AIG failure would have been ‘scarier’ than that of Lehmans

The failure of American insurance giant AIG in September 2008 would have been "even more damaging" than the failure of Wall Street bank Lehman Brothers, former US treasury secretary Timothy Geithner has said.

Testifying at the trial of a legal action filed by AIG's largest shareholder over the US government's bailout of the insurer, Mr Geithner, who was head of the Federal Reserve Bank of New York at the time, said that there would have been "mass panic on a global scale" if the insurer had defaulted.

“You’ll see default possibilities explode on all financial firms,” he said, conceding that letting AIG fail as regulators had done with Lehman Brothers in September 2008 would have been “catastrophic in impact.”

The aftershocks from the collapse of Lehman Brothers were “very much on my mind” in the days after the bank’s failure, he said.

The government rescue of AIG was necessary, he said, to prevent the country from plunging into a second Great Depression.

Starr International, the investment firm owned by former AIG chief executive Maurice "Hank" Greenberg, is suing the US government for punishing the insurer by taking a 80 per cent stake in 2008 and imposing an interest rate of 14 per cent on a bailout loan of $85 billion (€ 67 million).

The company is seeking at least $25 billion in damages for shareholders of the company that Mr Greenberg managed for almost 40 years until 2005.

Mr Geithner followed Hank Paulson, the US treasury secretary at the time of the AIG's bailout at the height of the financial crisis, in the witness box. Former Federal Reserve chairman Ben Bernanke is scheduled to testify later today.

Under questioning by Starr's trial lawyer David Boies, Mr Geithner struggled to recall specific details around when the US government considered taking an ownership stake in AIG and even when the insurer was put on a "dashboard" of institutions to watch as the crisis deepened.

Mr Boies read to the former treasury secretary testimony he had given before Congress and public statements he had made along with excerpts from his recently published memoir, Stress Test, which covered the financial crisis. "That sounds like you're quoting me," Mr Geithner said in response to the lawyer at one point, a phrase he repeated during his questioning.

While in the witness box, the former treasury secretary had to consult his own book when responding to questions about passages he wrote and was unable to answer specifics about the size of AIG’s bailout as it grew with the deterioration in the financial crisis in the autumn of 2008.

Asked at one point about one report from a subordinate at the New York Fed in March 2008, Mr Geithner said: “I would typically have been given a blizzard of reports about market conditions throughout that period of time.”

The court also heard about the former treasury secretary’s opposition to inflicting losses on senior creditors, a reference that will be familiar to the Irish public given Mr Geithner’s veto on burning senior bondholders in failed Irish banks in the run-up to the EU-IMF bailout in November 2010.

Mr Geithner agreed that he believed that when Government is forced to intervene with a bailout of a financial firm, it will be tempting to maximise immediate losses taken by the private sector - such as imposing haircuts on senior creditors - but that this is not a desirable approach.

He blamed the overall crisis on the absence of any authority or single accountable agency responsible for limiting the risk to the financial system from outside the core banking sector. By 2007, the role of banks had shrunk to the point where non-banks such investment banks and financial institutions, were more important in providing credit to the economy.

The court also heard about the New York Fed’s “Doomsday Book” - a “big fat binder” containing details of the regulator’s emergency responses or “firefighting equipment,” said Geithner. A new version of the Doomsday Book, updated this year, has been lodged in court but has been kept under seal or held in secret.

The trial continues at the United States Court of Federal Claims in Washington, DC.