Litigation may be slowly doing the job missed or only partially completed by various governmental investigations into the financial crisis. The Valukas report on the Lehman bankruptcy was revealing, and numerous foreclosure defense attorneys have opened cans of worms that the powers that be would rather pretend simply don’t exist.

The New York Times reports tonight that a case filed last year was unsealed last week. It plumbs a continuing sore point with the public, namely the generous terms of the AIG bailout, both to the company (which defied the government and insisted on remaining largely intact when the plan had been to sell its various units to repay the government funding) and to its credit default swap counterparties. The litigation has the potential to be revealing, particularly if it goes into discovery (various depositions are likely to become public in pre-trial jousting, um, motions). The Times gives an overview:

The lawsuit, filed by a pair of veteran political activists from the La Jolla area of San Diego, asserts that A.I.G. and two large banks engaged in a variety of fraudulent and speculative transactions, running up losses well into the billions of dollars. Then the three institutions persuaded the Federal Reserve Bank of New York to bail them out by giving A.I.G. two rescue loans, which were used to unwind hundreds of failed trades.

The loans were improper, the lawsuit says, because the Fed made them without getting a pledge of high-quality collateral from A.I.G., as required by law.

“To cover losses of those engaged in fraudulent financial transactions is an authority not yet given to the Fed board,” said the plaintiffs, Derek and Nancy Casady, in their complaint, filed in Federal District Court for the Southern District of California.

The lawsuit names A.I.G., Goldman Sachs and Deutsche Bank as defendants, but not the Fed.

The lawsuit itself names other defendants, including Merrill and its successor Bank of America, SocGen, and “Does 1 through 100.”

White shoe types will likely look down their noses at the filing. It makes rather eccentric use of graphics (for instance, including company logos) and includes charts, some of which are very helpful (tables with tabulations and timelines), while others are visual representations of arguments made in the text and hence would be deemed by style snobs to be redundant. It also is somewhat sensationalistic, even heated at points in tone (which does make for more lively reading) and does not unpack its arguments as much as appears to be typical in court filings.

Nevertheless, despite the rough style, there’s some intriguing reading, and the case does a clever job of juxtaposing e-mails and Congressional testimony by AIG executives with various disclosures of the AIG bailout process and the terms of the loan facilities.

To my non-expert eye, the case appears to hinge on the argument that begins on p. 43, that the Fed loans were in violation of the Fed’s authority under the widely-cited “unusual and exigent circumstances” clause. I had taken the reading of former central banker, now Citigroup economist Willem Buiter on this, that it gave the Fed the authority to lend against a dead dog if it chose to.

That appears to be inaccurate, and I wonder if the focus upon this section will embolden the Audit the Fed crowd to have another go at the central bank.

Specifically, the “unusual and exigent” language includes other restrictions, which I read as all being operative:

1. The central bank can lend against “notes, bills, and other drafts of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal reserve bank

2. The “notes, bills, and other drafts of exchange” must be discounted

3. The Federal reserve bank making the loan must obtain evidence that the non-bank party seeking the loan can’t get credit from other banks

4. “….five or more members of the Board of Governors must affirmatively vote to authorize the discount prior to the extension of credit.”

The case focuses on allegedly fraudulent representations made by AIG and the various major dealers in the course of obtaining the financing. But the part I find interesting is the Fed’s evident non-compliance with the requirements of this section, particularly the fact that the central bank lent 100% against the face value of the AIG CDOs, between taking out the CDS and then lending the bailout vehicle Maiden Lane III the funds to buy the CDOs. Interestingly, the SIGTARP investigation missed this issue. If this was at all considered, the argument may have been that the AIG equity in MLIII was tantamount to a discount, but the lawsuit argues that notion is bogus. Since AIG was broke, any money for the AIG equity came from the outside (in fairness, it’s a bit more complex, thanks to reserves set aside over the collateral dispute).

The suit argues that the initial loan was made under false premises, since the loan was secured by all assets of AIG, when the assets were already pledged (all the regulated subs have prior claims on them, both to creditors and policy-holders). The understanding, as depicted in various less-than-official accounts, like the Andrew Ross Sorkin Too Big Too Fail, is that the loans were secured by the equity of the subs. Fine in theory, but in practice, that isn’t what the loan document says, and as important (although not argued in the case) is the amount of the loan was based on what AIG needed to stay afloat, not on any effort to find a market value of the assets pledged and discount that.

In addition, the notion that it was acceptable to lend against stock appears to be based on the discount schedule that the Fed posts and revises from time to time as to the types of collateral that are accepted for lending and the various discount rates established for them. But note that schedule is for depositary institutions. The Fed acted as if it could simply lend against the same assets held by non-depositaries, but the language of the germane section does not appear to support that idea.

The various disclosures of how the Fed lent against pretty much anything the banks could round up, including defaulted securities, is troubling. Defenders of the central bank argue no harm was done since the securities have recovered from crisis lows (well save the ones that went to zero). The problem is that the logic is circular. In many cases, the value of the securities now depends on the fact that the Fed is willing to lend at super low interest rates. So the “market” values are fictive and dependent upon Fed intervention, which is coming at the expense of savers. The interdependence between the Fed’s rescue facilities and its continued interventions is given a free pass, but those of us who are not at the top of the food chain are continuing to pay the cost.

Naked Capitalism

Seriously, there’s a difference between being rather foolish and outright bullcrap.

In the ‘you can’t make this crap up’ category this morning we have this report from Seeking Alpha:

The U.S. government and American International Group Inc. (NYSE: AIG) on Wednesday announced a deal to accelerate repayment of taxpayer dollars and clear the road for the company to reclaim its independence.

Terms of the arrangement, which were outlined in September, call for the company to borrow funds from the Treasury Department to repay the remainder of its debt owed to the Federal Reserve, leaving the Treasury holding the bulk of the beleaguered company’s common stock.

Once the world’s largest insurer, AIG received more than $180 billion of bailout funds from the government to help cover investments that vanished during the collapse of the U.S. real estate bubble. The “definitive recapitalization agreement” signed by AIG “marks an important step forward in our progress toward completely repaying taxpayers,” the company said in a statement.

Under the recapitalization plan, AIG “will have the right to raise up to $3 billion [and up to an additional four billion dollars with the consent of the Treasury Department] by August 15, 2011,” AIG said in a filing with the U.S. Securities and Exchange Commission (SEC).

The restructured deal also spells out the rights the Treasury Department will have under the accelerated exit plan as it begins to sell off its controlling stake in the giant insurer.

“Today’s announcement is a milestone in the government’s long-stated efforts to exit our investments in private companies as soon as practical while protecting taxpayers,” Tim Massad, acting assistant secretary for financial stability, said in a statement. “When all is said and done, we believe taxpayers will recover every dollar invested in AIG and stand a good chance of making a profit.”

The Treasury is aiming to sell at least $15 billion of its shares in the insurer in the first of a series of stock offerings starting in the first quarter of 2011, people familiar with the matter told The Wall Street Journal.

The $15 billion share sale represents roughly 25% of the government’s stake, given AIG’s current stock price. The government currently owns 79.8% of the company and is expected to increase its stake to 92.1% by converting preferred shares it owns into AIG common stock.

The plan will then revert to a careful balancing act as the government unloads an additional $60 billion in AIG stock over the next two years, hopefully without destabilizing the company and driving down the share price. While Treasury wants to exit its ownership as quickly as possible, the agreement will allow the company only the limited ability to sell shares to maintain its capital position or that of its insurance units.

The government will have complete control over the terms, conditions and pricing of any sale in which it participates, including any primary offering by AIG until the Treasury Department’s ownership of AIG’s voting securities falls below 33%.

Although AIG has the right to conduct two primary offerings per year, the Treasury Department may decide to participate in those offerings, and to prevent AIG from selling any stock into the market, according to The Journal.

The actual size of AIG’s offerings will depend on investor demand for the stock, which the company hopes to buttress with a series of investor presentations in the coming months, anonymous sources told The Journal.

AIG also must retire $20 billion in secured debt to the Federal Reserve Bank of New York and transfer other obligations from the New York Fed to the U.S. Treasury. The Treasury sales won’t happen until the two sides have worked out an agreement for those transactions.

The government can compel AIG to sell shares it holds in two companies: AIA Group Ltd and MetLife Inc. (NYSE: MET). AIG owns a portion of AIA, an Asian life insurer, after spinning the company off to help repay its debt. AIG got the MetLife stock when it sold another unit to MetLife.

AIG recently issued its first bonds in more than two years as part of an effort to line up $11 billion to $12 billion in “actual and contingent” liquidity to support it after its debt from the New York Fed is retired, Moody’s Investors Service (NYSE: MCO) said AIG was the biggest recipient of government aid during the financial crisis and has been a lightning rod for critics who have questioned the government’s decision to save it through the Troubled Asset Relief Program (TARP).

A Congressional Budget Office report in March said AIG’s ability to repay the bailout funds is an open question and that as much as $36 billion in assistance provided to the company since the start of the financial crisis may never be repaid.

“When AIG will be able to pay the government completely back for its assistance is currently unknown because the federal government’s exposure to AIG is increasingly tied to the future health of AIG, its restructuring efforts, and its ongoing performance as more debt is exchanged for equity,” the report said.

The Congressional Oversight Panel, created to oversee TARP, said in June that it is unclear if AIG can generate enough value for shareholders to ensure the U.S. government gets repaid in full, concluding that taxpayers “remain at risk for severe losses.”

STOP THE LOOTING AND START PROSECUTING

By Karen Weise

Deep in an article today on the government’s bailout of AIG, The New York Times cites sources saying that the Treasury Department’s “point man” on AIG, Don Jester, was a former Goldman Sachs employee who owned stock in the bank even as he was making decisions [1] on the bailout that ultimately channeled billions of taxpayer dollars to Goldman.

Owning stock in a company an official oversees typically is verboten, but because Jester was working as an outside contractor rather than an official employee, he was exempt from conflict-of interest rules [2].

American International Group building in New York City (Spencer Platt/Getty Images)

Goldman Sachs stood to benefit from the AIG bailout because Goldman had roughly $20 billion in insurance-like credit-default swaps with AIG — essentially bets by the investment bank that the housing market would go south. But if AIG collapsed, Goldman wouldn’t be able to collect on the bets. When the government instead bailed out AIG, taxpayers paid out the swaps at full face value, and Goldman Sachs got $12.9 billion [3] — more than any other of AIG’s customers.

Jester was Goldman’s deputy CFO when he left the firm in 2005. And here’s what the Times says [1] about his investments in Goldman:

Mr. Jester, according to several people with knowledge of his financial holdings, still owned Goldman stock while overseeing Treasury’s response to the A.I.G. crisis.

We contacted Jester this morning to comment on the story and confirm the stock ownership; we’ll post an update when we get a response. His spokesperson, Michelle Davis, told the Times that Jester followed what the paper paraphrases as an “ethics plan to avoid conflict with all of his stock holdings.” (According to a federal database search, Jester received $30,000 [4] for six months consulting at the Treasury Department.)

Earlier this year, a Times op-ed online dubbed Jester one of the “mystery men” [5] of the financial crisis and noted that Jester was at the center of the Treasury Department’s response to AIG’s impending collapse. During the chaotic two months in the fall of 2008, Timothy Geithner, then the head of the Federal Reserve Bank of New York, spoke on the phone with Jester 103 times — more than other person aside from then-Treasury Secretary Henry Pauslon. Jester relocated to AIG’s offices for a period of time, the paper reported.

The government’s decision to have AIG pay out Goldman and others bets at full value has been controversial. The Times said while several of the Federal Reserve Bank of New York’s outside advisors recommended it force banks to take losses on their bets with AIG, Jester advocated for full repayment:

According to the documents, Mr. Jester opposed bailout structures that required the banks to return cash to A.I.G. Nothing in the documents indicates that Mr. Jester advocated forcing Goldman and the other banks to accept a discount on the deals.

As an example of the advice against paying full value for the deals, the Times cited a presentation from an advisor [6] to the New York Fed, which outlined five reasons banks should agree to concessions. The Federal Reserve Bank of New York defended its decisions to the Times:

“This was not about the banks,” said Sarah J. Dahlgren, a senior vice president for the New York Fed who oversees A.I.G. “This was about stabilizing the system by preventing the disorderly collapse of A.I.G. and the potentially devastating consequences of that event for the U.S. and global economies.”

ProPublica

By Karl Denninger

Just two of the articles circulating today regarding the huge losses the US Taxpayer is going to take on the bailout of AIG:

U.S. Faces ‘Severe’ AIG Losses, Says Panel

By SERENA NG

A watchdog panel reviewing the bailout of American International Group Inc. said U.S. taxpayers “remain at risk for severe losses” and that the government didn’t act aggressively enough to protect U.S. taxpayers during the 2008 rescue.

In a lengthy report, the bipartisan Congressional Oversight Panel concluded that the U.S. government, which owns nearly 80% of the insurance giant, is likely to “remain a significant shareholder in AIG through 2012″ and it is unclear if taxpayers “will ever be repaid in full.”

The report contrasted with more optimistic comments Wednesday by Federal Reserve Chairman Ben Bernanke before a U.S. House panel. Mr. Bernanke said that every major financial institution receiving government aid at the height of the financial crisis has repaid taxpayers with interest and dividends, and AIG is not expected to be any different. “AIG, I believe, will repay,” he said.

Since September 2008, the Federal Reserve Bank of New York and the Treasury Department have committed up to $182.3 billion to support AIG and provided roughly $132 billion of those funds so far. AIG is on the hook to repay about $101 billion mainly through asset sales and stock sales, and the rest is to be recouped from mortgage securities the New York Fed took onto its balance sheet.

The oversight panel’s report noted that, while the rescue of AIG helped the financial system avert collapse, the government “failed to exhaust all options” before committing taxpayer funds to AIG. The panel argued that the government could have done more to organize a rescue effort involving private-sector funds or concessions from other financial institutions, which ended up being beneficiaries of the AIG bailout.

It also said a controversial decision by the New York Fed in late 2008 to pay off AIG’s trading partners in full on $62 billion in soured mortgage trades “distorted the marketplace” and protected AIG creditors at the expense of taxpayers.

“Billions of taxpayer dollars were put at risk, a marketplace was forever changed, and the confidence of the American people was badly shaken,” the report said. The panel, which oversees the government’s financial-bailout program, is chaired by Elizabeth Warren, a Harvard Law School professor.

In a statement, Treasury spokesman Andrew Williams said the government had “only hours” to make critical decisions in September 2008 and noted that “Treasury has spent more time in meetings with [the panel] answering questions about the decisions made.” He added that the panel’s suggested alternatives overlook the fact that “the global economy was on the brink of collapse” at the time.

A Fed spokesman said the central bank believes the actions it took to rescue AIG in September 2008 were necessary and disagrees with “the view that there were any better alternatives that were workable in the extreme circumstances of the time. It added that policymakers need “much better tools for dealing with such situations in the future.”

The report, which spanned more than 300 pages, is being released about two weeks after the panel held a full-day hearing on AIG. At that hearing, AIG’s chief executive Robert Benmosche said he was confident taxpayers would get their money back “plus a profit.”

Days later, an AIG plan to sell its biggest Asian life insurance business to British insurer Prudential PLC for $35.5 billion was canceled, a setback to AIG’s efforts to repay taxpayers. On June 2, Treasury’s chief restructuring officer Jim Millstein told the panel that AIG should be able “to realize value equivalent to the $35.5 billion” price through an alternate strategy that could include an initial public offering of the overseas unit, the report said. It added that, at that meeting, Mr. Millstein also acknowledged that AIG needs to map out an updated strategy in the coming months to repay the government.

The panel said the government’s exit strategy—which involves selling off its stake in AIG—is subject to substantial market risk and depends on AIG’s ability to rebuild a sustainable business in the coming years. If markets or AIG’s performance worsen significantly, Treasury could opt to pursue “a more aggressive break-up strategy and/or strategic bankruptcies of certain business lines,” the report says.

Ms. Warren on Wednesday said the panel didn’t view the Prudential deal failure as “a significant indicator of taxpayer repayment. That [depends] much more on how AIG’s insurance business performs,” said Ms. Warren, adding that drawing up a tight repayment timeline for AIG could be counterproduc tive. “We don’t want to limit the company’s ability to make money—we want a profit on behalf of the American taxpayer.”

An AIG spokesman reiterated earlier comments made by its CEO to the panel, saying that “we are well on our way to remaking AIG into a more streamlined and focused company” that is committed to repaying taxpayers and strengthening its units.

The panel’s report also highlighted the overlapping roles of various parties that were involved the AIG bailout. It noted that people from a small group of law firms, investment banks and regulators sometimes represented conflicting interests. For example, lawyers representing a group of banks that had considered providing a rescue package to AIG ended up becoming lawyers to the Fed, while banks that were potential rescuers became the main beneficiaries of the bailout.

“These entanglements created the perception that the government was quietly helping banking insiders,” the report said.

The panel added, however, that after reviewing scores of documents, it found “no evidence of any…concerted effort” by regulators or government officials to orchestrate the AIG bailout to specifically benefit firms that the regulators previously worked at—a tacit acknowledgment of controversy surrounding AIG’s relationship with Goldman Sachs Group Inc.

Michael R. Crittenden contributed to this article.

AIG’s Problems Far Greater Than Bush Officials Told Public

By Greg Gordon | McClatchy Newspapers

WASHINGTON — At the peak of the 2008 financial crisis, then-Treasury Secretary Henry Paulson and top Federal Reserve officials told the nation that there was an urgent need for the government to lend $85 billion to the American International Group so the giant insurer’s temporary cash squeeze wouldn’t trigger global financial chaos.

Nearly two years later, taxpayers are on the hook for twice that amount, and it now appears that Paulson and senior Federal Reserve officials either plunged ahead without understanding AIG’s financial situation and the risks it posed to taxpayers — or were less than candid about one of the largest corporate bailouts in U.S. history.

AIG reported combined total losses of $110 billion in 2008 and 2009, erasing any doubt that the government stepped into a colossal mess.

AIG was at the epicenter of all the government bailouts of financial institutions in 2008, a company through which more than $90 billion in federal money flowed out the back door to some of the same Wall Street banks whose risky behavior fueled the crisis. Among the leading beneficiaries of the AIG bailout was investment banking giant Goldman Sachs, which Paulson headed until June 2006.

Explanations of the bailout from current and former top government officials have never fully jibed, fueling allegations that most of the money was always intended for Wall Street rather than Main Street.

Elizabeth Warren, the chairwoman of the Congressional Oversight Panel that’s tracking the use of bailout money, said at a hearing in late May that the government “broke all the rules” with its rescue of AIG, which she labeled a “corporate Frankenstein” that defied regulatory oversight.

As the Fed wired billions of dollars to AIG in the fall of 2008, state and federal officials assured the public that the company’s financial woes were limited largely to its parent, which had wagered $2 trillion on exotic financial instruments and incurred massive losses on housing-related investments. AIG’s six dozen U.S.-based insurance companies, the regulators said, were all on solid footings.

A McClatchy analysis of the finances of 20 of AIG’s larger insurance subsidiaries at the time has found a much bleaker picture, however: More than $200 billion in potential red ink was obscured by entanglements in which these subsidiaries bought stock in, reinsured or guaranteed debts of their sister companies.

Despite the regulators’ public assurances and AIG’s assertion that pooling arrangements among its subsidiaries made the liabilities look worse than they actually were, AIG has since propped up its insurance subsidiaries with $31 billion of taxpayers’ dollars, and its total debt to taxpayers — once as much as $182 billion — still could reach $162.5 billion.

Now the company, nearly 80 percent owned by taxpayers, is reporting profits again and appears to have stabilized. Even before AIG’s planned $35.5 billion sale of a prized Asian insurance subsidiary collapsed on June 1, however, government auditors projected that bailing it out will still cost taxpayers as much as $47 billion.

Most experts agree that shoring up the giant insurer was important to prevent a systemic financial breakdown, but critics question the government’s handling of the bailout — from its misleading early portrayals of AIG’s financial condition to failing to press Wall Street creditors such as Goldman to accept discounted payments from AIG.

Warren, whose panel is completing a critical report on the bailout, said, “The government invented a new process out of whole cloth.”

In a normal restructuring, she said, AIG’s shareholders “should have lost everything, and its creditors should have taken substantial losses.”

Neil Barofsky, the special inspector general assigned to watch over hundreds of billions in federal bailout dollars, last fall also criticized the Fed’s decision to pay Goldman and others 100 cents on the dollar to settle AIG’s insurance-like bets, known as credit-default swaps, on offshore mortgage securities.

Instead, creditors such as Goldman were paid in full, and AIG shareholders’ stock was diluted twentyfold, but not wiped out.

Now Barofsky is investigating whether New York Fed employees may have concealed information about the bailout and whether Wall Street firms might have defrauded taxpayers by concealing risks in seven offshore deals that AIG had insured. To settle AIG’s positions, the New York Fed wound up buying mortgages in deals that appeared headed for default.

A central question is how much U.S. officials knew about the company’s problems when they decided to bail it out.

Thomas Baxter, the general counsel of the Federal Reserve Bank of New York, acknowledged in phone interviews that the Fed’s understanding of the insurer’s financial condition “changed over time as we got to know AIG and its problems.”

“That led us to come up with different solutions as we learned . . . that its problems were both liquidity (a cash squeeze) and capital (insufficient assets),” he said.

Robert Eisenbeis, a former research director for the Federal Reserve Bank of Atlanta, said that the AIG bailout “was painted as a liquidity problem, and it was a solvency problem. And it’s still a solvency issue.”

In making the massive loans to AIG, the Fed was wielding vast emergency powers that dated to the post-Depression era and were expanded by Congress in 1991.

Treasury Secretary Timothy Geithner, who headed the New York Fed in the fall of 2008, told Congress in late January that the central bank had the authority “to protect the financial system from broad-based runs,” but could lend only to “firms that were solvent,” able to pay their debts.

He made no mention of AIG’s questionable solvency.

In his recently published book, “On the Brink,” Paulson describes advising President George W. Bush at a White House meeting on Sept. 16, 2008, that AIG needed a large but temporary cash infusion.

Paulson also wrote that he persuaded presidential candidates Barack Obama and John McCain not to call the AIG rescue a “bailout,” and they obliged.

He recalled that he told Bush that AIG, unlike the investment bank Lehman Brothers, which had gone bankrupt two days earlier, didn’t have a shortage of assets — “at least we didn’t think so at the time.”

However, Paulson also recalled learning within weeks that AIG was “in dreadful shape . . . a badly wounded company” on the verge of collapse, unable even to make the interest payments on its government loans. On Nov. 5, 2008, the day after the presidential election, Paulson advised Bush that the Treasury Department would pay $40 billion to buy preferred stock in the insurer to keep it alive.

Paulson wrote that Bush asked his Treasury Department aide, Jim Lambright: “Will we ever get the money back?”

“I don’t know, sir,” Lambright replied.

A spokeswoman for Paulson referred a reporter to his book and declined further comment.

The GAO found last year that Paulson and the New York Fed initiated the rescue without consulting the Office of Thrift Supervision, a Treasury Department agency that regulated AIG’s consolidated operations because the insurer owned a savings bank, but which never policed the company effectively.

The OTS had sent AIG a scathing, confidential letter in March 2008 citing its failure to write off losses from its swaps dealings properly and downgrading the insurer’s regulatory rating.

However, the officials at the New York Fed who were watching over AIG knew so little about its financial troubles that the insurer wasn’t among the “top 10 exposures” they were monitoring until days before the bailout, Sarah Dahlgren, an executive vice president at the powerful regional bank, told Warren’s panel.

Insurers such as AIG seldom make much of their money from policy premiums, which they must set aside to pay future claims. To generate big profits, they need investment bonanzas.

AIG’s gambles instead racked up colossal losses.

One AIG investment company, AIG Securities Lending, borrowed as much as $94 billion in high-grade bonds from domestic life insurers and loaned $76 billion of the bonds to U.S. banks in return for cash. It then invested the short-term money in long-term mortgage securities backed by loans to homebuyers with marginal credit.

Douglas Slape, the chief financial analyst for the Texas Department of Insurance, said that Texas regulators discovered, during a routine exam in 2007 just as the housing market began to stutter, that AIG had “overinvested in one sector — the housing market.”

State regulators pressed AIG to unravel the program, but it had divested only about a quarter of its risky securities by the third quarter of 2008, when the crisis hit.

The banks’ demanded their short-term money back in return for the bonds, which escalated AIG’s cash drain.

After the taxpayer bailout, McClatchy found, AIG distributed $20 billion in securities lending losses among its insurance subsidiaries, and then offset the red ink by booking similarly sized capital contributions that only could have come from taxpayers. That lifeline kept seven life insurers in the black, according to their regulatory filings.

However, AIG then assessed several of the insurers $7 billion, cobbling that together with government cash and loans to finance a $43.7 billion settlement that returned the bonds to the insurers and left taxpayers holding risky mortgage securities.

W.O. Myrick, a retired Louisiana chief insurance examiner who’s studied AIG, criticized state regulators for allowing the insurers to “falsify” their balance sheets by continuing to list the bonds as assets while they were loaned to banks.

“Had something been done back then,” Myrick said, “there would have been people that would have been speaking up to avoid long prison terms,” perhaps leading to action that could have prevented the massive securities lending losses.

Many of the company’s troubles have been blamed on its colorful former chairman, Maurice “Hank” Greenberg. While he presided for 37 years over its growth into a trillion-dollar goliath with operations in more than 130 countries, the firm also ran afoul of the law.

Beginning in 2004, the SEC obtained three court injunctions barring AIG from illegal practices including bid rigging and accounting fraud, including concealment of liabilities in offshore companies that it secretly controlled. In 2004 and again in early 2006, the Justice Department and AIG signed agreements that deferred criminal prosecution.

The worst shenanigans didn’t occur until after Greenberg’s 2005 departure, however. The firm’s London subsidiary, AIG Financial Products, issued $500 billion in insurance-like contracts, known as credit-default swaps, which amounted to bets on the performance of securities.

From 2004 to 2006, AIG wrote swaps for Goldman and other banks covering $70 billion in mortgage securities, most of them backed by home loans to shaky borrowers.

When the housing market crash sank the securities’ value, the banks clamored for the cash AIG had posted as collateral on these swaps.

AIG wound up settling most of its bad bets by effectively buying the underlying securities from U.S. and European banks, most of them for their full face value of $62 billion, including $15.6 billion to Goldman, a firm that had a decades-long relationship with the insurer and former executives perched in senior Bush administration jobs.

AIG then used the securities as collateral for a $24.3 billion loan from the Federal Reserve Bank of New York.

Some critics allege that in buying those securities, the New York Fed illegally accepted as loan security the same kinds of toxic assets that firms such as Goldman were desperate to dump.

Unlike President Franklin Roosevelt in the Depression era, neither Bush nor Obama stood up to the major financial institutions by refusing to bail out those with “bad assets,” said Michael Aguirre, a San Diego lawyer who’s fighting in an appeals court for the right to sue AIG for allegedly defrauding policyholders.

“AIG went to always higher levels of fraud, higher levels of risk, and finally this whole thing blew up,” but the insurer still got bailed out, Aguirre said.

Fed officials say the loans were legal, and that the securities, the best slices of packages marketed offshore, have recouped so much value that taxpayers are ahead $6 billion to $7 billion.

A newly released October 2008 draft analysis by Blackrock, Inc., a financial services firm assisting the New York Fed with the bailout, concluded that the securities were essentially safe bets all along. Even in a catastrophic scenario, Blackrock found, there was little risk of more than a partial loss of interest payments on those mortgage-backed securities.

Sylvain Raynes, an expert in structured securities who’s followed the subprime mortgage meltdown, said that if Blackrock’s analysis is accurate, Goldman and others had few grounds to demand more cash from AIG, and “no bailout was needed.”

The New York Fed’s Baxter said the rescue of AIG “wasn’t about Wall Street,” but about calming panic and unfreezing credit markets.

AIG’s creditors “came in all shapes and sizes, and I’m not fighting that some were large financial institutions,” Baxter said. “But that’s not why we did what we did. It was the rest of America, really: Pensions, 401K holders, municipalities.”

Thomas Gober, a former Mississippi chief insurance examiner, however, fears that AIG’s problems run so deep that taxpayers and insurance policyholders will be left holding the bag.

Gober, who said he’s been paid as a plaintiff’s expert witness in suits against the company, alleged that until it was rescued, AIG’s parent followed a business model that he said resembled a Ponzi scheme.

The parent company, he charged, drained billions of dollars in dividends from its subsidiaries, deceived regulators by shifting liabilities to affiliates or offshore companies and lured consumers to make lump sum investments in a bid to keep pace with spiraling obligations.

AIG denies such allegations.

Gober said state regulators couldn’t keep up with the schemes because they never coordinated a simultaneous financial audit of all of AIG’s 71 domestic insurers, 18 of which have now been sold, so he attempted one himself last year.

He now predicts $300 billion in additional losses to taxpayers and policyholders — possibly double or triple that — “based on AIG’s pattern of false accounting schemes and persistent overstating of assets and understating of liabilities.”

“I’m expecting it to be a significant insolvency when all the propping up stops,” said Myrick, the Louisiana examiner who’s spent hundreds of unpaid hours studying AIG subsidiaries’ regulatory filings and examination reports. He warned that policyholders, such as those who bought retirement products guaranteeing monthly fixed-income payments, could be at risk.

Robert Benmosche, AIG’s chief executive, dismisses such talk. In a phone interview, he said that, “the policyholders are completely protected . . . in every country we do business in.”

Scott Harrington, a professor at the University of Pennsylvania’s Wharton School of Business who specializes in insurance, agrees that U.S. policyholders won’t get hurt. He said he finds it “fundamentally implausible” that policyholders will be left short “now that the U.S. government is standing behind any and all claims against AIG.”

Benmosche acknowledged that the company “would not be here as it is today if it were not for government support.”

He predicted, however, that the firm’s recovering core operations and steady selloff of assets will propel the repayment of its $132.3 billion in outstanding taxpayer loans ahead of a 2013 deadline.

In testimony to Warren’s panel in late May, Benmosche said he thought the company could generate $6 billion to $8 billion in net profits by 2011.

“If he can get it to $8 billion (in) after-tax earnings,” said James Millstein, the Treasury Department’s chief restructuring officer, “we’re gonna be repaid in full.”

In recent weeks, Benmosche and AIG have trumpeted an upgrade of its credit ratings and the potential for a huge financial boost by selling two plum Asian insurance companies, American International Assurance, or AIA, and the American Life Insurance Co., known as Alico, for $51 billion by year’s end.

However, London-based Prudential PLC pulled out of the AIA purchase after British regulators questioned whether the company could carry the extra debt load and its shareholders protested.

“AIG is in the best shape it’s been in two years,” Benmosche said in a letter to employees after the deal fell through, “and our goals remain the same: to honor all of our obligations, divest certain assets to repay the U.S. government and ensure that our remaining businesses thrive.”

AIG is expected to make good on its $83 billion debt to the New York Fed, but the Government Accountability Office predicted in April that the company will draw down the remaining $22 billion available on a nearly $30 billion credit line from the Treasury Department.

The most recent forecasts from the Congressional Budget Office and the Treasury Department project taxpayer losses of $36 billion to $47 billion on Treasury loans to AIG totaling nearly $70 billion.

Moreover, while nearly every major bailed-out bank has arranged to repay its emergency government loans, American taxpayers still own a 79.8 percent stake in AIG, a company with a labyrinth of internal financial relationships and such a history of law breaking that a Delaware judge last year likened it to “a criminal organization.”

There’s a New AIG Story. I Was an AIG Exec. Here’s the Deal.

Richard (RJ) Eskow - Consultant, Writer, Policy Analyst

It’s looking like the SEC/Goldman Sachs lawsuit could open up a whole new can of worms — one that Tim Geithner and some bank executives aren’t likely to be very happy about. The story’s about AIG and I used to work there so, as much as I like to stay out of the story, a little personal background is in order. We’ll do the story first and then get to the personal stuff.

The story is this: As almost everyone knows by now, the SEC filed a suit against Goldman over a program called Abacus. The suit alleges that Goldman didn’t tell Abacus investors that the bonds they were essentially insuring were being picked by a firm (Paulson) which was betting that they’d fail. Remember that Twilight Zone episode called “To Serve Man,” where the aliens promised to help everybody but were really just getting ready to eat them? In this story the investors are the humans and Goldman’s execs are the aliens.

The slide show Goldman used to pitch Abacus is pretty damning. It starts with so many pages of fine-print “disclaimers” and “risk factors” that it seems like a Viagra ad (“call your doctor if …”). There’s a lot in there about well-respected (but at best gullible) ACA, this firm that Goldman claimed was picking the bonds. About half of the 66 slides sing ACA’s praises, but there’s no mention of Paulson. There are long descriptions of ACA’s capabilities, their “internal” and “external data sources,” and their “defensive trading” designed to “minimize real market value exposure.”

To serve man. “It’s a cookbook!”

Here’s where it gets uncomfortable for Geithner and some executives. Remember all that criticism of the taxpayer-funded AIG bailout, and how under Tim Geithner’s direction (he was running the New York Fed then) AIG paid 100 cents on the dollar to Goldman and other “counterparties” for its debts? It turns out that AIG insured seven Abacus deals, and the debts they were ordered to pay may have included payoffs on some of these deals. It turns out that AIG reportedly wanted to pay 60 cents on the dollar, but Geither’s New York Fed directed them to pay the full amount.

AIG paid $13 billion from its bailout to Goldman at Geithner’s direction. And now, as the Wall Street Journal reports, the SEC “is investigating whether other mortgage deals arranged by some of Wall Street’s biggest firms may have crossed the line into misleading investors.” And, while “It isn’t known what deals the SEC is investigating,” the Journal adds that “among the firms that created mortgage deals that soon went sour were Deutsche Bank AG, UBS AG and Merrill Lynch & Co., now owned by Bank of America Corp.”

Who were some of the other counterparties paid by AIG under Geithner’s direction? Deutsche Bank, UBS, Merrill Lynch, and Bank of America. This is already a big story, and it could get much bigger. None of those firms can be happy today, knowing that they’re being drawn into the firestorm surrounding Goldman Sachs. And Geithner can’t be happy that his handling of AIG is once again in the news. He took a beating for it back then (including from right-leaning Forbes, the self-described “capitalist tool”), and the NY Fed’s eventual defense of its own actions was ineffectual. Among other things, it claimed that the counterparties’ “contractual rights were well-protected.”

Not if they lied, they weren’t. Nobody has a “well-protected right” to enforce contracts made under false pretenses. It looks now as if the New York Fed didn’t try hard enough.

It’s not as if people weren’t objecting at the time. Eliot Spitzer was all over the issue. Former AIG CEO Hank Greenberg, who had been forced out by Spitzer, wrote that “the federal government is using AIG as a conduit to pump massive sums to the counterparties of AIG’s credit default swaps.” Spitzer, along with William Black and Frank Portnoy, had a very reasonable request: Release AIG’s emails from that period so we can get to the bottom of the situation. That’s a good idea today, too – no matter who it might make uncomfortable.

Now AIG is considering a lawsuit to get some of that money back from Goldman. Two members of Congress want to collect the money, too. Good idea. If it embarrasses some people in high places, there’s a solution for that too: They can push for aggressive derivatives reform, which is something Geithner’s reportedly been resisting up to now. None of us can change our past actions, but we can all vow to do better in the future.

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I can’t write about AIG without disclosing the fact that I used to be an executive there. Not that I’ve been hiding it — I’ve mentioned it in interviews and elsewhere — but I didn’t cover the last AIG crisis so I never had to address the conflict of interest issue directly. Now I do, so here’s the deal:

I worked for a health care company that was acquired by AIG, and wound up staying there for about seven years. I was well-liked at AIG, and I liked working there. I wasn’t involved with financial products. I worked in risk management and property/casualty, focusing on workers’ compensation and health issues. Then I became President of an AIG subsidiary and joint venture that did international health projects and some investment work. I never worked directly for Hank Greenberg, although I had several meetings with him and was the target of his well-known interrogative wrath at least once.

I was still working on Wall Street, though not at AIG, when “quants” became trendy and financial products really began taking off. (We had an all-Wall Street rock and roll band in those days. I still wonder what became of the keyboard player from Merrill Lynch.) Regarding financial products: Some of us thought we saw thunderclouds forming, but everyone told us that these guys knew what they were doing. It turned out there were thunderclouds.

There’s a lot more to the story than that, but for now I’ll just say that my opinion of AIG is this: It was a good company when I worked there. Many people found the aggressive culture hard to handle, but I didn’t. (God knows what that says about me.) It had some real flaws – it was notoriously slow to pay claims, for example. Still, I had many friends there, some of whom caught undeserved flack for what the financial products people did. AIG contained many different companies, but it appears that the 200 employees of the financial products group operated by a completely different set of rules.

The insurance and risk management operations were essentially sound and well-run, and from everything I know they still are. Nobody got rich from bonuses — certainly not me. And the sooner those sound businesses can get out from under the wreckage wrought by the financial products group and its enablers, the better off everybody will be — including the American taxpayer.

Richard (RJ) Eskow, a consultant and writer, is a Senior Fellow with the Campaign for America’s Future. This post was produced as part of the Curbing Wall Street project. Richard blogs at:

No Middle Class Health Tax
A Night Light

One of the first things that ‘put me off’ of Obama was the choice he made of key appointments to his Administration, selecting the two Robert Rubin acolytes Tim Geithner and Larry Summers to his team, marginalizing Paul Volcker, and then making no place for Robert Reich. Although I am sure that, like the rest of us, he puts his pants on one leg at a time, he has shown himself to be a remarkably intelligent and competent member of the Washington political world. I admire him.

Make no mistake, the Fed looks to have been abusing its secrecy and its position, and Bernanke and Geithner are culpable. Reich makes the points as well or better than I could so here is his recent piece on the subject. All the blog’s are picking it up.

As I recall, the Fed said they were only acquiring ‘investment grade’ instruments, which would be taken on its balance sheet in support of the US Dollar, in addition to the usual Treasury Debt. The recent exposures of the holdings of Maiden Lane show these to be more like junk bonds, and certainly not as represented.

The Fed must be audited, and it role as the ‘master regulator’ and as the place where the Office of Consumer Financial Protection would be located is a farce, a cruel joke. Chris Dodd must either be senile, entirely cynical, or believe the American people to be complete idiots. The only reason I could even imagine for considering it is that the Fed is a ‘cost plus’ agency, meaning that they are self funding out of the mechanism of creating money, taking all their costs out before they turn over the interest income from the public debt back to Treasury. This is also a source of their growth and power. The problem that public agencies often have is that the industries that are regulated by them use their donations and lobbyists to stifle approrpriations for the agencies that regulate them in order to hamper and stifle them.

How can you even think of putting an office of reform and consumer protection in the very institution that was at the epicenter of a historic fraud? And shows itself completely willing to mislead the public, and some even believe perjure itself to the Congress to protect its true owners, the big Banks?

There are more things to come. But the frauds yet to be revealed may very well shake this government to its foundations, and very few blogs and almost none of the mainstream media are yet pursuing those stories of market manipulation, secret dealings, insider trading and official protection of corruption.

From The Fed Is In Hot Water by Robert Reich

“First, only Congress is supposed to risk taxpayer dollars. The Fed is not part of the legislative branch. Its secret deals, announced almost two years after they were done, violate the democratic process, if not the Constitution itself. Thomas Jefferson put a stop to Alexander Hamilton’s idea of a powerful central bank out of fear it would be unaccountable to the public. The Fed has just proven Jefferson’s point.

Second, if the Fed can secretly bail out big banks, the problem of “moral hazard” – bankers taking irresponsible risks because they know they’ll be rescued – is far greater than anyone assumed after Congress and the Bush and Obama administrations bailed out the banks. Big banks will always be too big to fail because they know the Fed will secretly back them up if they get into trouble, even if Congress won’t do it openly.

Third, the announcement throws a monkey wrench into the financial reform bill now on Capitol Hill, which gives the Fed additional authority by, for example, creating a consumer protection bureau inside it. Only yesterday, Sen. Jim DeMint (R-S.C.) blasted the Dodd bill for expanding the Fed’s authority “even as it remains shrouded in secrecy.” (When Jim DeMint and I agree on something you know it has to be close to a universal truth. – Jesse lol)

The Fed has a big problem. It acts in secret. That makes it an odd duck in a democracy. As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

That it chose to reveal the truth about its activities during a week when Congress is out of town, when much of official Washington and the Washington media have gone on vacation, and only after several federal courts have held that the Fed must release documents related to its bailout of Bear Stearns, suggests it would rather remain secret than become transparent.

Much of what Ben Bernanke and Tim Geithner did (when Geithner was at the New York Fed) in 2008 was presumably necessary. But the public has no way of knowing. The public doesn’t even know who else the Fed has bailed out, or what entities it will bail out in the future. All we know is the Fed secretly bailed out Bear Stearns and AIG and thereby subjected taxpayers to risks that remain even today, without informing the public. That’s not a record on which to build public trust.”