September 16, 2008
Can the Government Buy an Insurance Company for Cheap?
Posted by David Zaring

Apparently so.  Good news if you have stock in the United States - boy can that country buy low.  Anyway, as you've all probably read, the Fed opened the discount window for AIG in exchange for 80% of its stock.  Amazing dilution. No, I can't recall the government having ever done this before.  And yes, this sort of invitation to trade credit for equity is utterly unprecedented in the Fed's use of section 13 of the Federal Reserve Act.  The below analysis of this administrative action reserves all M&A questions to other corporate experts.

There's really no statutory authority for the AIG takeover (the Fed and Paulson went to the Hill, and got nothing, not that they possibly could have in a couple of Tuesday evening hours).  I won't bother noting that the DC Circuit, were it to sit in judgment on whether the Fed could buy the world's largest insurer, would undoubtedly conclude that the plain language of its governing statute (which is to make emergency loans, not require takeovers in exchange) would not permit the takeover under Chevron USA v. NRDC.

And I will wait for others to opine on whether the Fed got a good deal.  Legally, the basis for Fed action - not that it is reviewable - would be that the acquisition of the petitioner is a reasonable interpetation of its ability to open the discount window to anyone. 

I imagine that the legal answer to that question depends on a nice distinction between practice and plain language. Under the plain language of the statute, interpreted imaginatively, the Fed can extend credit, upon the right showing, to any company or individual, and so why not insist on conditions on the loan?  Heck, why couldn't EPA, in the name of fishable swimmable rivers (that's Clean Water Act language), ban all pesticides, including dishwasher detergent, or nationalize water users like the steel industry?  Maybe it can!  Which might be good news for environmental activists.

The usual reason why government agencies can't so act has something to do with settled expectations - if a government agency has never done it, and never done anything like it, then it usually can't do it, no matter how broad the grant of Depression era authority. 

But, in the Fed's legal defense, maybe, just maybe, the settled expectations are different here, based on the government's takeovers of Fannie and Freddie, and the pleading by AIG for government involvement.  Does the very fact that the insurer hoped for Fed action suggest that the Fed could act?

Hmmm.  The other defense would be that emergencies are emergencies, and when that happens the rules go out the window, and hopefullly regular elections mean that the officials the people trust are dealing with the emergency.  Abraham Lincoln adopted that reasoning, and he won the Civil War.  I suspect we're at the "anything goes in an emergency" stage of things.  But maybe reasonable minds could disagree.

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Comments (21)

1. Posted by pwb on September 17, 2008 @ 3:31 | Permalink

How is paying $85b for 80% of AIG a good deal?


2. Posted by fedgovernor on September 17, 2008 @ 7:31 | Permalink

Um ... you forgot something: The Federal Reserve is a private bank ... it is not "the government." Although the government appoints federal reserve chairmen and governors, the FED is a private institution.

It is not the government.

It is the Federal Reserve that bought AIG ... not the government. And the FED can buy anything it wants with the money it prints.

What? You thought the government printed the money?

Well, you were wrong.


3. Posted by ff11 on September 17, 2008 @ 7:58 | Permalink

I wouldn't phrase it as "the Government Buying an Insurance Company for Cheap". It is more like "the Government Throwing $85 Billion Into a Bottomless Pit".


The Insurance company in question managed to sucker the government into putting our hard earned money into it after investors had wised up and wouldn't touch it with a ten foot pole.


4. Posted by N328KF on September 17, 2008 @ 8:15 | Permalink

fedgovernor, you are delusional if you think that making appointments is the only role that the government has with the Fed. The Fed is a policy arm of the government, though your literalist view doesn't seem to allow for this interpretation.


5. Posted by Jim on September 17, 2008 @ 8:25 | Permalink

The Bureau of Engraving & Printing does print the money; the fed banks put it into circulation. Yes, the fed banks are theoretically owned by the member banks, as are the Home Loan Banks, but that doesn't mean that they are controlled by their owners. The federal government controls who runs them.


6. Posted by Henry Bowman on September 17, 2008 @ 8:25 | Permalink

The use of the term emergency is almost always a maneuver designed to grab power, which is precisely how Mr. Lincoln used the method. I see little different here.


7. Posted by Angus Hendrick on September 17, 2008 @ 8:57 | Permalink

The "is the government" thread seems beside the posts point. The question is: given that Fed is controlled by U.S. Law, are its actions in accordance with that law? It is patently fallacious to say "the FED can by anything it wants," as the statutes that govern it limit what it can spend its money on (again precisely the posts point). For a partial list of statutes governing the Fed see: http://www.theconglomerate.org/2008/09/can-the-governm.html


8. Posted by Matt Bodie on September 17, 2008 @ 9:06 | Permalink

As to whether the taxpayers are on the hook for this, see:
http://dealbreaker.com/2008/09/treasury-departments-new-finan.php


9. Posted by Angus Hendrick on September 17, 2008 @ 10:07 | Permalink

I Kant spel... jeez.


10. Posted by Angus Hendrick on September 17, 2008 @ 10:10 | Permalink

For crying out loud... the link should be:www.federalreserve.gov/boarddocs/supmanual/cbem/200804/8000.pdf

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