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AIG bailout architects leave questions for executives to answer

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(Bloomberg) — The trial over the American International Group Inc. bailout shifts this week from the architects of the 2008 rescue, who spent days testifying as to why they imposed the terms they did on the ailing insurer, to the executives who accepted their demands.

Maurice “Hank” Greenberg’s Starr International Co., AIG’s biggest shareholder before the bailout, accuses the U.S. of imposing illegally severe conditions in the rescue and is seeking at least $25 billion in damages.

Robert Willumstad and Edward Liddy, two of Greenberg’s successors as chief executive officer at theinsurance giant, are set to testify this week in the U.S. Court of Federal Claims in Washington, where Judge Thomas Wheeler is hearing the case without a jury. The trial started Sept. 29.

Key regulators involved in the rescue, including Federal Reserve Bank of New York executives Sarah Dahlgren and Margaret McConnell, and Eric Dinallo, former superintendent of the State of New York Department of Insurance, also are expected to take the witness stand.

Starr alleges in its shareholder suit that the U.S. didn’t have the authority to demand 80 percent of AIG’s equity in consideration for a loan and didn’t pay a fair price for the stock it took. It also claims the government imposed a punitive 14 percent interest rate on the initial $85 billion loan.

Bailout Leaders

The leaders of the bailout, Henry Paulson, Timothy Geithner and Ben Bernanke, all told the court last week that the rescue was needed because AIG’s failure would have been catastrophic to the financial system.

They added little new information about how the government determined it had the authority to demand equity in setting terms for a loan.

Willumstad was forced to resign as CEO as a condition of the bailout, which began on Sept. 16, 2008. He’s expected to testify about his efforts to cobble together a private-sector rescue of the companyand his discussion of the terms of the government’s last-minute intervention to prevent an AIG bankruptcy. Willumstad, 69, is now chairman of Adelphi University in Garden City, New York.

Liddy, his successor, was hand-picked by regulators and headed AIG until August 2009. He’s expected to discuss his interactions with government officials regarding the form of stock the U.S. ultimately took from AIG and the creation of a trust to hold it. The 68-year-old former insuranceexecutive is now chairman at US Foodservice in Rosemont, Illinois.

‘Crazily High’

McConnell, of the Federal Reserve Bank of New York, wrote an October 2008 e-mail to Geithner and others describing a “crazily high” interest rate on the bailout loan that was “forced on us (meaning FRBNY) by people that have since punted on all the hard things.”

Dahlgren was involved in the monitoring of AIG at the time of the bailout and is expected to testify about the selection of Liddy and involvement of the New York Fed and Treasury in the insurer’s internal governance.

Dinallo participated in discussions about using money from AIG’s insurance subsidiaries to help bail out the parent just before the government stepped in.

The government has argued that Starr and other shareholders are seeking a benefit they’re not entitled to since the alternative to the bailout was bankruptcy.

‘Worth More’

“Twenty percent of something is worth more than 100 percent of nothing,” a Justice Department lawyer said in his opening statement.

Geithner, who led the New York Fed at the time of the bailout, testified he was “aware of a substantial back-and- forth” over “the legal questions around whether the Fed could directly hold equity” as part of a rescue. He also said he was unaware of any other emergency loan by the Fed conditioned on a surrender of equity.

Bernanke told the court he didn’t think about the specifics of the Fed’s emergency lending powers.

“All I knew was that our authority was broad and that I would rely on counsel in individual cases,” the former Fed chairman testified.

Bernanke, who along with other members of the Fed’s board of governors authorized the emergency loan, told the court the central bank “used its powers in an ad hoc way” because it had no other option for safely dealing with a financially troubled “systemic firm.”

‘As Necessary’

He said he didn’t know how some elements of the loan — the interest rate and the equity demand, or the form of equity — were arrived at. The central bank approved the general conditions for the financing and gave the New York Fed the discretion “to make adjustments to the term sheet as necessary,” Bernanke said.

Paulson, who was treasury secretary in 2008, wasn’t asked about the Fed’s powers to set the loan terms. He testified that he supported harsh conditions for AIG to send a message to markets that government assistance would come only at a stiff price.

The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).