02/17/2012 12:00 pm ET Updated Apr 18, 2012

The 99% Takes AIG to Court

In May, the first "whistleblower" lawsuit was unsealed, naming AIG, Goldman Sachs and Deutsche Bank as defendants. Derek and Nancy Casady, a retired journalist and a health-food storeowner in Southern California filed the suit. Following motions to dismiss by the defendants and the Casady's responses to those motions, oral argument has been set for April 23, 2012 before Judge John A. Houston, United States District Court, Southern District of California.

What does this mean? In the simplest terms, a judge has ruled the Casady's arguments are worth hearing and this could be a big headache for AIG and the banks for a start.

Mary Williams Walsh at the New York Times picked up the story, explaining that the lawsuit "asserts that AIG and two large banks engaged in a variety of fraudulent and speculative transactions, running up losses well into the billions of dollars. Then the three institutions persuaded the Federal Reserve Bank of New York to bail them out by giving AIG two rescue loans."

Attorney for the plaintiffs, Michael J. Aguirre, former counsel for the City of San Diego, licensed forensic fraud investigator, and an expert on Wall Street financial reform, asserted in summary in the recent NYT article that he understands extraordinary measures had to be taken by the Fed in 2008, but also explained that the Fed was still required to comply with its own regulations.

The precedent set by the emergency loans to AIG currently allow other non-banks to assume that should they engage in high-risk behavior once again, the Fed has the authority to bail them out.

This is the gist of the Casady action.

According to the New York Times, "The litigation shines a critical light on the Federal Reserve's on-again-off-again power to bail out nonbanking institutions. The Fed first got that authority during the Great Depression, but Congress revoked it in 1958. And then, as the legal walls between banking and other financial services began to fall in the 1990s, Congress once again gave the Fed the power to make emergency loans to nonbanks."

The relevant language allowing the Fed such power was squeezed into a Congressional bill passed the day before Thanksgiving in 1991 by former Senator Christopher Dodd. Senator Dodd added the proviso at the request of certain Wall Street firms, including Goldman Sachs.

The banks, of course, were allegedly underwriting these financial products knowing full well that the underlying mortgages were garbage. Meanwhile, AIG was writing credit default swaps (i.e. insurance contracts) on the CDOs (while aware that they did not have the funds to cover these contracts), allowing the banks to shield the enormous amount of risk they were taking from their financial statements.

Incredibly, as Aguirre's forensic fraud analysis alleges, while AIG was engaging in these practices, it was working out a plea deal with the Justice Department relating to another scandal and ultimately pledged to refrain from creating financial products designed to facilitate financial statement fraud. Then, when the market collapsed, AIG made a number of false statements to secure the bailout loans; for example, they represented that the underlying assets they pledged to the Fed as collateral were far more valuable than they really were (since these assets were already encumbered). And the funds from those rescue loans made by the Fed ultimately found their way to Goldman Sachs and the other banks that participated in the fraudulent scheme.

The Casady suit claims that judicial review is required, as proper Congressional review was not applied and the law encourages high-risk behavior of the kind that led to the 2008 collapse of Lehman Brothers and the huge bank bailouts that nearly sent the global economy into a second Great Depression.

Sounds clear enough, yes? But let's not be too quick to forget what the oft-used euphemism "high-risk behavior" refers to, because by the way, it continues on apace.

In short, what the Casady plaintiffs want to make clear (and public) is that AIG allegedly lent the assets of its subsidiaries to the big banks in exchange for cash. With this cash, they bought residential mortgage backed securities (RMBS), which helped inflate the market for collateralized debt obligations (CDOs) that the banks were selling. CDOs are the toxic mortgage backed derivatives that brought down the financial system.

The next big questions: Will the government get involved? After oral arguments, will the case go to trial?