01/16/2013 04:29 pm ET Updated Mar 18, 2013

Matt Taibbi Sort of Defends AIG Shareholders' Lawsuit - for Good Reason

Rolling Stone's Matt Taibbi often shocks and offends -- a rare feat for writers who primarily cover the financial world -- and has built up his share of both fans and detractors. The financial industry winces when he, for instance, calls Goldman Sachs a "vampire squid." But Taibbi's new post in his "Taibblog" on the much-reviled lawsuit against the U.S. government by shareholders of bailout recipient American International Group may put some of his fans in triple-bypass surgery

In a rant headlined, "Hank Greenberg Should Be Shot into Space for Suing the Government over the AIG Bailout," Taibbi calls Maurice "Hank" Greenberg -- AIG's CEO from 1968 to 2005 and current CEO of the financial services company Starr International that is filing the shareholder lawsuit -- "maybe the biggest douchebag of all time." But then comes the real shocker. Taibbi puts forth a partial defense of the reviled lawsuit. "Here's the funny thing about the lawsuit filed against the government," he writes. "It isn't all wrong. In fact, parts of it are quite on the mark."

This is the same lawsuit that caused great embarrassment to AIG following the launch of its "Thank You, America" ads. After enduring an outpouring of outrage from politicians, the media, and the general public, AIG's board of directors declined to join the suit last week. But Greenberg's Starr is moving forward with the case on behalf of itself and AIG shareholders "similarly situated."

Why is Taibbi defending the seemingly indefensible? Because he knows the real recipients of the federal government's "rescue" of AIG were not its shareholders, but his loathed "vampire squid," Goldman Sachs, as well as some of the largest banks in America and the world that were counterparties with AIG on risky mortgage bets. The banks bought derivatives called credit default swaps from AIG, supposedly as insurance against default of their mortgage securities.

These banks were just as reckless as AIG, if not more so, in creating the mortgage instruments that AIG would insure. Yet after AIG's bailout and takeover, with the U.S. government taking nearly 80 percent of the company, the insurer under the Federal Reserve's control would reimburse these bad bets at 100 cents on the dollar.

The lawsuit characterizes the AIG rescue -- organized in large part by President George W. Bush's Secretary of Treasury and former Goldman Sachs CEO Henry Paulson, with Treasury secretary-to-be Tim Geithner playing a co-starring role as president of the New York Fed -- as a "covert, inequitable backdoor bailout" for Goldman Sachs and AIG's other bank counterparties. It claims that the government's demand on the AIG board to approve the government's supermajority stake in the company constituted an illegal "taking" under the Fifth Amendment and violated Delaware law, under which AIG is incorporated, that prevents any party from taking such a huge stake without a shareholder vote.

While Taibbi may not subscribe to all of Greenberg's legal claims, he largely agrees with the lawsuit's characterization of a "backdoor bailout" that benefitted AIG's financial counterparties much more than the firm itself. So have other expert bodies that have looked closely at the bailout. These include the Congressional Oversight Panel (COP) on the financial crisis chaired by now-Sen. Elizabeth Warren (D-Mass.), which concluded in 2010 that the large banks that were "counterparties to several different kinds of agreements with AIG" emerged "ultimately as the direct and indirect beneficiaries of the government rescue."

Yet last week, Warren, seemingly oblivious to her panel's previous work, said that AIG's joining in its shareholders' lawsuit "would be outrageous." She was one of many who said that for AIG to join the suit would be to "bite the hand that fed them."

Contra Warren and others, Taibbi characterizes the government rescue as case of AIG being fed upon, with big banks taking big bites of its hide. He writes:

The Fed, the U.S. Government, and the less completely f---ed Wall Street powers like Goldman and Barclays and Citigroup absolutely did conspire to seize AIG and then use a monstrous mixture of AIG's assets and public money to keep themselves alive. In essence, AIG was the helpless fat guy in the lifeboat who got eaten when the rest of the survivors ran out of food.

These banks did feast at both taxpayer and AIG shareholders' expense. A standard refrain against the suit has been, "How dare AIG shareholders sue when they got $182 billion from the taxpayers!" Yet after AIG was taken over, more than $100 billion was immediately disbursed to its counterparties, as the banks were reimbursed at full value for their mortgage derivatives.

Goldman Sachs, with its former CEO then serving as Secretary of the Treasury, was the largest beneficiary of AIG's bailout-within-a-bailout, receiving nearly $13 billion. Other lucky recipients included Deutsche Bank of Germany and Societe Generale of France, each of which was bestowed with nearly $12 billion. Bank of America and Citigroup "only" received $5 billion and $2 billion, respectively. If anyone should be taking out ads thanking America for bailing out AIG, it is these banks.

Reviewing these payouts, the COP panel -- the one Elizabeth Warren chaired -- blasted the government for paying these banks in full, noting in its report that it is the norm for creditors to take "haircuts" in bankruptcy proceedings. But by taking the option of bankruptcy off the table (even a bankruptcy in which restructuring is partially financed by the government), "the government had seriously undermined its own leverage," the panel wrote. It concluded that, "the moral hazard problem unleashed by making whole AIG‟s counterparties ... has turned out to be a key act in undermining the credibility of America's system of financial regulation."

The lawsuit argues that had the government not used AIG's assets and the taxpayer dollars it received to fully reimburse AIG's counterparties, shareholders, as well as taxpayers, might have been better off. Taibbi paraphrases Greenberg's suit as saying, "that left to its own devices, [AIG] would have negotiated a better deal than the complete, 100-cents-on-the-dollar surrender that it 'agreed' to under the guidance of the likes of Tim Geithner and Ben Bernanke."

Warren's COP panel was also somewhat sympathetic to AIG's shareholders, stating in its report, "AIG shareholders have seen their positions severely diluted (if not nearly wiped out) by the government. Pre-bailout shareholders of AIG were much more significantly diluted than shareholders were in the subsequent rescues of Citigroup and Bank of America." Indeed, Bank of America, Citi, and Goldman Sachs shareholders could be said to have directly benefitted at the expense of AIG shareholders, given that these banks got fully reimbursed on the inflated value of many shoddy mortgages.

Had a bankruptcy proceeding been allowed, AIG could have examined whether the banks had misrepresented the quality of the mortgages on which they had bought default contracts -- just as insurance companies investigate medical and property claims before paying out. It's not unreasonable to think that AIG just may have found reason to disqualify some payouts.

In fact, Reuters reported last weekend that AIG was suing the New York Fed "in a bid to preserve its right to sue Bank of America Corp and other issuers of mortgage debt that went sour." This step is necessary, AIG's suit alleges, because New York Fed officials told Bank of America in December 2012 that a Fed financing vehicle named "Maiden Lane" had "assumed from AIG all litigation claims" involving this mortgage debt during the bailout. Reuters legal columnist Allison Frankel expressed bafflement as to why "the Fed has sided with BofA" and seems to be protecting it from potential fraud claims from AIG.

In reviewing the sordid history of the AIG "rescue," it appears that the big government hand that "fed" AIG slipped in a few doses of poison as well as sustenance, and then diverted some of that sustenance to AIG's big bank counterparties. A couple of "bites" from Greenberg's suit that lead to government officials being held accountable are just what shareholders and taxpayers needs to prevent such backdoor bailouts in the future. To borrow a Taibbi term of art, sometimes it takes a vampire squid to beat a vampire squid.

John Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute. Evan Woodham, a research associate at the Competitive Enterprise Institute, contributed to this article.