointments, Geithner has gone to Warburg Pincus, Summers has returned to Harvard and his consultancies, and Paulson has retired. These gents knew who “buttered their bread”. And they effectively shut out other views about what needed to be done to make banks safer, such as from Paul Volcker and Sheila Bair. The outcome? I have written that Dodd-Frank has been watered down to the point where banks are not much safer than they were in early 2008.

The Starr Lawsuit

Maurice Greenberg is one of the most interesting financial figures of our time. And he is no shrinking violet. Greenberg founded AIG and made it into the largest insurance company in the world. But was removed by its Board in 2005. However, he remains the head of Starr International, a predecessor of AIG. And Starr owns a lot of AIG stock as does Greenberg personally. The lawsuit is interesting. Filed by Starr International in 2011, it argues that the settlement the government reached with (AIG) was so punitive that it amounted to an improper taking of private property by the United States under the Fifth Amendment. An important piece of evidence in the suit is that the US government forced AIG to pay 100 cents on the dollar for all bank insurance claims.

Bernanke, Paulson and Geithner were deposed by Starr’s lawyers. There is definitely more to come on this issue. Why is all this relevant? For more on the significance of this issue, it is worth looking back for a timeline on what has already happened.

The Timeline[1]

1. Late summer 2008 – global market for asset backed securities drying up, big banks reluctant to lend to each other. Many of the world’s largest banks effectively collapse resulting in the global recession of 2008.
2. A semi-autonomous AIG unit based in London had guaranteed a large amount of asset-backed securities. It was a profitable business: it amounted to more than 17% of AIG’s operating income in 2005. But as the asset backed security market collapsed, claims poured into AIG.
3. In mid-September 2008, Treasury Secretary Paulson and Geithner, then head of the Federal Reserve Bank of New York (FRBNY) met with senior executives of AIG and the Bank’s headquarters in New York. The only outsider in that meeting was Lloyd Blankfein who replaced Paulson as CEO of Goldman Sachs (GS).  As I reported, Goldman had a large stake in AIG’s survival: an insurance claim for asset-backed securities of almost $13 billion.
4. That meeting resulted in an $85 billion credit line from the FRBNY later in September 2008. At that time, the FRBNY had to be used because TARP was not enacted until October 3, 2008. AIG got an additional $40 billion from TARP on November 25th.
5. Ultimately, the government pledged $182 billion to save AIG.  Does this smell just a little bit?  Read on.  Much of what follows comes from e-mail correspondence between the government and AIG requested by Congressman Darrell Issa in his role as Chairman of the House Committee on Oversight and Government Reform.  Issa requested this information following a news story from Bloomberg.  (Bloomberg did an excellent job following this story).
6. In the October-November 2008 period, claims against AIG mounted.  The AIG staff was prepared to negotiate claims down to 60 cents on the dollar inasmuch as AIG was effectively in receivership, with its liabilities exceeding its assets without the government support.
7. But the government (Paulson and Geithner) said no, pay in full.
8. The government did everything it could to keep the names of who was getting paid off out of the AIG reports to the SEC.  It hoped the SEC would accept a total amount paid without the names of who got paid.
9. The SEC did not accept the report submitted by AIG without the names and amounts paid.  On December 30, 2008, Jeffrey P. Riedler, Assistant Director of the SEC, send a letter to AIG requesting the details on who got paid. The e-mail correspondence Issa received reveal considerable effort of the part of the government and their lawyers to keep payment details private.  And in fact, they were able to keep the details from being released until March 15, 2009.
10. The following table details who got paid what from AIG (billions of US$):

Source:http://www.aig.com/aigweb/internet/en/files/CounterpartyAttachments031809_tcm385-155645.pdf

Analysis

What was going on? What were Paulson and Geithner up to? Why pay off the banks in full? It could be argued that Paulson feared a collapse of the entire banking system if the banks did not receive the full amount they were owed. This does not hold up. Goldman and other recipients said they would have survived if they got less.

In his book, Geithner says:

“Default was not an option. The numbers were so large that we decided it was at least worth exploring whether AIG’s counterparties would accept voluntary haircuts on their claims. A few cents on the dollar in concessions could have saved taxpayers perhaps $1 billion. But seven of eight top counterparties flatly rejected anything less than 100 cents on the dollar…. And even threatening default could have prompted the rating agencies to downgrade AIG….”

Nonsense.  AIG was effectively bankrupt when the Federal government took it over and everyone knew it.  And what do you think companies are going to say when asked whether they want to get paid in full?

So the rating agencies downgrade AIG?  At that point, so what?

Gretchen Morgenson of The New York Times has suggested:

“Perhaps A.I.G. was treated differently because the government saw an opportunity in the insurer’s liquidity crisis: It could become an enormous taxpayer-funded piggy bank from which the government could funnel billions to a throng of teetering banks.” [2]

Why try to keep the payments secret? From the e-mails Issa obtained, it is certainly clear that the government and its attorneys did everything they could to keep this information secret.  You only attempt a cover up like this if you feel you are doing something wrong.

Geithner: was he involved? A Treasury spokeswoman claims Geithner was recused from working on issues involving specific companies in advance of his nomination to be Treasury Secretary on November 24, 2008. Well, how about the September meetings? Geithner was involved from the beginning.  And it is a real stretch to think he was not kept “in the loop” on something this big as it progressed.

Again from Geithner’s book:

“I thought no-haircuts was a no-brainer….Nevertheless, our failure to impose haircuts on AIG’s counterparties would become Exhibit A for the populist outrage and critique of our crisis response grist for noisy congressional hearings and moralistic oversight reports.”

Well, I guess I am part of the “populist outrage” and I am a “moralist” on this subject too. We will learn more as the Starr lawsuit progresses. As the Presiding Judge Thomas Wheeler has said:

“I think by the time we get finished with this case and we have our trial, we’re going to have the full picture on everything that occurred regarding the government’s rescue of A.I.G.”

[1] This is taken from an earlier piece I wrote.  Both Bloomberg and Gretchen Morgenson of The New York Times did an excellent job in covering this story.

[2] “Court Casts A New Light on a Bailout”, NYT, Sept. 28, 2014.