Discrepancies between the public pronouncements and the internal emails of ex New York Federal Reserve boss Tim Geithner at the height of the US financial crisis served to make it an uncomfortable morning in the witness box for the ex-Treasury Secretary.
Starr International's legal representative in the court David Boies, questioning Geithner for a second day in the Starr International v US Govt case in the Federal Claims Court of New York, confronted Geithner with emails and other documents in which he appeared to say that the US Government was taking on significant risks with its loans to AIG in return for equity. Boies compared this with Geithner's public pronouncements that the loans were relatively low-risk.
In exchanges that occasionally became heated, Boies also produced documents that indicated Geithner's opinion at the time to be that losses had been imposed upon shareholders in AIG proportionate to the mistakes made by the firm. Boies then noted that the US government hadn’t undertaken any analysis specifically to ascertain what those mistakes were, how big they were, and who was to blame.
Geithner's response was that AIG was a unique case in the size of the problems it was facing (in Q4 2008 it booked a loss of $61.7bn, mainly because of continued severe credit market deterioration, and for 2008 as a whole it lost $99.3bn). Citing the benefits of hindsight, he added that it was not possible to assess the exact effect of each management decision at AIG. Geithner also observed that AIG was an insurance company – regulated by the states in the US – which meant that the Central Bank had little insight into the risks that AIG was taking. This was compounded by the fact that AIG Financial Products, the division that generated most of AIG's stratospheric losses, was headquartered in New York but was effectively based in London. Geithner said that the Fed had "no formal supervisory relationship with AIG" and that this had created "an exceptional set" of moral hazards.
Defending the high rate of interest – a core part of Starr International's case that the rescue was unfair to AIG shareholders – Geithner said that the terms had to be tough enough not to create further moral hazard; if the loan rate was generous, the rescuers feared that other companies might deliberately travel the government bailout route. He also said that the government wanted some protection in the event that the collateral placed by the AIG parent company – mainly stock in its operating insurance company subsidiaries – declined in value. As it transpired, the US government ended up making a significant profit on the scheme, while AIG shareholders lost more than 90% of their interest in the recovery.
Under friendly questioning from a lawyer from the US Department of Justice, Geithner said that the New York Fed did not decide until the last minute that it had the authority to provide AIG with a loan secured by equity as collateral. A key point put forward by Boies was that the US government acted in a way that it new was beyond its technical powers.