After the federal government bailed out insurance giant American International Group (AIG), the company’s former CEO Maurice “Hank” Greenberg expressed his gratitude by suing the United States. In 2008 the government lent AIG $85 billion in return for a 79.9 percent stake in the company, which Greenberg claimed was an illegal taking of property from shareholders. Although the court ruled in Greenberg’s favor, it decided not to award the $40 billion in damages that he wanted. This decision, which both sides will likely appeal, could discourage the government from engaging in future bailouts, as such a move could be deemed illegal.

In his ruling, Judge Thomas Wheeler stated that the Fed had crossed the legal line in demanding an equity stake in the company; however, he did not believe that AIG’s shareholders had been damaged by the move. Since the company would have gone bankrupt without government funding, he did not award damages. According to Wheeler, “20 percent of something [is] better than 100 percent of nothing.”

While Wheeler acknowledged the positive effects of the bailout, he also argued that the government should not have taken such a large portion of the company’s ownership. But without that requirement, the government may not have been confident enough to give billions of dollars to a company that was failing due to risky business practices. The ruling could create a precedent that discourages the government from dealing with future financial crises. Many Americans are upset by Greenberg’s victory, especially because the taxpayer-financed bailout clearly saved AIG.

AIG and several other companies were involved in the sale of credit default swaps, but as the value of its mortgage-backed securities fell, its credit was downgraded because it could not provide adequate collateral to back outstanding loans. No private creditors were willing to provide money to the company since AIG was in a downward spiral and any loan would mean taking on a considerable amount of risk. But if AIG did not receive the necessary collateral, it would have almost certainly gone bankrupt and its collapse could have disastrously affected the global economy. As a result, the federal government stepped in. The Fed offered AIG an $85 billion bailout package, but also required the company to give a 79.9 percent stake to the U.S. government, which later grew to as much as 92 percent.

AIG signed the deal the same day it was offered. The company not only avoided bankruptcy but also rebounded to an even larger recovery than expected. Since 2010, AIG made a series of moves to gain value and the U.S. government sold back its last shares in 2012, generating about $22 billion for taxpayers.

So what exactly was Greenberg upset about? He sued the Fed because he believes that demanding an 80 percent stake in the company as a condition of the bailout violated the takings clause of the Fifth Amendment. As the largest stockholder, he argues that the terms of the bailout constituted an illegal taking of shareholders’ property. Big banking corporations were arguably just as guilty as AIG of risky practices, yet they received much more lenient terms for government funding. Greenberg notes that the terms given to Morgan Stanley and Citigroup were much more generous.

In what has been termed “backdoor bailouts,” corporations like Goldman Sachs and Bank of America ended up receiving AIG bailout funds, but without the same demands. Because these banks were the largest creditors of AIG, they received some of the $85 billion without any terms and despite their involvement in the risky investments. When Greenberg brought his case to the AIG Board in an attempt to get the corporation to join the lawsuit, they declined–particularly because it would have created a PR nightmare for the company. The sad thing is that Greenberg’s case has some validity–other giant corporations were bailed out but did not face harsh penalties.

Despite Greenberg’s argument, the fact remains that the government’s actions saved AIG and its stockholders from imminent bankruptcy. The terms of the bailout were steep since AIG was grossly insolvent, and the loan was riskier than many of the other bailouts. Moreover, the influx of $85 billion was worth much more than the $12.8 billion that the company was worth on the day before the bailout. Some, like Senator Elizabeth Warren (D-Mass.), have also pointed out that the rate at which the Fed loaned AIG money, known as the Libor rate, was artificially low at the time due to manipulation by several large banks. As a result it saved AIG and other bailout recipients millions or even billions of dollars. Greenberg’s frustration over not being treated exactly the same as others sounds like it belongs more in a kindergarten classroom than in a courtroom.

The results of this case will almost certainly affect how the government deals with any future financial crises. Due to the dramatic amount of money the government gave AIG and the circumstances that led to its downfall, the government decided to demand assets, a deal that AIG accepted. This case may set precedent that harsh terms for a bailout, even when they are crucial to the health of the U.S. economy, may be deemed illegal, forcing the government to use a light hand when a heavy one is needed. Although he technically won, Greenberg did not receive the money he wanted, sending another powerful message: if the government bails you out, good luck trying to get compensation for the terms.

The U.S. government found AIG a stray, starving dog with no one else willing to feed it. Sure, AIG wasn’t given Purina like some of the other dogs, but it was fed enough to survive and get back on its feet. In response, Greenberg decided to bite the hand that fed him. Maybe we should have left AIG to face the hungry hounds of the free market.

Maurin Mwombela

Maurin Mwombela is a member of the University of Pennsylvania class of 2017 and was a Law Street Media Fellow for the Summer 2015. He now blogs for Law Street, focusing on politics. Contact Maurin at staff@LawStreetMedia.com.

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TARP is the Troubled Asset Relief Program, created to help stabilize the financial system during the financial crisis of 2008. This program was the focus of significant debate when it was created. Read on to learn about the program, the different sides of the debate, and how it fares a few years after its inception.

What is TARP?

TARP was authorized by Congress through the Emergency Economic Stabilization Act of 2008 (EESA), and is overseen by the Office of Financial Stability at the U.S. Department of the Treasury. It was essentially a way for the government to address some of the problems of the 2008 subprime mortgage crisis. It allowed the government to buy some stocks from big banks and other financial institutions while those companies were struggling, with the understanding that in a few years they’d be sold back to the companies. The government would profit, and the companies would be able to get back on their feet. This is obviously a simplified explanation — there was much back and forth on what TARP should and could actually do.

Was TARP successful?

Yes and no — we don’t really know yet. The TARP program was instituted just a few years ago, and while the economy certainly appears to be be getting better, long-term effects are mostly unknown. If anything, programs like TARP are more frequently invoked as political talking points rather than economic topics of discussion. There is also some disagreement as to how much TARP actually cost taxpayers — with so many different moving parts, it’s difficult to calculate. What seems most striking however, is the ire that TARP and other “bailout” programs received.

What was the argument for TARP?

Proponents believe that TARP helped prevent a financial Armageddon by directly or indirectly injecting funds into banks that were on the brink of collapse. Even those who didn’t necessarily agree with the way that TARP was enacted agreed that it was essential to keep things afloat during such a turbulent period of American economic conditions. As former GOP Presidential nominee Mitt Romney put it:

The TARP program, while not transparent and not having been used as wisely it should have been, was nevertheless necessary to keep banks from collapsing in a cascade of failures. You cannot have a free economy and free market if there is not a financial system… The TARP program was designed to keep the financial system going, to keep money circulating in the economy, without which the entire economy stops and you would really have an economic collapse.

This reduced the number of lost jobs by approximately 85 million, reduced or displaced the number of housing foreclosures by approximately three million, and increased consumer confidence. It cost taxpayers $50 billion, which is 85 percent less than the Congressional Budget Office’s original estimate. Additionally, banks have returned at least 78 percent of their borrowed TARP funds with interest. Those in favor of TARP also praise its ability to infuse liquidity and flexibility into a struggling economy.

What is the argument against TARP?

Opponents believe that TARP was a rushed, ad hoc policy. Even if it helped prevent a complete financial meltdown, it did not live up to one of its major original goals of supporting struggling homeowners. Its Home Affordable Modification Program (HAMP) prevented less than half of the foreclosures that original estimates projected it would. TARP only helped the big banks grow bigger and did little to help the common man on Main Street. Such programs set a bad precedent and implicitly encourage banks to continue making risky choices.

Opponents also argued that because the United States is a democracy the American people shouldn’t have to support a program, like TARP, that received such intense backlash from the public. The political toxicity made it more dangerous, to the point where some politicians didn’t even want to discuss it. That could have prevented much-needed discussions to help improve the program, and make it even more effective. Even if it did work in some ways, it’s difficult to bill such a despised program as successful. As Anil Kayshyap of the University of Chicago put it:

The TARP was presented by former Treasury Secretary Hank Paulson in a misleading way, because buying toxic assets never made sense. That confusion led to the populist rhetoric that TARP was just a bailout for the banks. “The public’s frustration has led to a general rise in populist political rhetoric and has polluted the policy discussion in many other areas.” Also, it did nothing to forestall foreclosures.

 

Courtesy of CBO.gov. Click here for a bigger version.

Conclusion

TARP was an attempt to fix a huge problem — the monumental financial crisis that the United States was facing. Six years we still see some after-effects of the crisis, and whether or not we’re out of the woods completely is a topic that is still up for debate, but the long-term effects of programs like TARP probably won’t be known for a few years. The arguments will continue, however — look for economic arguments that invoke memories of TARP to be present in both the 2014 and 2016 elections.

Resources

Primary

Federal Reserve: TARP Information

Additional

CBS: Auto and Bank Bailouts Prove Effective

Seeking Alpha: The Five Most Effective Bailouts

The New York Times: Audit Finds TARP Program Effective

Pro Publica: Bailout Tracker

Phys Org: Are Corporate Bailouts Effective?

Congressional Oversight Panel: TARP Provided Critical Support But Distorted Markets and Created Public Stigma

TIME: Bailout Report Card: How Successful Have the Financial-Relief Efforts Been?

The New York Times: Where the Bailout Went Wrong

Reuters: Are Americans Really Benefiting From TARP Repayments?

Politico: Criticism of TARP Persists

Salome Vakharia

Salome Vakharia is a Mumbai native who now calls New York and New Jersey her home. She attended New York School of Law, and she is a founding member of Law Street Media. Contact Salome at staff@LawStreetMedia.com.

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