In AIG Case, Panic Gets a Slap on the Wrist

After seven years, the federal government has finally received its comeuppance. U.S. Judge Thomas C. Wheeler gave the Federal Reserve a severe tongue lashing, a tsk-tsking for the central bank’s financial-crisis overreach.

That ought to teach ‘em.

The actual result of the case is to confirm the status quo. In “emergencies,” restraint on government adds up to precisely nothing.

Consider the case at hand involving the bailout of the giant insurance company American International Group at the height of the 2008 panic.

Wheeler was confronted with an intriguing question of law: What are the limits of government intervention in the economy during times of crisis? It was a case with no good guys, only flawed actors, a suit I like to think of as Chutzpah v. Panic.  You may know the case by its formal name, Starr International Co. v. U.S. (11-cv-00779). In more common parlance, it was also referred to as that crazy suit former AIG head Hank Greenberg filed against the feds.

On the one hand, in the cool light of hindsight, this was a clear case of government overreach. The Fed regulates the banking system, and has no jurisdiction over insurance companies. But during the financial crisis the Fed stepped in, covered AIG’s liabilities and claimed majority ownership.

As Wheeler wrote, “The Board of Governors and the Federal Reserve Banks . . . did not have the legal right to become the owner of A.I.G. There is no law permitting the Federal Reserve to take over a company and run its business in the commercial world as consideration for a loan.”

On the other hand, you have a company that was one of the worst and most reckless actors in the financial industry — and that was the least of the problems in this litigation. Before the government bailout, AIG was hurtling straight off a cliff toward bankruptcy, all by its own hand. Its shareholders were destined to get wiped out. As Wheeler noted: “The inescapable conclusion is that A.I.G. would have filed for bankruptcy. In that event, the value of the shareholders’ common stock would have been zero.” Hence, Greenberg’s demand for $40 billion in compensation was why his claim represented pure chutzpah. (For more on AIG, see thisthisthisthisthisthis and of course this).

Complicating matters more, we know the AIG takeover was a debacle. The Special Inspector General of the government’s bailout program already told us the Federal Reserve Bank of New York screwed up the AIG rescue. The feds even wanted a national security exemption for AIG, to keep the whole mess secret. That was how much panic there was at the time.

In theory, the ruling may limit the Fed’s ability to deal with the next crisis. In practice, during a genuine panic, there are no rules. That is the most significant dicta of the case. The government overstepped its authority during what was considered to be an emergency. To prevent this, you can sue the government; seven years later, a pyrrhic victory is yours.

Consider how flexible the First Amendment becomes during times of war. Think of how much privacy rights shrunk after the  terrorist attacks. How do we get the internment of 120,000 U.S. citizens of Japanese descent during World War II? How do we ignore our own treaties against torturing prisoners?

There is that word again: Panic.

The Fed certainly panicked as AIG (not to mention the entire financial system) teetered. The answer to the complaints was “Go ahead and sue us.” So Greenberg did. His victory was in name only.

What might this mean in the next financial crisis? Maybe a day of delay. Assume a plaintiff can find a friendly judge to issue a favorable ruling based on the Starr International case. It probably wouldn’t take the government more than a day to find an appellate court to overrule the judge on an emergency basis. Only after that takes place, can the plaintiffs begin their appeals. And as we just learned, that will take about seven years.

In an emergency, the government often ignores what courts say. The Constitution isn’t a suicide pact — that’s the phrase you will hear at such a time.

Best of luck. Maybe there’s a pyrrhic victory in your future.

 

Originally published as: Hank Greenberg’s Chutzpah vs. Fed’s Panic

 

 

 

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What's been said:

Discussions found on the web:
  1. VennData commented on Jun 16

    Ah the joys of incorporating a subsidiary in light-touch regulatory London and selling insurance on the entire global banking industry so cheaply that the CDS creators could still make money.

    Skill.

  2. save_the_rustbelt commented on Jun 16

    Reminds me of an insurance claim I worked many years ago.

    Firemen rolled out on a cold, bitter, icy night and due to their skill a business was saved from a catastrophic loss.

    As is typical in fires caught early, there was more water damage than physical fire damage.

    What did the grateful owner say?

    “The dummies used too much water!”

    No amount of logic would convince him that he would have nothing but ashes without the water.

    Such is the AIG bailout.

    • intlacct commented on Jun 17

      Great analogy, save the rustbelt.

    • intlacct commented on Jun 17

      Tax the uber wealthy within a centimeter of the dessicated scrotum that contains their enormous, ungrateful ballz.

      …Just a thought.

  3. Futuredome commented on Jun 16

    The Government did nothing. It was the bank of new york( Aaron Burr’s Chase Manhattan) that used a form of “ad hoc” government power. The Federal Reserve system as a whole, was in the dark what New York was doing. The sadder thing is, the market respected it.

  4. rd commented on Jun 16

    Isn’t Dick Fuld running around moping and whining because he didn’t get a deal like AIG’s? It is all in the eye of the beholder.

  5. Robert M commented on Jun 16

    SEC 101 of TARP says the government can do what it did:
    Authorizes the Secretary to establish a Troubled Asset Relief Program (“TARP”) to purchase troubled assets from financial institutions. Establishes an Office of Financial Stability within the Treasury Department to implement the TARP in consultation with the Board of Governors of the Federal Reserve System, the FDIC, the Comptroller of the Currency, the Director of the Office of Thrift Supervision and the Secretary of Housing and Urban Development.

    Requires the Treasury Secretary to establish guidelines and policies to carry out the purposes of this Act.

    Includes provisions to prevent unjust enrichment by participants of the program.
    http://ths.gardenweb.com/discussions/2580870/section-by-section-breakdown-of-the-bailout-bill

    Such a bunch of BS that this went to trial

  6. MikeR44 commented on Jun 17

    I thought Geithner et. al. took over AIG to save Goldman and other financial “swaps” holders. The banks and investment companies insured by AIG’s division would have lost billions. Geithner was not going to let that happen to his buddies. Does anyone know the dollar amount of these “swaps” that were protected by the bailout?

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