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June 16, 2015
Brattle Principal Michael Cragg’s Testimony Contributes to Finding on Government Treatment of AIG

In the recently released decision from the United States Court of Federal Claims, Judge Wheeler sided with Brattle client Starr International Co. Inc., formerly one of the largest shareholders of American International Group (AIG) common stock, finding that that the Federal Reserve overstepped its authority by taking 79.9 percent of AIG’s equity as a condition of its loan to AIG. This element of the decision echoed testimony of Brattle principal Dr. Michael Cragg, which was restated in the opinion.

According to Dr. Cragg, “[t]he punitive terms imposed by the Federal Reserve on AIG’s shareholders, including the onerous interest rate and equity taking, were inconsistent both with (1) the Federal Reserve’s central banking function of lender of last resort, and (2) the manner in which the Federal Reserve exercised its lender of last resort powers with respect to other institutions.” Moreover, “[t]he Federal Reserve was able to impose punitive terms on AIG’s shareholders by misusing its monopoly position as lender of last resort to expropriate AIG shareholder equity in a manner entirely inconsistent with any legitimate economic policy or rationale.”

In his testimony, Dr. Cragg also addressed the explanations given for the Government’s treatment of AIG. He explained why, in the context of the Government’s role as lender of last resort, the “Government’s alleged justifications for treating AIG in this manner, i.e., punishment, addressing moral hazard, preventing a windfall, and compensating for credit risk, [were] not economically supportable.”

The court sided with Starr and other AIG shareholders, stating: “There is no law permitting the Federal Reserve to take over a company and run its business in the commercial world as consideration for a loan.”

Another element of Dr. Cragg’s testimony restated in the decision showed how AIG was treated differently compared to other institutions and Morgan Stanley in particular. In a chart reproduced from the Cragg trial exhibits, the terms of Federal Reserve’s lender of last resort assistance to AIG are shown to have involved much higher interest rates, higher collateral haircuts, commitment fees, and fees on undrawn funds in addition to equity being taken as consideration.

The judge criticized the government for “’unduly harsh treatment’ of A.I.G. compared with other financial institutions that were bailed out during the financial crisis.”

A team of economists from The Brattle Group, led by principal Paul Hinton, senior associate Florin Dorobantu, and associate Jehan deFonseka, worked with the trial team from Boies, Schiller & Flexner and Skadden, Arps, Slate, Meagher & Flom for nearly a year.