WASHINGTON — At the peak of the 2008 financial crisis, then-Treasury Secretary Henry Paulson and top Federal Reserve officials told the nation that there was an urgent need for the government to lend $85 billion to the American International Group so the giant insurer's temporary cash squeeze wouldn't trigger global financial chaos.
Nearly two years later, taxpayers are on the hook for twice that amount, and it now appears that Paulson and senior Federal Reserve officials either plunged ahead without understanding AIG's financial situation and the risks it posed to taxpayers — or were less than candid about one of the largest corporate bailouts in U.S. history.
AIG reported combined total losses of $110 billion in 2008 and 2009, erasing any doubt that the government stepped into a colossal mess.
AIG was at the epicenter of all the government bailouts of financial institutions in 2008, a company through which more than $90 billion in federal money flowed out the back door to some of the same Wall Street banks whose risky behavior fueled the crisis. Among the leading beneficiaries of the AIG bailout was investment banking giant Goldman Sachs, which Paulson headed until June 2006.
Elizabeth Warren, the chairwoman of the Congressional Oversight Panel that's tracking the use of bailout money, said at a hearing in late May that the government "broke all the rules" with its rescue of AIG, which she labeled a "corporate Frankenstein" that defied regulatory oversight.
As the Fed wired billions of dollars to AIG in the fall of 2008, state and federal officials assured the public that the company's financial woes were limited largely to its parent, which had wagered $2 trillion on exotic financial instruments and incurred massive losses on housing-related investments. AIG's six dozen U.S.-based insurance companies, the regulators said, were all on solid footings.
A McClatchy Newspapers analysis of the finances of 20 of AIG's larger insurance subsidiaries at the time has found a much bleaker picture, however: More than $200 billion in potential red ink was obscured by entanglements in which these subsidiaries bought stock in, reinsured or guaranteed debts of their sister companies.
Despite the regulators' public assurances and AIG's assertion that pooling arrangements among its subsidiaries made the liabilities look worse than they actually were, AIG has since propped up its insurance subsidiaries with $31 billion of taxpayers' dollars, and its total debt to taxpayers could reach $182 billion.
Now the company, nearly 80 percent owned by taxpayers, is reporting profits again and appears to have stabilized. Still, government auditors project that bailing it out will still cost taxpayers as much as $47 billion.
Most experts agree that shoring up the giant insurer was important to prevent a systemic financial breakdown, but critics question the government's handling of the bailout — from its misleading early portrayals of AIG's financial condition to failing to press Wall Street creditors such as Goldman to accept discounted payments from AIG.
Warren, whose panel is completing a critical report on the bailout, said, "The government invented a new process out of whole cloth." In a normal restructuring, she said, AIG's shareholders "should have lost everything, and its creditors should have taken substantial losses."
Neil Barofsky, the special inspector general assigned to watch over hundreds of billions in federal bailout dollars, last fall also criticized the Fed's decision to pay Goldman and others 100 cents on the dollar to settle AIG's insurance-like bets, known as credit-default swaps, on offshore mortgage securities.
Instead, creditors such as Goldman were paid in full, and AIG shareholders' stock was diluted twentyfold, but not wiped out.
Now Barofsky is investigating whether New York Fed employees may have concealed information about the bailout and whether Wall Street firms might have defrauded taxpayers by concealing risks in seven offshore deals that AIG had insured.
A central question is how much U.S. officials knew about the company's problems when they decided to bail it out.
Thomas Baxter, the general counsel of the Federal Reserve Bank of New York, acknowledged that the Fed's understanding of the insurer's financial condition "changed over time as we got to know AIG and its problems."
"That led us to come up with different solutions as we learned . . . that its problems were both liquidity (a cash squeeze) and capital (insufficient assets)," he said.
Robert Eisenbeis, a former research director for the Federal Reserve Bank of Atlanta, said that the AIG bailout "was painted as a liquidity problem, and it was a solvency problem. And it's still a solvency issue."
Treasury Secretary Timothy Geithner, who headed the New York Fed in the fall of 2008, told Congress in late January that the central bank had the authority "to protect the financial system from broad-based runs" but could lend only to "firms that were solvent," able to pay their debts.
He made no mention of AIG's questionable solvency.
In his recently published book, On the Brink, Paulson describes advising President George W. Bush at a White House meeting on Sept. 16, 2008, that AIG needed a large but temporary cash infusion.
He told Bush that AIG, unlike the investment bank Lehman Brothers, which had gone bankrupt two days earlier, didn't have a shortage of assets — "at least we didn't think so at the time."
However, Paulson also recalled learning within weeks that AIG was "in dreadful shape . . . a badly wounded company" on the verge of collapse, unable even to make the interest payments on its government loans. On Nov. 5, 2008, the day after the presidential election, Paulson advised Bush that the Treasury Department would pay $40 billion to buy preferred stock in the insurer to keep it alive.