In the financial trial of the century, the most important document is missing. The document is the term sheet that the government says it gave AIG’s board right before taking the company over in Sept. 2008. The government says the AIG board thus approved the Draconian terms that benefited Goldman Sachs and other rivals. But other evidence, including AIG’s contemporaneous securities filings, suggests the board was agreeing only to sell the government warrants not transfer 80% of the common stock to it for a song. The missing document would prove which side is telling the truth.
That’s one of many amazing points of contention noted by Yves Smith of Naked Capitalism in her relentless digging into what government really did during the financial crisis. Most recently, she alleges and documents perjury and obstruction of justice by top federal officials in the pending case of former AIG shareholders against the US. The case alleges that the government trampled on corporate law rights and that the Fed exceeded its authority—allegations that I document in my book, The AIG Story, written with Hank Greenberg, lead plaintiff in the case.
Smith lays out her claims in an extensive blog post at Naked Capitalism, accompanied by reams of additional documents and examples. For those looking for a skinny version, here is an abridged adaptation. Most examples concern Scott Alvarez, general counsel of the Board of Governors of the Federal Reserve; there is one with with Tom Baxter, general counsel of the New York Fed, who worked with Tim Geithner. The shareholders are represented by the noted trial lawyer, David Boies. The point about the term sheet is at the end.
Example 1
Boies: Would you agree as a general proposition that the market generally considers investment-grade debt securities safer than non-investment-grade debt securities?
Alvarez: I don’t know.
Example 2
Boies: [Presents a copy of the Financial Crisis Inquiry Commission report stating that the Fed had lowered the standards it applied for the quality of collateral for its loans under two programs then devised to support lending and asks] Do you see that?
Alvarez: I see that. . .
Boies: . . . [W]ould you agree that the Federal Reserve had lowered its standards regarding the quality of the collateral that investment banks and other primary dealers could use while borrowing. . . ?
Alvarez: No.
Boies: You would not agree with that?
Alvarez: Right.
Example 3
Boies: Now, the interest rate that was set for the AIG 13(3) loan was an interest rate that you believed at the time of your deposition was the interest rate that had been discussed between AIG and certain private-sector banks; correct?
Alvarez: That’s correct….
Boies: And insofar as you are aware, that interest rate was simply accepted by the Federal Reserve without any analysis or consideration as to whether that interest rate was a reasonable interest rate; correct, sir?
Alvarez: No.
Boies: Let me ask you to look at your 2012 deposition at page 33, lines 16 through 20: QUESTION: Was any analysis or consideration done or given by the United States to the question of whether the interest rate that the banks were asking for in the discussions was a reasonable interest rate? ANSWER: No, not that I’m aware of”
Example 4
Boies: [After introducing an email of Saturday Sept 20 reporting that Morgan Stanley had informed Fed president Tim Geithner the prior day (a Friday) that Morgan Stanley would be unable to open on Monday]. Do you think that Morgan Stanley, on September 14th, 2008, could have continued to operate if you had taken away the primary dealer credit facility and not substituted something equal in its place?
Alvarez: I don’t know if Morgan Stanley was even borrowing on that day….
Boies: Mr. Alvarez, did I hear you say that you didn’t know whether Morgan Stanley was borrowing from the primary dealer credit facility?
Alvarez: On September 14th I think was your question.
Boies: Was it borrowing from the primary dealer credit facility at any time in September 2008?
Alvarez: I don’t know the answer to that…
Boies: Would it surprise you that that number was as high as $100 billion?
Alvarez: I just don’t know.
Boies: While we’re on the subject of Morgan Stanley, there came a time when the Federal Reserve System was apprised that unless Morgan Stanley got federal assistance or additional federal assistance to what they were already getting over a weekend, that Morgan Stanley would not be able to open the following Monday, correct?
Alvarez: No, I’m not aware of that ever happening…I’m not aware that Morgan Stanley — I’m not aware of that. I don’t know what you’re referring to. Could you be more specific?
Boies: You were the general counsel of the Federal Reserve Board at that time?
Alvarez: Yes, I was.
Example 5
Alvarez: It is common for banks in the business of banking to obtain equity interests in connection with distressed debt and speculative — in distressed debt situations, and the comptroller of the currency has authorized this in a variety of circumstances, so it is within the business of banking and incidental to the business of banking.
Commentator (Smith engaged to review this testimony): . . .Debtor in possession loans only get paid in cash: fees and interest. They cannot require warrants, much less equity, because at the time the DIP loan is made, nobody knows who will be getting the equity in the reorganized company or if there will even be a reorganized company. . . . It’s also not normal for competent lenders . . . to take equity other than in the form of warrants or another contingent exposure. The reason is that taking equity taints one’s status as a lender, and the implication in the event of bankruptcy that a court would subordinate your loan. . .
Example 6
Boies: What’s correlation risk?
Baxter: Correlation risk doesn’t go so much to the legal issues associated with the collateral. It goes to the valuation. And the problem with taking shares of a subsidiary as collateral for a loan made to the parent is that if the parent files in bankruptcy, that customarily will have a deleterious effect on the value of the subs, particularly in a regulated space like insurance and banking. Boies: Can you expand upon what? What do you mean? What is the correlation risk concerned with insured subsidiaries?
Baxter: Well, you can value an insured subsidiary today, for example, where the parent company is fully operating and not in bankruptcy. Once the company, the parent, goes into bankruptcy, you lose all source of parental support, so with respect to the ability to downstream equity, for example, that goes away. So a bankruptcy of a parent always has an adverse effect on the valuation of subsidiary shares. It can’t be good for the subsidiaries. And that is a shorthand summary of correlation risk.
Commentator (a recognized bank regulatory expert Smith engaged): The bankruptcy of a parent only matters if the parent has guaranteed the sub’s liabilities or there’s some sort of integrated operation that can be disrupted. The FDIC’s whole single-point-of-entry proposal is premised on the idea of the parent going bankrupt while the subs are ring-fenced and seamlessly moved to a bridge bank. Heck, that’s the FDIC receivership model already more-or-less. In any case, insurance solvency regulation is based around the sub — I don’t think it involves the parent at all.
Example 7
Boies requested that the defendants produce the term sheet the government prepared and submitted on September 16, 2008 when demanding that AIG’s CEO and board assent to the terms of the takeover. The defendants never produced the term sheet, apparently suggesting it has been lost. AIG’s CEO, Bob Wilumstad, who had seen the term sheet, called it amateurish.
Apparently, no other AIG board member ever saw the term sheet. Instead they relied on an oral report of its content by representatives of the Fed.
The Fed says it told the board it was taking an equity stake (outright ownership of stock along with associated voting rights) while AIG’s SEC filings referred only to warrants (options to buy stock, requiring additional consideration and unaccompanied by voting rights until exercised).
According to Yves: “the Fed got Willumstad to fax a signed page stating ‘American International Group, Inc. hereby agrees to and accepts the summary of terms for the Senior Bridge Facility presented to AIG…’ to which the Fed would attach the term sheet. . . . Baxter asserts that he actually got a term sheet faxed back, even though the Fed has been unable to produce one.”
Boies: Now let me go to Plaintiffs’ Trial Exhibit 94. This is a fax cover page and a signature page that was faxed to you at 8:44 p.m. on September 16; correct?
Baxter: What I recall, Mr. Boies, is receiving this page, which is PTX 0094, but what I recall was appended to it was the term sheet. So I don’t recall receiving it in my office in this form. The first page and the second page were there, but what I got also had the term sheet attached. Boies: So it’s your testimony that when this came to you, there was a term sheet attached to it?
Baxter: That’s the way I remember it. Now, I don’t — this is my fax number, and I don’t man the fax machine, so it’s possible whoever pulled this from the fax machine put the two together. I don’t know. But what I remember, Mr. Boies, is getting this fax with the term sheet attached….
Boies (to the judge): Your Honor, I want to be very clear about this, and I don’t want counsel who was not involved in discovery to misspeak to the Court. That document I do not believe anyone has testified was a document faxed to Mr. Baxter. Now, what I believe that document to be is something that has been put together, but — by somebody, but I don’t believe anybody has testified that document was faxed to Mr. Baxter at 8:44 p.m. on September 16.
Gardner (government defense lawyer, to the judge): I don’t actually think that’s Mr. Baxter’s testimony. What I understood Mr. Baxter to just say is he does not know whether or not the term sheet was faxed along with the cover page or someone from his office put them together. That’s what I understood his testimony to be. If I’m mistaken, Mr. Baxter certainly will correct me. But all I can tell you right now is that JX 83 is a copy of those three things put together, and Mr. Baxter’s testimony is what it is.
HAT TIP: FRANK PASQUALE