The Washington Post Sunday - - BUSINESS - BY STEVEN PEARLSTEIN

Amer­i­cans were an­gry when Wall Street’s greedy and risky be­hav­ior trig­gered a global fi­nan­cial cri­sis in 2008. They were an­grier still when the gov­ern­ment had to bor­row and spend hun­dreds of bil­lions of dol­lars to res­cue mort­gage gi­ants Fan­nie Mae and Fred­die Mac, the largest banks and the in­sur­ance com­pany AIG. They were out­raged when they found out that ex­ec­u­tives at those en­ter­prises were con­tin­u­ing to re­ceive big salaries and bonuses.

So just imag­ine how it out­ra­geous it would be if some Wall Street sharpies went to court to ar­gue that they didn’t ben­e­fit enough from the bailouts and that tax­pay­ers should pay them tens of bil­lions of dol­lars more.

In fact, they did. And, ac­cord­ing to legal ob­servers, they just might pre­vail.

“Law­suits of the Rich and Shame­less” is how the co­me­dian Jon Ste­wart dubbed it.

“An ab­sur­dist com­edy. . . wor­thy of the Marx Broth­ers or Mel Brooks,” wrote John Cas­sidy, the New Yorker’s eco­nomics cor­re­spon­dent.

For tax­pay­ers, it looks to be an­other ex­am­ple of the old adage that no good deed goes un­pun­ished.

In two sep­a­rate cases, the gov­ern­ment now stands ac­cused of over­step­ping its author­ity when it took ex­tra­or­di­nary mea­sures to pre­vent a fi­nan­cial melt­down in the fall of 2008. The Wall Street fig­ures who are su­ing say their prop­erty was seized with­out com­pen­sa­tion, in vi­o­la­tion of the Con­sti­tu­tion. One case was brought by Mau­rice “Hank” Green­berg, the leg­endary for­mer chief ex­ec­u­tive of AIG who built it into the world’s largest in­surer. Fil­ing the other case is a group of hedge funds that bought Fan­nie and Fred­die stock for pen­nies per share af­ter the com­pa­nies were put in gov­ern­ment con­ser­va­tor­ship.

Fed­eral dis­trict court judges in Wash­ing­ton and New York ini­tially dis­missed both chal­lenges. Their opin­ions noted, some­what point­edly, that the Wall Street plain­tiffs were not only un­harmed but ac­tu­ally came out bet­ter off as a re­sult of the gov­ern­ment res­cues. Yet both groups have now found a more sym­pa­thetic hear­ing a stone’s throw from the front gate of the White House, at a lit­tle-known brick court­house called the U.S. Court of Claims.

There, Green­berg is ask­ing the court to award him and other AIG share­hold­ers at least $23 bil­lion from the Trea­sury. He says that’s to com­pen­sate them for the 80 per­cent of AIG stock that the Fed­eral Re­serve de­manded as a con­di­tion for its bailout. Judge Thomas Wheeler has re­peat­edly sig­naled his agree­ment with Green­berg. A de­ci­sion is ex­pected any day.

In the Fan­nie and Fred­die case, the de­ci­sion is fur­ther off, with the trial set to begin in the fall. The hedge funds are chal­leng­ing the gov­ern­ment’s de­ci­sion to con­fis­cate all of the firms’ an­nual prof­its, even if those prof­its ex­ceed the 10 per­cent div­i­dend rate that the Trea­sury had ini­tially de­manded. This “profit sweep” ef­fec­tively pre­vents the firms from ever re­turn­ing the gov­ern­ment’s $187 bil­lion in cap­i­tal and free­ing them­selves from gov­ern­ment con­trol.

Ear­lier this year, Judge Mar­garet Sweeney re­fused to dis­miss the case and gave lawyers for the hedge funds the right to sift through the memos and e-mails of gov­ern­ment of­fi­cials in­volved. Within weeks, Fan­nie and Fred­die shares, which had been trad­ing at about $1.50, started trad­ing as high as $3 based on ru­mors that the doc­u­ments re­vealed in­con­sis­ten­cies in gov­ern­ment of­fi­cials’ state­ments. The hedge funds are ask­ing for the re­turn of as muc has $100 bil­lion in prof­its and an end to the Trea­sury-im­posed profit sweep. In her com­ments, Sweeney has shown sym­pa­thy with their ar­gu­ment that the gov­ern­ment can’t hold them in­def­i­nitely in a legal limbo in which they have no claims to as­sets of the com­pany they os­ten­si­bly own.

When th­ese cases were filed, many legal ob­servers thought they were a long shot, even friv­o­lous. But from their pro­ce­dural rul­ings and com­ments from the bench, said David Zar­ing, a pro­fes­sor of legal stud­ies at the Whar­ton School of Busi­ness, both judges have in­di­cated they are at least open to the plain­tiffs’ legal the­o­ries and will­ing to hold the gov­ern­ment accountable for what it did dur­ing the fi­nan­cial cri­sis.

“I think peo­ple’s views have changed,” Carl To­bias, a pro­fes­sor at the Uni­ver­sity of Rich­mond Law School, said of the AIG case. Green­berg’s lawyers, he said, “were able to present ev­i­dence and per­suade the judge that there were some se­ri­ous is­sues here. It’s pos­si­ble the judge could rule in their fa­vor in some way.” AIG’s Hank Green­berg: Vic­tim or in­grate?

Even be­fore the fi­nal pa­pers for AIG’s bailout were signed, in Septem­ber2008, one share­holder was al­ready ag­i­tat­ing against it.

Hank Green­berg had been forced out as chair­man and chief ex­ec­u­tive in 2005 af­ter state and fed­eral reg­u­la­tors un­cov­ered that the com­pany had been en­gaged in sham trans­ac­tions that al­lowed AIG and its cor­po­rate cus­tomers to ma­nip­u­late re­ported earn­ings, avoid taxes, evade reg­u­la­tory re­quire­ments and hide risks and li­a­bil­i­ties from share­hold­ers. Ever since, Green­berg has been on a mission to re­store his rep­u­ta­tion and re­gain con­trol of the­com­pany tha the had ruled over with an iron hand for 37 years.

Even in ex­ile, Green­berg re­mained AIG’s most im­por­tant share­holder, con­trol­ling 20 per­cent of the com­pany’s stock. He suc­cess­fully sued some AIG ex­ec­u­tives in court and re­cruited away oth­ers to build his own ri­val in­sur­ance com­pany. He also agreed to pay $15 mil­lion to set­tle civil charges brought against him by the Se­cu­ri­ties and Ex­change Com­mis­sion, though he re­fused to ac­knowl­edge any wrong­do­ing.

Green­berg has re­peat­edly claimed that if he’d still been in charge, AIG would never have got­ten into the mess it did. But that is im­pos­si­ble to know.

What is known, how­ever, is that when Green­berg was in charge, he ran the com­pany “as if it were a feu­dal state . . . dis­dain­ful of mod­ern con­cepts of in­ter­nal con­trols and reg­u­la­tory com­pli­ance,” ac­cord­ing to one per­son with in­ti­mate knowl­edge of the com­pany’s man­age­ment. Af­ter his fir­ing, AIG paid $1.6 bil­lion to set­tle mul­ti­ple counts of ac­count­ing fraud brought by the SEC.

What is also known is that the two lines of busi­ness that were the source of AIG’s ma­jor prob­lems dur­ing the 2008 cri­sis were launched on his watch. He helped to cre­ate their risky busi­ness mod­els and strate­gies, which were based on play­ing one reg­u­la­tor off an­other and en­gag­ing in com­plex fi­nan­cial ar­range­ments be­tween reg­u­lated sub­sidiaries and a largely un­reg­u­lated par­ent com­pany. And both busi­ness lines took root in the same clever rules-bend­ing cor­po­rate cul­ture that had al­ways been Green­berg’s trade­mark.

“The AIG which came beg­ging to the Fed’s doorstep was the AIG that Hank Green­berg built,” said James Mill­stein, the Trea­sury of­fi­cial who over­saw AIG’s re­struc­tur­ing. “It’s cap­i­tal struc­ture was opaque, itwas heav­ily de­pen­dent on short-term fund­ing, with a highly lever­aged fi­nan­cial prod­ucts sub­sidiary that had been or­ga­nized to evade ef­fec­tive reg­u­la­tory over­sight.” Green­berg, he said, “ran the par­ent com­pany like a hedge fund with a triple Arat­ing.”

As the fi­nan­cial cri­sis un­folded, AIG’s fun­da­men­tal flaws were fi­nally ex­posed. On the same week Lehman Broth­ers col­lapsed, des­per­ate ex­ec­u­tives went to the Trea­sury and the Fed­eral Re­serve look­ing for a loan. Dozens of Fed of­fi­cials were dis­patched to AIG head­quar­ters on Pine Street in lower Man­hat­tan. Within days, they were con­vinced that with­out a sub­stan­tial cash in­fu­sion, AIG would be forced to file for bank­ruptcy, threat­en­ing the sol­vency of anum­ber of big banks in Europe and the United States.

To avoid such a melt­down, the Fed agreed un­der its emer­gency author­ity to act as a lender of last re­sort, lend­ing AIG an ini­tial $85 bil­lion. The terms were to be the same as AIG’s in­vest­ment bankers had of­fered the pre­vi­ous week, with­out suc­cess, to pri­vate lenders — a 14 per­cent in­ter­est rate and own­er­ship of 80 per­cent of the com­pany. With lawyers sit­ting in the next room ready to file a bank­ruptcy pe­ti­tion, AIG di­rec­tors re­luc­tantly agreed to the terms.

In his cur­rent suit against the gov­ern­ment— which has gen­er­ated 300 docket items, 70 de­po­si­tions, 4,600 ex­hibits, 36 mil­lion pages of doc­u­ments and tes­ti­mony from two for­mer Trea­sury sec­re­taries and the for­mer Fed chair­man — Green­berg has re­lied on the legal ad­vice and rep­re­sen­ta­tion of su­per-lawyer David Boies. Boies gained his megawatt sta­tus in the 1980s suc­cess­fully de­fend­ing IBM against the gov­ern­ment’s ef­fort to break it up, and in the 1990s pros­e­cut­ing the gov­ern­ment’s case to break up Mi­crosoft. He also rep­re­sented Al Gore in the Supreme Court case over the con­tested 2004 elec­tion. But few clients have been as lu­cra­tive as the liti­gious Green­berg, whom he has also rep­re­sented in ear­lier dis­putes: Dis­putes with the New York at­tor­ney gen­eral. Dis­putes with the SEC. Dis­putes with AIG it­self. Even a slan­der suit against for­mer New York at­tor­ney gen­eral Eliot Spitzer. Pub­lished es­ti­mates of Boies’s legal fees in all th­ese cases run to well over $100 mil­lion.

In chal­leng­ing the gov­ern­ment takeover, Boies has tried out a num­ber of legal the­o­ries in dif­fer­ent courts, spin­ning what fed­eral judge Paul En­gel­mayer in New York mock­ingly called a tale of “plun­der . . . and treach­ery wor­thy of an Oliver Stone movie.”

In Boies’s retelling of the AIG res­cue, gov­ern­mentof­fi­cials de­lib­er­ately set out to co­erce and pun­ish the gi­ant in­surer while of­fer­ing cushy bailouts to big banks like Cit­i­group, Mor­gan Stan­ley and Gold­man Sachs. That “equal pro­tec­tion for bil­lion­aires” ar­gu­ment had largely fallen on deaf ears, per­haps be­cause the gov­ern­ment’s treat­ment of AIG turned out to be hardly puni­tive. Once in­ter­est rates on the gov­ern­ment’s loan were re­duced and the whole ar­range­ment rene­go­ti­ated three years later, the gov­ern­ment wound up earn­ing less than 4 per­cent a year on what grew to be­come a $182 bil­lion bailout. That’s not very dif­fer­ent than its deals with the banks.

The ar­gu­ment that fi­nally caught Judge Wheeler’s at­ten­tion, though, was more nar­rowly le­gal­is­tic: the law au­tho­riz­ing the Fed to make emer­gency loans to pri­vate firms men­tions charg­ing in­ter­est but con­tains no ex­plicit author­ity to take com­pen­sa­tion in the form of stock.

“If we’re right on that, we win,” Boies said in an in­ter­view last week. “If we aren’t, we lose.”

By bas­ing his case on a chal­lenge to the Fed’s author­ity, Boies told Wheeler that he doesn’t need to con­sider how things have turned out for AIG share­hold­ers since the res­cue. He need only ask the nar­rower ques­tion, what was AIG’s stock worth on that day in Septem­ber 2008, when the stock was “il­le­gally” trans­ferred to the gov­ern­ment? Based on that day’s trad­ing price on the New York Stock Ex­change, that would be about $23 bil­lion.

Not so fast, replied the Jus­tice Depart­ment lawyers.

For one thing, they said, there was no co­er­cion — AIG di­rec­tors vol­un­tar­ily agreed to hand over the stock. Their choice that day was clear: They could ei­ther ac­cept the Trea­sury’s terms and wind up with 20 per­cent of some­thing, or decline help, go bank­rupt and get 100 per­cent of noth­ing. Re­luc­tantly, they chose 20 per­cent of some­thing.

And as to the $23 bil­lion loss that Green­berg and other share­hold­ers claim to have suf­fered, gov­ern­ment lawyers pointed to the same stock mar­ket ta­bles but drew a dif­fer­ent con­clu­sion. In the hours be­fore the res­cue terms were an­nounced, AIG stock was trad­ing as low as $1.25. Af­ter the an­nounce­ment, the stock had tripled to $3.75. Green­berg should be thank­ing the gov­ern­ment, they said, not su­ing it.

But what seemed to gov­ern­ment lawyers like a slam-dunk ar­gu­ment seemed ir­rel­e­vant to Wheeler. If the gov­ern­ment didn’t have the author­ity to take the stock in the first place, he asked dur­ing fi­nal ar­gu­ments, then doesn’t the law re­quire the gov­ern­ment to re­turn it? Fan­nie and Fred­die: Il­le­gal takeover or con­ser­va­tor­ship?

When Trea­sury Sec­re­tary Hank Paul­son de­cided the gov­ern­ment needed to take over Fan­nie Mae and Fred­die Mac in Au­gust of 2008, he too had a choice: Un­der the law gov­ern­ing the fed­er­ally char­tered mort­gage gi­ants, he could ei­ther put them in re­ceiver­ship, un­der which they would be shut­down and their as­sets used to pay off their cred­i­tors, or put them into con­ser­va­tor­ship, un­der which the gov­ern­ment would at­tempt to sta­bi­lize them and nurse them back to fi­nan­cial health. He chose con­ser­va­tor­ship but urged Congress to take steps to en­sure they never again emerged in a form giv­ing share­hold­ers all the prof­its and tax­pay­ers all the risk.

Both Paul­son and the man who suc­ceeded him, Ti­mothy Gei­th­ner, have tes­ti­fied that it never oc­curred to them dur­ing the cri­sis that Fan­nie and Fred­die might one day be able to fully re­pay the gov­ern­ment or that there would be any­thing left over for share­hold­ers by the time the con­ser­va­tor­ship ended. But things turned out dif­fer­ently than they ex­pected.

Be­cause of the suc­cess of the gov­ern­ment res­cue, and the nearto­tal retreat of pri­vate lenders and guar­an­tors from mort­gage fi­nance, Fan­nie and Fred­die re­turned to prof­itabil­ity and sol­vency by the end of 2012 — per­haps not coin­ci­den­tally, at the very time the gov­ern­ment swept all of their prof­its into the Trea­sury.

What Paul­son and Gei­th­ner also didn’t an­tic­i­pate was that, de­spite a bi­par­ti­san con­sen­sus that the mort­gage gi­ants should be wound down, Congress would be un­able to agree on a sys­tem to re­place them. Democrats and their in­dus­try al­lies in­sist that some limited form of gov­ern­ment guar­an­tees are nec­es­sary to en­sure the avail­abil­ity of af­ford­able 30-year mort­gages at fixed rates. Tea party Repub­li­cans are just as adamant they will not agree to any gov­ern­ment guar­an­tees that once again put tax­pay­ers on the hook.

While it is three hedge funds — Perry Cap­i­tal, Fairholme Fund and Per­sh­ing Square Cap­i­tal, led by Wil­liam Ack­man — that have sued the gov­ern­ment, the out­come will likely af­fect all share­hold­ers. Th­ese in­clude a num­ber of small banks that were en­cour­aged by the Paul­son Trea­sury to buy pre­ferred shares in the months be­fore Fan­nie and Fred­die’s down­fall, and tens of thou­sands of small, in­di­vid­ual hold­ers of com­mon stock, in­clud­ing many for­mer em­ploy­ees and re­tirees in the Wash­ing­ton area. Their claim is that Congress and the White House are us­ing Fan­nie and Fred­die to fund the fed­eral bud­get.

But James Par­rott, a fel­low at the Ur­ban In­sti­tute, says the idea that th­ese com­pa­nies will ever emerge from con­ser­va­tor­ship and be able to earn prof­its for their share­hold­ers is a fan­tasy. Par­rott helped con­ceive of the profit sweep while work­ing in the Obama White House. He says that even if Fan­nie and Fred­die were al­lowed to use cur­rent prof­its to pay back the Trea­sury’s $187 bil­lion in­vest­ment, they would still have to raise hun­dreds of bil­lions moreto have the cap­i­tal to op­er­ate in­de­pen­dently.

Other gov­ern­ment of­fi­cials say Fan­nie and Fred­die’s prof­its are them­selves a fic­tion, be­cause they would not ex­ist but for the gov­ern­ment stand­ing be­hind all of their fi­nan­cial obligations. If the Trea­sury were to charge them any­thing close to a mar­ket rate for its guar­an­tee, there would be no prof­its.

But that’s al­ways been the case for Fan­nie and Fred­die. From the be­gin­ning they were set up to be a unique hy­brid: gov­ern­ment­backed en­ter­prises with pri­vate share­hold­ers and pri­vate cap­i­tal. Un­til Congress comes up with an­other ar­range­ment, say lawyers for the share­hold­ers, the prof­its are real and the share­hold­ers are en­ti­tled to use them to pay down the Trea­sury’s in­vest­ment and begin re­cap­i­tal­iz­ing the com­pany and pay­ing them­selves a div­i­dend. By some es­ti­mates, that could hap­pen in the next sev­eral years if prof­its con­tinue at cur­rent lev­els.

Gov­ern­ment lawyers and of­fi­cials dis­miss such spec­u­la­tion. Un­der the law set­ting up the con­ser­va­tor­ship, they ar­gue, Fan­nie and Fred­die’s share­hold­ers are en­ti­tled to noth­ing. They have no right to sue in court. They are not en­ti­tled to vote on any cor­po­rate de­ci­sions. They are not en­ti­tled to a penny of the com­pa­nies’ prof­its or any pro­ceeds from the sale of com­pany as­sets. Not now, not ever. In ef­fect, the gov­ern­ment is claim­ing the right to op­er­ate Fan­nie and Fred­die how­ever it wants, for as long as it wants, un­til it’s ready to close them down for good.

In an opin­ion last fall, Judge Royce Lam­bert of U.S. Dis­trict Court in Wash­ing­ton ul­ti­mately ruled that that was what Congress in­tended when it wrote the laws gov­ern­ing Fan­nie and Fred­die but ac­knowl­edged that such a sweep­ing as­ser­tion of gov­ern­ment pow­ers may “raise eye­brows or even en­gen­der a feel­ing of dis­com­fort.” It will now be up to Sweeney and the Court of Claims to de­cide whether what Congress in­tended amounts to an il­le­gal and un­con­sti­tu­tional tak­ing.

One thing is al­ready known, how­ever. In de­cid­ing whether share­hold­ers or tax­pay­ers will profit from gov­ern­ment bailouts, judges Sweeney in the Fan­nie and Fred­die case and Wheeler in the AIG case are un­likely to have the last word. With so­many bil­lions of dol­lars at stake, their de­ci­sions are al­most cer­tain to be ap­pealed all the way to the Supreme Court.

For Den­nis Kelle­her, a for­mer Se­nate staffer and cor­po­rate lit­i­ga­tor who heads an ad­vo­cacy group for fi­nan­cial sec­tor re­form, it’s all just an other ex­am­ple of Wall Street’s “in­de­fen­si­ble ar­ro­gance. . . .Wall Street lives in an al­ter­na­tive uni­verse where at all times it’s heads I win, tails you lose.”



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