By Aruna Viswanatha
WASHINGTON (Reuters) - One of the more unusual trials to come out of the 2008 financial crisis began on Monday in front of a federal judge who is considering whether the U.S. government's rescue of American International Group Inc was, in fact, legal.
In a case that explores the limits on U.S. government power in responding to major financial crises, the six-week 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: former Federal Reserve Chairman Ben Bernanke, and former Treasury secretaries Timothy Geithner and Henry "Hank" Paulson are expected to testify.
On Monday, a lawyer for a company owned by the insurance company's former chief executive, Maurice "Hank" Greenberg, set the scene by arguing that the government unlawfully sought to punish AIG shareholders with excessively harsh terms.
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There is "no precedent" and "no justification" for the New York Fed to demand a nearly 80 percent stake in the company in addition to a high interest rate for an $85 billion loan to AIG, star trial lawyer David Boies said in his opening remarks.
The New York Fed cannot "ask for a benefit the agency is not authorized to demand," Boies said.
Greenberg, through his Starr International Co, was AIG's largest shareholder at the time. Starr filed a 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.
On Monday a lawyer from the U.S. Department of Justice, Kenneth Dintzer, said AIG received assistance only because of the potential global consequences of the company filing for bankruptcy, and that the loan terms made sense given market conditions.
"The goal was not to save AIG, it was to save the world from AIG," Dintzer said.
The trial is unfolding before U.S. Judge Thomas Wheeler, who last month rejected the United States' bid to dismiss the lawsuit. He said the case, which seeks as much $50 billion in damages, involved "complex financial and economic issues" that deserved analysis.
The case is before the U.S. Court of Federal Claims, which mainly deals with lawsuits from people arguing they are owed money by the U.S. government.
The case poses two central questions. One is whether the government literally took $35 billion worth in AIG shares, and effectively paid only $500,000 for them. The Fifth 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.
On Monday Boies, who represented former Vice President Al Gore before the U.S. Supreme Court during the contested 2000 presidential election, said AIG's treatment was not in line with assistance the New York Fed offered other financial institutions.
Citigroup Inc , for example, received loans at a much lower interest rate without having to provide equity as collateral, he said, even though the government later accused the company of fraud in its mortgage securities business that fueled the crisis.
"They say Citibank is the fraudster ... yet AIG is the only company they single out for punishment," Boies said.
Dintzer, the government's lawyer, said the bailout in the end raised the value of AIG shares, and that policymakers had to consider "moral hazard" concerns when calculating its terms.
"Shrinking a benefit to shareholders is not punishment, it is a benefit," Dintzer said.
AIG finished repaying the full $182.3 billion bailout in December 2012, leaving taxpayers with a profit of nearly $23 billion.
Greenberg, 89, led AIG for nearly four decades before his 2005 ouster.
The trial's first witness, Federal Reserve general counsel Scott Alvarez, took the stand on Monday morning, and was expected to continue testifying later in the afternoon.
The case is Starr International Co v. U.S., U.S. Court of Federal Claims, No. 11-00779
(Reporting by Aruna Viswanatha; editing by John Whitesides, Doina Chiacu and Matthew Lewis)