Judgment from the United States Court of Federal Claims on the AIG lawsuit:

Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan…Moreover, there is nothing in the Federal Reserve Act or in any other federal statute that would permit a Federal Reserve Bank to take over a private corporation and run its business as if the Government were the owner. Yet, that is precisely what FRBNY did.

It is one thing for FRBNY to have made an $85 billion loan to AIG at exorbitant interest rates under Section 13(3), but it is quite another to direct the replacement of AIG’s Chief Executive Officer, and to take control of AIG’s business operations. A Federal Reserve Bank has no right to control and run a company to whom it has made a sizable loan.

As FRBNY’s outside counsel from Davis Polk & Wardwell observed on September 17, 2008 in the midst of the AIG takeover, “the [government] is on thin ice and they know it. But who’s going to challenge them on this ground?” Answering this question, the “challenge” has come from the AIG shareholders, whom the Government intentionally excluded from the takeover process…As the Court noted during closing arguments, 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.

Any time the Government saves a private enterprise from bankruptcy through an emergency loan, as here, it can essentially impose whatever terms it wishes without fear of reprisal. Simply put, the Government often may ignore the conditions and restrictions of Section 13(3) knowing that it will never be ordered to pay damages.

Response from the Fed:

The Federal Reserve strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective. The court’s decision today in Starr International Company, Inc. v. the United States recognizes that AIG’s shareholders are not entitled to compensation for that decision, and that the Federal Reserve’s extension of credit to AIG prevented losses to millions of policyholders, small businesses, and American workers who would have been harmed by AIG’s collapse during the financial crisis. The terms of the credit were appropriately tough to protect taxpayers from the risks the rescue loan presented when it was made.

The important implication here is that the government clearly could have imposed much harsher terms on the other financial firms it bailed out, yet, for some reason, consciously chose not to do so. Feel free to leave your theories as to why in the comments.

Related links:
Illiquid, insolvent, what’s the difference? — FT Alphaville

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