“On Monday Judge Thomas Wheeler of the U.S. Court of Federal Claims ruled that the Federal Reserve Bank of New York’s seizure of a controlling stake in AIG during the financial crisis was “an illegal exaction under the Fifth Amendment.””, The Wall Street Journal Editorial Board
Washington’s Illegal Bailout
Hank Greenberg wins an historic victory against the Fed seizure of AIG.
Maurice “Hank” Greenberg, former chairman and chief executive officer of AIG Photo: Michael Nagle/Bloomberg News
For every angry taxpayer who wondered in 2008 how the government could take over one of the world’s largest insurance companies, a federal judge has now provided the answer: It couldn’t, at least not within the bounds of the law.
On Monday Judge Thomas Wheeler of the U.S. Court of Federal Claims ruled that the Federal Reserve Bank of New York’s seizure of a controlling stake in AIG during the financial crisis was “an illegal exaction under the Fifth Amendment.” The judge explains that the New York Fed, the Treasury and their outside counsel at the Davis Polk law firm “carefully orchestrated the AIG takeover so that shareholders would be excluded from the process. These entities avoided at all cost the opportunity for any shareholder vote.”
The Fed and its regional banks can lend in an emergency. But they lack the authority to seize ownership of private companies. Did government officials realize at the time that they were violating the Constitution? If so, they probably figured they could get away with it. In a Sept. 17, 2008 email, a Davis Polk lawyer wrote that “the [government] is on thin ice and they know it. But who’s going to challenge them on this ground?”
The man who did challenge them is former AIG CEO Hank Greenberg, who now leads Starr International, which brought the case on behalf of AIG shareholders. Monday’s decision is vindication for Mr. Greenberg, who has argued for years that AIG was treated much more harshly than the giant banks and was used as a vehicle to rescue those banks.
Judge Wheeler agrees. “Since most of the other financial institutions experiencing a liquidity crisis were counterparties to AIG transactions, the Government was able to minimize the ripple effect of an AIG failure by using AIG’s assets to make sure the counterparties were paid in full on these transactions,” he writes.
The feds charged AIG much more than it charged the banks to borrow money, and it demanded 79.9% ownership in AIG for the privilege. “With the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act,” he writes. The feds later sold the shares for a $22.7 billion profit.
This is all a significant rebuke to the main government actors at the time: Treasury Secretary Hank Paulson, chief of the New York Fed Tim Geithner, and Fed Chairman Ben Bernanke.
Though Mr. Greenberg won the legal argument and a moral victory, he lost on his claim that AIG would have been better off in bankruptcy and thus should be compensated for the seizure. Judge Wheeler ruled that AIG shareholders would likely have been wiped out in a bankruptcy, so they can’t claim to have suffered harm. But the judge nonetheless adds that “a troubling feature of this outcome is that the Government is able to avoid any damages notwithstanding its plain violations of the Federal Reserve Act.”
Both sides are reviewing the decision and won’t say whether they plan to appeal, but the mixed verdict may be the best in a bad situation. Taxpayers will not be required to pay a damage amount that would be highly speculative. But the judicial branch of government has forcefully reminded the executive of its legal limits, even in a crisis.
Fed officials are upset that Congress wants to rein in their emergency and regulatory powers. Congress might have less cause to act if the Fed showed more respect for the law.