Former Treasury Secretary Paulson: AIG Bailout was Punitive

Former Treasury Secretary Henry "Hank" Paulson told a packed courtroom on Monday that AIG shareholders were singled out for punishment as part of the U.S. government's attempt to contain the contagion of the 2008 financial crisis.

The testimony from Paulson appeared to bolster some claims contained in a lawsuit brought by former AIG Chief Executive Hank Greenberg, who contends the terms of a government loan to AIG cheated its shareholders.

"AIG, either fairly or unfairly, ... became a symbol for all that is bad on Wall Street," Paulson said as he testified about the U.S. government's bailout of the insurance giant, which began with a $85 billion loan from the New York Federal Reserve in September 2008.

Paulson, testifying in federal court in Washington, also said he supported the loan and its terms as appropriate for the circumstances.

Paulson was a chief architect of the U.S. government's response to the unprecedented global credit crisis. He has since written a book about the experience, but Monday's courtroom setting put Paulson on the hot seat in a way he has not experienced since Congress wrapped up its hearings on the subject years ago.

In the case of AIG, the Fed initially charged a high interest rate for the first loan and required a nearly 80 percent stake in the company in exchange, which Greenberg's lawyers have said was illegal.

Paulson said such terms were necessary to protect against "moral hazard," or concerns that other companies would take reckless risks under the belief that the government would bail them out with few consequences.

But in response to questions from a government lawyer, Paulson said Citigroup's shareholders were not subject to similar terms, in part because policymakers were concerned about short sellers who were exerting pressure on Citi's stock and would profit if the rescue targeted Citi's shareholders.

Paulson said he was worried the traders would take the same strategy to the next bank, a concern he said he did not have about any of AIG's peers.

Paulson took the stand Monday morning wearing a dark suit and red tie and appeared relaxed, answering questions so directly that Greenberg's lawyer, star litigator David Boies, wrapped up what he expected to be six hours of testimony within a little over one hour.

The testimony by Paulson comes in the second week of what is expected to be a six-week trial. Former Treasury Secretary Timothy Geithner and former Federal Reserve Chairman Ben Bernanke are expected to testify later this week.

Paulson, who served as President George W. Bush's Treasury secretary from 2006 to 2009, was previously the chief executive of Goldman Sachs Group Inc and now runs an institute that focuses on climate change and other issues.

The case is Starr International Co v. U.S., U.S. Court of Federal Claims, No. 11-00779.

(Reporting by Aruna Viswanatha; Editing by Steve Orlofsky)