(Bloomberg) — The Federal Reserve Board of Governors didn't wantto bail out American International Group Inc. with an $85 billionloan, preferring that the insurer find a savior in the privatemarketplace, the Fed's top lawyer told a judge.

“We were telling AIG we were not interested in making thisloan,” Scott Alvarez, the Fed's general counsel, testified in thelawsuit brought by Maurice “Hank” Greenberg's Starr InternationalCo.'s lawsuit alleging the U.S.'s assumption of 80 of AIG's equitywas illegal. “We did everything we could to encourage them topursue other options.”

The Fed board would “just as soon not have made this loan ifthey could have avoided it,” Alvarez testified.

In the days leading up to the mid-September 2008 bailout, DonaldKohn, the vice-chairman of the Fed at the time, “was generallydiscouraging” to AIG officials about prospects for a central banklifeline “because he believed they should pursue a private sectorsolution,” Alvarez testified.

Alvarez also told the court he “had no doubt” that the Fed hadthe legal authority to take an equity position in a company as itdid with AIG.

Alvarez made his comments during cross-examination by JusticeDepartment lawyer Scott Austin after more than nine hours ofquestioning by Starr's lawyer, David Boies. Starr lawyers hadestimated that Alvarez would be on the witness stand for 2 1/2hours at the nonjury trial at the Federal Court of Claims inWashington.

Unconstitutional 'Taking'

Starr claims the the assumption of AIG stock by the FederalReserve Bank of New York in exchange for the $85 billion loanamounted to an unconstitutional “taking” of private property. Starrwas AIG's largest shareholder when the financial crisis struck.

Starr contends that the Fed didn't have the legal right todemand the surrender of equity in exchange for a bailout.

Earlier in the day, under questioning by Boies, Alvarez defendedloosened collateral standards for low-interest loans the Fed madeavailable to investment banks.

He disputed the statement that the Fed “lowered its standards”in granting loans against non-investment grade securities, callingthat a “value judgment.”

“I do not agree that it's less safe,” he said.

Fed's Uncertainty

Boies introduced several e-mails and other correspondencerevealing U.S. uncertainty about its authority to structure therescue of AIG in a way that would allow the Fed to take control ofthe insurer and head off shareholder opposition.

He asked Alvarez about an e-mail sent to him on Sept. 21, 2008,days after the bailout, by a New York Fed lawyer who wrote, “I amtrying to keep this moving because of a concern that there will bea shareholder action.”

Alvarez testified that regulators were concerned shareholderswould “do things that would not be in the interest of repaying theloan.”

Referring to other documents in which regulators expressmisgivings about the extent of their powers, Boies asked Alvarez,“Did you agree the New York Fed didn't have authority to purchaseequity?”

“It depends what you mean by purchase,” Alvarez replied, sayinghe couldn't respond because “purchase” is too ambiguous a word.

Strained Exchanges

The back-and-forth was one of several strained exchanges betweenBoies and Alvarez.

Greenberg, who built AIG into the world's biggest insurer beforeleaving in 2005, claims the government should have provided atleast $25 billion in compensation. He argues that banks includingMorgan Stanley and Citigroup Inc. got bailout loans at rates ofless than 4% without surrendering shares while AIG was charged 14percent.

The government says Starr's alternative to the Fed's bailout wasbankruptcy. AIG returned to profitability and repaid the assistancein 2012, leaving the government with a $22.7 billion profit.

The trial, which began Sept. 29, is expected to last six weeks.Alvarez is among 85 prospective witnesses. Former Federal ReserveChairman Ben Bernanke, ex-Treasury Secretary Henry Paulson andformer Treasury Secretary Timothy Geithner, the head of the NewYork Fed at the time of the bailout, are scheduled to appear nextweek.

The case is Starr International Co. v. U.S., 11-cv-00779, U.S.Court of Federal Claims (Washington).

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