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* Lawsuit seeks $25 billion for AIG shareholders
* Starr International says AIG takeover unconstitutional
* Federal Reserve Bank of New York also sued
* Treasury Department calls AIG bailout necessary, legal
By Jonathan Stempel
Nov 21 (Reuters) - A company run by former American International Group Inc Chief Executive Maurice "Hank" Greenberg sued the U.S. government for $25 billion, calling the 2008 federal takeover of the insurer unconstitutional.
The lawsuit marks an unusual effort to force the government to pay shareholders, who have seen AIG's stock price tumble 98 percent since the middle of 2007, when the insurer's risky bets on mortgage debt through credit default swaps began to falter.
Greenberg's company, Starr International Co, also filed a lawsuit against the Federal Reserve Bank of New York, whose president at the time of the takeover was Timothy Geithner, now U.S. Treasury Secretary.
Once AIG's largest shareholder, Starr said the government took a roughly 80 percent stake in AIG and charged an "punitive" 14.5 percent on federal loans without seeking a shareholder vote, hoping to provide a "backdoor bailout" for AIG trading partners such as Goldman Sachs Group Inc .
It said the bailouts that began on Sept. 16, 2008, violated shareholders' rights to due process and equal protection, and a Fifth Amendment ban against taking private property for public use without just compensation, known as the "takings clause."
Greenberg, 86, had led AIG for nearly four decades prior to his 2005 ouster. Starr once owned 12 percent of AIG.
"The government's actions were ostensibly designed to protect the United States economy and rescue the country's financial system," David Boies, a lawyer for Starr, said in the complaint.
"Although this might be a laudable goal, as a matter of basic law, the ends could not and did not justify the unlawful means employed," he continued. "The government is not empowered to trample shareholder and property rights even in the midst of a financial emergency."
Shareholders of other companies, including mortgage financiers Fannie Mae and Freddie Mac and the bank Citigroup Inc , also saw their holdings diluted in the fallout from the 2008 financial crisis. It is unclear whether Starr's constitutional arguments might apply to them.
Starr sued the government in the U.S. Court of Federal Claims in Washington, D.C., which handles lawsuits seeking money from the government. It brought that lawsuit on behalf of itself and other AIG shareholders.
The case against the New York Fed, which gave AIG an $85 billion credit line, was filed in the U.S. District Court in Manhattan. AIG's bailouts eventually totaled $182.3 billion.
Despite broad public anger at how bailouts were conducted, it is "hard to imagine Hank winning," Adam Levitin, a professor at Georgetown Law School, said in emailed comments.
Levitin noted the AIG bailout had been approved by the insurer's board and the terms "arguably" were fair.
The U.S. Treasury Department said it is reviewing the matter and expects to defend its actions vigorously.
"The government provided assistance to AIG -- and stopped it from collapsing -- in order to prevent a meltdown of the entire global financial system," Tim Massad, assistant secretary for financial stability, said in a statement. "Our actions were necessary, legal, and constitutional."
A spokesman for the New York Fed said the allegations were meritless.
"AIG's board of directors had an alternative choice to borrowing from the Federal Reserve and that choice was bankruptcy. Bankruptcy would have left all AIG shareholders with worthless stock. The Federal Reserve's actions with regard to AIG helped to restore financial stability in the United States during a period of intense volatility and vulnerability in the U.S. economy," said Jack Gutt, New York Fed spokesman.
AIG spokesman Mark Herr declined to comment. AIG is Abased in New York and was named as a nominal defendant in both lawsuits.
The $25 billion estimate reflects what Starr called the value of the government's stake on Jan. 14, 2011, when it swapped AIG preferred stock for 562.9 million common shares. AIG was once the world's largest insurer by market value.
"Courts have recognized that the takings clause can apply to intangible property such as shareholder rights," said Ilya Somin, a George Mason University law professor who has written about the takings clause. "It is not clear how valuable these rights are, especially given all of AIG's liabilities."
The bailouts began one day after Lehman Brothers Holdings Inc went bankrupt and Bank of America Corp agreed to buy Merrill Lynch & Co.
But according to Starr, the AIG bailout was done as "a vehicle to covertly funnel billions of dollars to other preferred financial institutions" such as Goldman. Some trading partners were paid 100 cents on the dollar.
Goldman spokesman Michael DuVally declined to comment.
The government's AIG stake has fallen to about 77 percent.
AIG itself in August sued Bank of America for $10 billion over alleged losses on mortgage securities.
Greenberg stepped down from AIG amid questions by regulators over its accounting practices.
In 2006, AIG paid $1.64 billion to settle federal and state probes into its business practices and in July 2010 it agreed to pay $725 million to settle a shareholder lawsuit accusing it of accounting fraud and stock price manipulation.
Starr's counsel Boies is a partner at Boies, Schiller & Flexner. One of the best-known U.S. lawyers, he represented Vice President Al Gore after the 2000 presidential election, and now represents players locked out by the National Basketball Association.
Boies was not immediately available for further comment on Monday.
AIG shares closed down 87 cents, or 4 percent, at $21.01 on the New York Stock Exchange, as stock prices fell broadly.
The cases are Starr International Co v. U.S., U.S. Court of Federal Claims, No. 11-00779; and Starr International Co v. Federal Reserve Bank of New York, U.S. District Court, Southern District of New York, No. 11-08422.