For three days in a federal court here, trial lawyer David Boies jabbed at former top government officials Henry Paulson and Timothy Geithner about why they treated American International Group Inc. so harshly when engineering the 2008 bailout of the company.So far, the prominent attorney has landed mostly glancing blows.
Mr. Boies instead built a painstaking--and at times complicated--argument that the officials wrongfully imposed tough terms to punish AIG and overstepped the government's legal authority in taking a 79.9% equity stake in exchange for providing an $85 billion loan.
On Thursday, Mr. Boies will take aim at an arguably bigger player in the drama: former Federal Reserve Chairman Ben Bernanke.
The testimony of the former senior government officials is part of a class-action lawsuit filed in 2011 by Starr International Co., an investment and charitable firm run by AIG's former longtime chief executive, Maurice R. "Hank" Greenberg, and which was AIG's largest shareholder in 2008. The case is being heard as a bench trial in the U.S. Court of Federal Claims. The suit seeks $40 billion for shareholders.
Mr. Boies's grilling of the government's three former heavy hitters has transformed the once-obscure, long-shot piece of litigation into a high-profile courtroom battle.
"The government certainly has scored points" so far, said Anthony Sabino, an attorney who specializes in federal litigation and professor of law at St. John's University. He added it is "far from over" andthat he thinks "there is still an enormous risk that the government will be found liable for overreaching, at least to some extent."
In testimony Wednesday afternoon, Mr. Geithner, who was president of the Federal Reserve Bank of New York at the time of AIG's rescue, took responsibility for setting some of the controversial terms, saying he wanted to set an example for other financial firms.
Mr. Geithner said it was his decision to set the interest rate on AIG's loan at a minimum of 12% a year, a rate the New York Fed's general counsel confirmed under questioning last week that he had referred to internally as "loan sharky."
Under questioning from government lawyers after almost two days of fielding Mr. Boies's inquiries, Mr. Geithner said he wanted the rate to be "tough enough to try to mitigate some of the exceptional moral hazard."
He later added that he hoped the terms would "not [be] viewed as attractive by firms at the time...or firms in the future" which might seek government assistance.
Asked by government lawyer Kenneth Dintzer if the taking of the 79.9% equity stake was meant to punish shareholders as Starr maintains, Mr. Geithner responded that "some would say it that way; in fact, I may have, too." But he said it was more accurate to say the equity stake was meant to avoid an "undue windfall" to shareholders.
AIG, which long has been a leading insurer globally, nearly collapsed as a result of a financial-product unit's large sales of an unregulated type of insurance that protected banks and other clients against losses on complex mortgage bonds. In September 2008, AIG faced billions of dollars of collateral calls and increasingly had trouble meeting them, culminating in a plea for help to the government in mid-September 2008.
The government has said in court filings that it sought the equity stake as part of its consideration for the $85 billion loan. AIG used its insurance units as collateral, something the Fed was unaccustomed to dealing with, so it wanted the equity stake as additional compensation for taxpayers for the risk they were taking on in lending to AIG.
By late 2012, AIG fully repaid the rescue package, which ultimately swelled to $184.6 billion in assistance and a 92% government stake, as the company narrowed its focus to core insurance operations and regained its footing.
Mr. Geithner also described in vivid terms the drama that was unfolding in 2008 as the financial crisis worsened. When Mr. Dintzer asked why he was responding to emails at 3 a.m. in September 2008, Mr. Geithner replied, "The world was falling apart. We were trying to figure out whether to do anything about it."
A key part of the lawsuit alleges AIG didn't voluntarily accept the rescue package's onerous terms but had them forced upon it by the government.
Mr. Boies is pulling together material from an array of sources seeking to prove Starr's contention that government officials wrongfully sought to punish AIG shareholders, even as they considered it imperative for the then-giant financial-services company to accept the terms because an AIG bankruptcy would cause widespread harm to the economy.
Perhaps as a preview of Thursday's testimony, the attorneys also introduced in court on Wednesday a Sept. 13, 2008, email from Mr. Bernanke, three days before AIG's rescue, in which he wrote of the company, "We think they are days from failure. They think it is a temporary problem. This disconnect is dangerous."