One of the more unusual trials to come out of the 2008 financial crisis is set to begin on Monday, when a federal judge will consider whether the U.S. government's rescue of American International Group Inc (AIG.N) was, in fact, legal.
In a case that explores the limits on U.S. government power in responding to major financial crises, the trial is expected to revisit in detail the New York Federal Reserve's September 2008 decision to extend a bailout package to AIG as the insurance giant was minutes from bankruptcy.
The AIG bailout, on the heels of the Lehman Brothers collapse in 2008, preceded the "too big to fail" auto and bank bailouts the federal government undertook during a U.S. financial crisis underpinned by faulty mortgage lending.
The major players in that drama will be back on the Washington stage during the six-week trial: Former Federal Reserve Chairman Ben Bernanke, and former Treasury Secretaries Timothy Geithner and Henry "Hank" Paulson.
A lawyer for the insurance giant's former chief executive, Maurice "Hank" Greenberg, was expected to argue that the government unlawfully sought to punish AIG shareholders with excessively harsh terms.
Greenberg's lawyers have said in court papers the bailout "offer" from the New York Fed to provide AIG an $85 billion loan in exchange for high interest rates and a nearly 80 percent stake in the company amounted to unconstitutional theft from AIG shareholders.
Greenberg, through his Starr International Co, was AIG's largest shareholder at the time. Starr filed lawsuit, to considerable public scorn, in November 2011.
Government lawyers have defended the actions as appropriate, pointing out that the deal had been approved by the AIG board, as the company faced no other alternative to bankruptcy. Lawyers at the U.S. Department of Justice have described the case as a "conspiracy theory" and "built on a mistaken premise."
"Starr's case stems from a misperceived entitlement ... that when AIG faced an existential crisis in September 2008, AIG was entitled to dictate the terms of its own rescue," they said in papers filed before trial.
But U.S. Judge Thomas Wheeler last month rejected the United States' bid to dismiss the lawsuit, which seeks as much $50 billion in damages, saying that the case involved "complex financial and economic issues" that deserved analysis.
The case poses two central questions. One is whether it was legal for the government to take $35 billion worth in AIG shares, and only effectively pay $500,000. The 5th Amendment to the U.S. Constitution prevents private property from being taken for public use without just compensation.
The other is whether the government was allowed to condition its first $85 billion loan on an equity stake in the company. Starr's lawyers have argued that the Federal Reserve Act does not allow the government to demand a stake in the company in exchange for the loan.
AIG finished repaying the full $182.3 billion bailout in December 2012, leaving taxpayers with a nearly $23 billion profit.
Greenberg, 89, led AIG for nearly four decades before his 2005 ouster.
Arguing for Starr is David Boies, who represented former Vice President Al Gore before the U.S. Supreme Court during the contested 2000 presidential election.
Few experts even expected the case to go to trial.
"Certainly what the government did was unusual ... my guess is that the government will win," said Hester Peirce, a senior research fellow at George Mason University who studies financial regulation.
"The standard idea is that during a crisis, what the government should do is lend freely, but they should do so at a penalty rate," Peirce said.
