I must admit that I haven’t been taking Hank Greenberg’s claim on behalf of AIG shareholders against the U.S. Government (Starr Int’l Co., Inc. v. United States, No. 11-00779C (Court of Federal Claims)) very seriously. I noted it as an oddity – a shareholder claim against the Government in the Court of Claims does not come around very often. But, although I had little doubt that the Government’s raid on AIG equity during the financial crisis was a “taking,” I figured there is no chance of a court ever holding the Government accountable. I read with bemusement the reports of testimony from Hank Paulson, Tim Geithner, Ben Bernanke, and the like, but that seemed more like a minstrel show than a takings trial. And David Boise, while a fine lawyer, struck me as pursuing this more to cement his reputation as a creative lawyer (and get a healthy fee from Mr. Greenberg) than actually to win.
That was before I managed to attend the closing argument before Court of Claims Judge Thomas Wheeler last Wednesday. I left the argument with the distinct sense that there is a serious claim here that, if politics doesn’t get in the way, could be successful. I was impressed by the substance of the plaintiffs’ argument and the lack of much substance in the Government’s defense.
As I understand the claims, albeit without actually having read the complaint or the numerous pleadings before the court, they are pretty simple. When the Nation was in the maelstrom of the financial crisis, money stopped flowing, and some folks believed it could bring down the entire banking system and economy. The Government moved to try to assist financial firms that were struggling with the lack of liquidity in the markets. It took steps to bring a number of firms back from the brink in the Fall and Winter of 2008, including Goldman Sachs, Citibank, Morgan Stanley, and AIG, among others, all of which faced a lock-up of liquidity after the bankruptcy of Lehman Brothers on September 15, 2008. It did so based on a Depression-era statute that authorized the Government to provide liquidity to solvent firms that were facing extinction because of liquidity problems. The provision relied upon was section 13(3) of the Federal Reserve Act, which authorized loans to these businesses based on four requirements: (1) the existence of “unusual and exigent circumstances”; (2) the borrower ’s ability to provide security for the loan; (3) the absence of private sources of liquidity; and (4) consideration in the form of an “interest rate” to be determined by the Board of Governors of the Federal Reserve “fixed with a view of accommodating commerce and business.”
The terms of the assistance given by the Government to other firms, however, differed substantially from the terms exacted from AIG. The loans to firms like Goldman, Morgan Stanley, and Citibank were made at rates determined by the Fed Board in the range of 2 to 3 percent. The terms demanded from AIG were far different: an interest rate of 14% plus the transfer of 79.9% of AIG’s equity to the Government. In other words, AIG was the only firm whose shareholders were required to dilute their ownership in order to obtain relief from the Government.
The claims are straightforward: (1) the extortion of 80% ownership of AIG from the shareholders as part of the price of assistance was a governmental taking of private property required to be compensated under the Fifth Amendment; and (2) the inclusion of the transfer of 80% of the equity of AIG to the Government as a term of the section 13(3) loan was an “illegal exaction” of property from the shareholders by the Government because it was not authorized by any statute.
The statutory argument seems particularly strong. Section 13(3) lays out precisely what the Government can obtain in return for providing an emergency loan, and that is an interest rate “fixed with a view of accommodating commerce and business.” There is no statutory authority to demand an ownership interest in return for providing relief, and, according to the oral argument, a provision for such was removed from an earlier draft of the statute precisely because Congress did not believe the Government should be in the business of acquiring ownership interests in private businesses in return for needed emergency financial relief.
The Government’s defenses, on the other hand, seem weak. The main ones seem to be that (1) there can be no taking or illegal exaction claims because the AIG shareholders, through their Board of Directors, voluntarily agreed to accept the Government’s terms, and they were not entitled to better terms; (2) demanding the transfer of equity ownership was fair and appropriate because otherwise the AIG shareholders would have gained a huge windfall from the government intervention; (3) demanding the transfer of equity ownership was necessary because otherwise the Government would be endorsing moral hazard; and (4) the shareholders didn’t suffer any damage anyway because the end result of the transaction lifted the value of their shares, even taking into account the 80% dilution, compared to no transaction at all.
These arguments seem transparently insufficient: (1) deciding to accept the Government’s “take it or leave it” terms hardly seems “voluntary” and much more seems like coercion; (2) the shareholders never actually accepted any terms – the Board of Directors did, without a shareholder vote (which probably was required for such a transfer of control and overall dilution) at the Government’s insistence (because the vote almost certainly would have failed); (3) the AIG shareholders would not have gained any windfall other than what section 13(3) contemplates – the recovery of a solvent, privately-owned firm from a liquidity squeeze – and, in any event, the “windfall” was certainly no different than the benefits accruing to shareholders of the other assisted entities (Goldman Sachs, Citibank, Morgan Stanley, etc.); and (4) the “moral hazard” argument suffers from the same flaw because all of the assisted entities were essentially in the same boat, plus, section 13(3) does not provide discretion to ask for more consideration as a means of avoiding “moral hazard,” or the like.
As for the argument that the shareholders suffered no loss from the taking of 80% of their equity away from them, that seems hardly to pass the “ha ha” test. It’s as if a mobster were to argue that a 20% per week vigorish on a “loan” is not excessive because the borrower is better off than having access to no funds at all, and the gangster simply wasn’t going to accept less interest. To be sure, the shareholders may well have gotten an immediate gain when the deal was announced because the alternative was bankruptcy, but that is a specious comparison. The appropriate comparison for purposes of determining whether the taking of equity caused a loss to shareholders is not to the denial of any emergency relief under section 13(3), but to the granting of relief on terms permissible under the statute. It was plain at the time that avoiding an AIG bankruptcy was a paramount Government objective because the unraveling of AIG could have caused a financial disaster, and I understand there is ample evidence in the record to support that allowing AIG to go under was not viewed as an acceptable alternative. But the Government insisted on the transfer to it of an 80% ownership interest to assure that the AIG shareholders “paid a price” for the relief. In other words, the benefit that went to the shareholders flowed from providing a section 13(3) loan, it was not the result of the Government’s decision to demand, apparently unlawfully, that they transfer 80% ownership in addition to the interest charged, which was the only form of consideration permitted by the statute. (In actuality, setting a rate of 14% interest was already a form of penalizing AIG, since it seems unlikely that this was “with a view of accommodating commerce and business” when the other firms were paying 2-3% interest.)
A review of AIG’s stock price movement after the bailing out of AIG became public shows that the 80% equity vigorish demanded by the Government was worth between $25 and $50 billion. That is the property that was demanded by the Government, apparently unlawfully, and it surely represents a real and compensable loss, just as the difference between 20% annual interest on a lawful loan and 1,000% annual interest from the loan shark represents a loss to the borrower from the loan shark’s unlawful conduct (even if the borrower was able to save his life by using the loan to pay off another gangster).
Who knows what Judge Wheeler will do, or what will happen on appeal to the Federal Circuit. The political consequences of finding that government officials at the highest levels acted unlawfully are daunting. But to me, the claims asserted are not as easily dismissed as the Government suggests. They warrant serious attention and evaluation, which appears to be exactly what Judge Wheeler is doing.
April 24, 2015
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