“I wonder whether fiat money and the absence of monetary rules played a role in the buildup of the imbalances that brought down AIG and others in 2008.”, Seth Lipsky, “Will Congress Now Rein in the Fed?”, The Wall Street Journal
Will Congress Now Rein In the Fed?
A federal judge says the government’s AIG bailout broke the law. Time for the legislature to step in.
By Seth Lipsky
The AIG building in New York’s financial district. Photo: brendan mcdermid/Reuters
Now that the U.S. Court of Federal Claims has concluded that the Federal Reserve violated federal law and the Constitution when it nationalized insurer AIG in September 2008, the big question is this: What is Congress going to do about it?
Judge Thomas Wheeler, who presided in the nonjury trial, shrank from awarding financial damages to AIG’s big shareholder, Starr International Co., which had sought more than $40 billion in the lawsuit. He reasoned that AIG had no option at the time except for bankruptcy, and so its shareholders would have been wiped out anyhow.
Starr and its chairman, former AIG chief executive Maurice “Hank” Greenberg, having won the moral victory, insist there is a remedy and will be appealing for damages. After all, the Fed handed over to the Treasury $22.7 billion in profit it made selling the equity it illegally seized in an AIG that supposedly was without value. That’s quite an incentive for the government to break the law.
All the more reason for Congress to address the larger questions raised by this astonishing case. Who watches the watchman? If ever a case put that question into sharp relief, this is it. And who better to answer than the Congress that created the Fed and has the formal oversight of the nation’s central bank?
It’s not as if the press has been on the job. It spent this trial down at the local bar having a drink with Marx and Engels—and laughing at the Bill of Rights. At the center of this case is a violation of the Fifth Amendment, the Constitution’s bedrock protection for private-property rights. It requires due process and just compensation before property can be taken for public use.
This seemed almost to offend the press. One dispatch in the Times called the case “ludicrous,” another “asinine.” The New Republic called it “mostly insane,” the New Yorker “absurdist comedy.” A headline in The Week called it “comically despicable.” A Bloomberg piece likened it to the slapstick courtroom classic “My Cousin Vinny.”
It strikes me that even the richest of Americans deserve more than such cynicism. How could the governors of our central bank, all of whom are bound by oath to support the Constitution, be so oblivious—or even hostile—to the parchment’s central protection of the property right?
Judge Wheeler was devastating on the point. The Federal Reserve Bank of New York’s taking of a 79.9% stake in AIG “constituted an illegal exaction under the Fifth Amendment,” he wrote. The Fed possessed emergency powers to make loans to distressed entities but not to “become the owner of AIG.”
The judge noted that over the years the Federal Reserve has made hundreds of emergency loans, but AIG is the only case in which it “demanded equity ownership and voting control.” It had no legal authority to do so or to run AIG’s business, he wrote.
That the Treasury managed to pocket a fast $22.7 billion out of the deal vindicates what economists call public choice theory. My preferred way to state its pith is the idea that government behaves in a way that makes it a competitor of private business.
The timing of Judge Wheeler’s decision may prove to be fortuitous. It comes into view just as the Federal Reserve begins its second century of operations. Congress is eyeing the central bank’s governance, duties and mandates, the logic of fiat money not tied to specie, and whether monetary policy should be subject to rules. A measure for Congress to audit the Fed passed the House nine months ago by 333 to 92, with more than 100 Democrats joining the Republicans
Later this month, I’m told, the chairman of the Joint Economic Committee, Rep. Kevin Brady (R., Texas), will reintroduce his Sound Dollar Act. The measure could, among other things, make price stability the Fed’s primary goal, effectively ending the era of Humphrey-Hawkins, which assigned the Fed the task of full employment; and it would reduce the relative power of the New York Fed that was at the center of the AIG debacle.
Mr. Brady is also likely to reintroduce a version of his Centennial Monetary Commission Act, designed to take a more strategic look at the Fed as it starts its second century. Should there be a role for gold? Should there be rules?
Meantime, the House Financial Services Committee, chaired by Rep. Jeb Hensarling (R., Texas), is all over the Fed. It has been sparring with Chairwoman Janet Yellen over, among other things, the possible leak from the Fed of information about monetary-policy deliberations.
In the Senate, the Banking Committee, chaired by Sen. Richard Shelby (R., Ala.), pressed Ms. Yellen in February over a proposal by John Taylor of Stanford University that the Fed set for itself a monetary rule and disclose it to Congress. I wonder whether fiat money and the absence of monetary rules played a role in the buildup of the imbalances that brought down AIG and others in 2008.
Ms. Yellen bridled at the idea of rules that even the Fed itself would set, saying she wasn’t a proponent of chaining the Federal Open Market Committee to “any rule whatsoever.” That’s an awfully hard line for a central bank that can’t even follow the bright line of the Fifth Amendment.
Mr. Lipsky is the author of “The Floating Kilogram and Other Editorials on Money,” just out from New York Sun Books.