For the first time in almost a decade, the Federal Open Markets Committee is likely to raise rates today. Whole careers have been launched without going through one of these things, so there's plenty of attention being paid, though I don't know, maybe instability in the bond market will make them less likely to do it.
That the speculation above is the sort of thing that a lot of people are doing illustrates what an odd creature of administrative law the FOMC is. It essentially is exempt from most rule of law requirements, although its empowering statutes featured a ton of guidance from Congress about what it should think about when it thinks about the monetary supply. But its decision about whether to raise or lower the federal funds rate is a matter left entirely to its discretion, and neither the courts, nor Congress, nor the President will have anything to say about it.
There's lots of good reasons for that - politicized money tends to be very susceptible to inflation. But one of the reasons to have administrative law is to render decisionmaking predictable, and really, nothing's more important than predictability when it comes to the monetary supply, where there's not a good reason, absent terrible economic conditions, to surprise anyone ever. In my view, that's why the FOMC has adopted rather stable customs in lieu of legal constraints, and I wrote about it here. Boring meetings, standardized voting, releases of the data on which the decisionmakers relied ... not of it is required by law, and yet all of it has been adopted by the agency.
Gretchen Morgenson says no, in a long front-page story in the Times, which should raise the hackles of any free-marketer. I though Matt Levine's comments were smart. The political economy of what to do about Fannie and Freddie is partly driven by the hedge funds who have taken big positions on the failed government agencies' stock, which wasn't wiped out when the government took the agencies over (and perhaps you can see how that structure is a weird one). If they don't win their takings claims based on that takeover, they want a "recap and release," that is, they want Fannie and Freddie to go back to being the super profitable guarantors of mortgages that they used to be. It's basically a big bet on Congress agreeing with them, because the current executive branch is dead set against it, and that seems like a very risky bet to me. It is also buccaneering capitalists pushing for government support for residential mortgages, which you don't expect to see every day; it appears that Morgenson thinks the hedge funds are onto something.
Anyway, the takings claim isn't a bad one - Steven Davidoff Solomon and I wrote about it here.
One of the amazing things that has happened in the wake of the financial crisis is that international bank regulators have moved from measuring two things - capital adequacy and the leverage ratio of banks - to measuring a lot of different things which must be computationally hard to keep in balance. In addition to the two extant measures, banks have to establish a net stabled funding ratio (NSF) designed to deal with long term assets, a liquidity coverage ratio (LCR) designed to deal with short term assets, and let's not forget the work being done in the US by the stress tests, labelled DFAST and CCAR, or Europe's MiFID.
Into the mix the Financial Stability Board has added a total loss absorbing capacity rule, or TLAC. The best way to think of this rule is as an alternative measure of the capital adequacy of very big banks, with an eye to the moment of failure; it requires banks, in addition to holding common stock and cash, to hold financial instruments like convertible bonds (or maybe plain old unsecured debt) that can be used to bail-in the bank - bail-in means that the bank looks to its creditors to provide it with resources to stabilize it, bailout means it looks to the government to provide those resources. Or, if you like, here's the FSB:
G-SIBs will be required to meet the TLAC requirement alongside the minimum regulatory requirements set out in the Basel III framework. Specifically, they will be required to meet a Minimum TLAC requirement of at least 16% of the resolution group’s risk-weighted assets (TLAC RWA Minimum) as from 1 January 2019 and at least 18% as from 1 January 2022. Minimum TLAC must also be at least 6% of the Basel III leverage ratio denominator (TLAC Leverage Ratio Exposure (LRE) Minimum) as from 1 January 2019, and at least 6.75% as from 1 January 2022.
Without going too far down this road, I think that these varied sorts of capital measurement are basically supposed to discourage regulatory arbitrage, though it also suggests how puissant big banks must be in handling their regulatory requirements. Not a place for a financial startup. TLAC is also a tax on big banks, of course, and a disincentive to become one of the thirty largest institutions in the world. Here's the WSJ with an explainer.
This all has to be adopted by the G20 at its next meeting, proving once again that in finance, the rules that really matter are set by an international, non-treaty based form of administration.
After stepping away to enjoy the pleasures of a summer virus, courtesy of my local one-year-old, I’m back for one last post to finish out my guest-blogging here, which I hope has been edifying or thought-provoking or at least mildly amusing for some readers. (Any and all thoughts, about my posts here or about To the Edge, would be greatly appreciated: pwallach at brookings.edu). For this last post, I want to return to the theme of “So Now What?”—this time not in the sense of policy prescriptions, but for the way we think about the law and how it relates to the legitimacy of crisis actions.
What I was driving at in my second AIG post, and what I explain in a number of contexts in the book, is that when Treasury and Fed officials adopt the role of financial crisis responders, they are unlikely to be subject to our stereotypical notion of the rule of law that centers on judges as the key enforcers of statutory and constitutional restraint. In this sense, I am in agreement with Eric Posner and Adrian Vermeule’s The Executive Unbound—though I reject their further inference that law itself becomes nothing more than a distraction for the nostalgic or naive, for reasons I’ve explained.
I like to think of this as a realist turn of thought: when we think about what the law means in practice, we ought to look at the evidence of what it does rather than starting with any hard and fast interpretive rules. But, like other uses of legal realism, this one is likely to generate backlash. Some of that will come from steadfast practitioners of legal dogmatics, who resent the heresy. But since I have no hopes of ever impressing the Senate Judiciary Committee, that doesn’t worry me much.
But ordinary people have their own reverence for the idea that our government and its instrumentalities are strictly creatures of law (see the fascinating Law’s Quandary, by Steven D. Smith). Their offense at deviation from this norm (perhaps rallied and organized by the professional formalists) is a far more troubling affair. Since the people’s judgment of the legitimacy of government’s actions is the ultimate determinant of legitimacy, that broader impression of lawlessness matters a great deal; indeed, it hangs like a cloud over future crisis responses.
Posner and Vermuele’s view is that in crises, “legality and legitimacy diverge, and legitimacy prevails.” In other words, our government and polity together slide over into a non-legal regime in which direct political checks are the only ones that matter. My contention is that this transition is likely to be much messier than they let on, in part because political channels are ill-defined.
This is especially the case for the Fed. American anxieties about paper money are older than the republic, not to mention fears of the “creature from Jekyll Island.” So the Fed will always face resistance in legitimizing its operations, especially in crises, when it is most visible. The Fed’s imposing presence can be accepted most readily as a valid delegation from Congress—but most such logic relies on confidence in the force of legal bonds. In other words, the Fed must at least seem legally accountable. This is all the more true because of the Fed’s perceived independence from politics. If we think the Fed is rightly insulated from sudden political passions, then we cannot count on direct-to-the-people accountability to substitute for legality.
In short, the central bank must style itself as a more accountable organ of government in some way that convinces at least some portion of skeptics; that is what legitimacy seems to require today. Discussion with Peter Conti-Brown has partially convinced me of the anachronistic nature of this view—but expectations are not necessarily any less influential because they are anachronistic. The political environment of America in 2015 is very different from what it was a century ago, and the Fed’s weirdness has become an obstacle to legitimacy today more than it may have been in the past. Keep America weird…but realize that the American people probably don’t have much patience for weirdness in their key policymaking institutions, and act accordingly. In some ways, Peter’s proposals about normalizing the appointment of the regional Fed presidents (which I’ve shied away from to this point) fit well into this mold.
Well, I could ramble on, but perhaps that charming fever hasn’t left entirely yet and so I’m better off cutting my losses. My sincere thanks to the Conglomerate for providing me an outlet for thinking out loud over the past few weeks, and especially to David for inviting me and engaging with my book. Hope that everyone enjoys the waning days of our crisis-free summer, as long as they last…
Continuing from my previous post on curious and curiouser aspects of Judge Thomas Wheeler’s Court of Federal Claims opinion in Starr v. United States, here I ask: what is the bottom line of the opinion’s holding, and what impact could it have on the future conduct of the Federal Reserve?
Judge Wheeler’s clearest holding is the following: “Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan” (7). If you look past all of the overwrought verbiage, this is clear as day, and there is nothing so very strange about the legal reasoning behind it. As Wheeler notes, no statutory provision gives any Federal Reserve Bank clear authorization for taking an equity position in a private corporation. In his mind, once the Fed chose to make a loan to AIG, it “had to abide by the restrictions of Section 13(3), which did not include the steps it took in taking 79.9 percent equity and acquiring voting control to nationalize AIG” (53).
Wheeler never makes it clear what “restrictions” he means; none of the statutory language provides anything like a prohibition on taking equity, and one could surely argue that the Federal Reserve Banks should be given a great deal of latitude in determining what kind of collateral they might require to ensure that its loans “are indorsed or otherwise secured” to their satisfaction. But let’s put those concerns aside for now. (I have yet to encounter a really thorough exploration of this point, and would be grateful to any reader who knows of one.) What impact would the “Federal Reserve Banks can never take any equity, ever” holding have if it stands?
My guess is, very modest. Most obviously, from a practical point of view, the holding is toothless. After being told its actions were illegal, the Fed is asked to pay no damages. Sensibly so: Wheeler relies on the familiar (and convincing) logic that a diluted 20% share in something is worth more than 100% of nothing, which is what shareholders were almost certain to get if the company was forced to enter bankruptcy. However thundering the condemnation of the Fed’s action, this is the definition of a slap on the wrist. It signals to the Fed that as long as it finds a way to transgress judicial interpretations of its statutes so as not to deprive any private interests, it will be effectively immunized against any judgments. If the clearly angry Judge Wheeler can’t find a way to assess meaningful penalties against the Fed, there is little reason to expect some other judge to do more.
This exposes a genuine perplexity about the relationship between the judiciary and the Fed. It really is hard to figure out exactly how the Fed is supposed to be held to any set of legal limitations by the judiciary, even when the Fed has precious little statutory support for its actions. As America’s central bank and lender of last resort, the Fed is far more dexterous and able to package its interventions as voluntary than other parts of the government. Figuring out exactly what the rule of law is supposed to look like for this sort of creature is inherently difficult (perfunctory book link).
One fairly natural conclusion to draw is that the judiciary is all-but-irrelevant in policing the Fed, and perhaps that is not such a terrible place to wind up. I’m not sure the American people, or whatever portion of them is likely to tune into these sorts of things, is likely to agree, however. Which suggests that the importance of Wheeler’s opinion, if it comes to have any, is likely to be political rather than legal. The Fed is well aware of its legitimacy problem and thinking hard about how to burnish its reputation as an institution that admirably performed its prescribed role during the crisis. However limited its practical import, Wheeler’s opinion threatens that effort and thus it is little surprise that the Fed has appealed.
Although this ongoing litigation purports to be about the extent of the Fed’s legal powers and how the institution will be allowed to use them, then, it isn’t really. Officials desperately fending off a financial meltdown are attuned to deep political imperatives to minimize damage that trump legalistic concerns, especially when those concerns are priced at zero. Instead, the case is about who the Fed is accountable to. The judiciary has made its bid to stay in the picture with Judge Wheeler’s opinion; whether that sticks remains to be seen. Whether it does or doesn’t, there is a great need to think about how Fed accountability can work to legitimize the institution through other channels, a subject I will take up in my next and last post here.
I want to spend two posts on Judge Thomas Wheeler’s Court of Federal Claims opinion in Starr v. United States, better known as “the AIG Trial,” which was released in June and got only a brief mention from David here at the Conglomerate. In my second post, I will address the import (or lack thereof) of the opinion for future financial crisis decision-makers. In this post, though, I want to luxuriate in the strangeness of the opinion and some of its more ambitious conclusions, because it’s a real doozy.
First, there is the unusually partial tone of the introductory section. Judge Wheeler makes it very, very clear that he has bought into the narrative offered by Starr—that is, by Hank Greenberg and his lawyer, David Boies. In no uncertain terms, Wheeler declares: “The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance” (6). And more: “The Government’s unduly harsh treatment of AIG in comparison to other institutions seemingly was misguided and had no legitimate purpose, even considering concerns about ‘moral hazard’” (7). Although he never uses the particular term, Wheeler has fully internalized the “backdoor bailout” critique of the government’s AIG rescue, judging it to be a clandestine rescue of AIG’s counterparties.
The appeal of this narrative has always been lost on me. As I note in To the Edge, all bailouts are for the benefit of the rescued institution’s counterparties. I’m not sure who exactly was supposed to be kept in the dark about the motive of insulating AIG’s many important counterparties from the liquidity-starved insurance giant’s chaotic failure, and so I’m not sure why “backdoor” has such bite for so many critics. But never mind! Here I just want to note how extraordinary it is for a judge to have so completely absorbed the rhetoric of the government’s critics, rejecting the idea that the government’s perspective has any legitimacy at all.
The next remarkable thing about Wheeler’s opinion is how willing he is to prioritize “effective” reasoning over formal legal reasoning, which manifests itself in a few ways. First, there is his repeated and deliberate use the “n” word: nationalization. In his judgment, AIG was nationalized, full stop. Never mind that this is a term without any precise legal meaning, or that AIG remained a publicly traded company throughout, or that a private board of directors and chief executive retained formal control. For Wheeler, this was so much show without meaning; in fact, everyone knew that officials within the government were calling the shots. So, too, AIG’s board of directors’ decision to take the Fed’s loan terms is to be regarded as a formality emptied of its meaning by the power dynamics of the circumstances. He literally says: “AIG was at the government’s mercy” (8). In the findings of fact section, he includes the following: “On September 22, 2008, AIG’s Dr. Jacob Frenkel stated to a colleague, Oakley Johnson, ‘the [G]overnment stole at gunpoint 80 percent of the company’” (26). Finally, in dismissing the importance of the government’s AIG Trust (which actually held the shares), Wheeler explicitly denounces “a classic elevation of form over substance” (62).
Readers, I am not terribly well versed in trial court opinions in corporate law cases, and so I would be glad to be corrected by those with more experience. But my reaction is: Wow. As far as legal opinions go, this is unfamiliar territory for me.
(Incidentally, Wheeler’s willingness to forego formalist reasoning as to AIG’s corporate form is not at all mirrored when he comes to consider the nature of the Fed’s powers, which he attempts to discern from explicit language in the Federal Reserve Act. This leads him to deny the Fed’s power to take equity—a point I will return to in my next post.)
Some other points seem like they have much broader implications. First, in staking out a sympathetic position with regards to AIG’s troubles in September 2008, Wheeler says the following:
Many market participants such as AIG also “found it difficult to derive fair market values for their securities based on market transactions.” Accordingly, AIG was forced to post collateral to its counterparties that “way exceeded any reasonable estimate of the actual risk of nonpayment on the CDS contracts” and this circumstance further strained AIG’s liquidity. (16, citations omitted)
If I’m reading that right, he is saying that AIG’s counterparties acted inequitably by forcing the company to honor the literal terms of its contracts; by implication, their use of market prices to value securities was “unfair” and this unfairness is somehow worth the court’s cognizance. If you follow out that logic, it takes you to some very strange places, especially in the context of financial crises.
Second, Wheeler’s finding of jurisdiction relies on a rather surprising reading of the Federal Reserve Act. He finds:
Starr is entitled to sue for the return of its money or property because it is an intended beneficiary under the Federal Reserve Act. … The Court declines to read Section 13(3) in a way that limits its benefits to only the governmental side of the financial system, and not to the individual businesses, corporations, partnerships or investors that comprise the entire financial system. Such a reading would allow the Federal Reserve Board to impose any conditions it desired on a Section 13(3) loan and avoid any judicial complaint of its unauthorized acts. (53-54, citations omitted)
This is something vaguely akin to taxpayer standing to challenge Federal Reserve loan-making. That is…unexpected, as I always thought that if there was any well-established judicial principle about the Fed, it was that judges should strenuously avoid second-guessing the terms of the Fed’s loans. I wonder whether the Federal Circuit will shortly revisit this thinking.
Finally, Wheeler makes a bold analogy made between the Fed’s driving a hard bargain with AIG and a 1960 case, Suwanee S.S. Co. v. United States, which featured a Maritime Administrator demanding a payment of $20,000 to the Treasury before he would grant permission for the international sale of two ships. In that case, the government argued that since it had complete discretion as to whether to grant the permission, it was allowed to make that permission conditional on a payment. The Court of Claims sensibly rejected this logic in the clearest terms: “officials have no authority to add to their function of determining the compatibility of the application with the public interest, the supererogatory function of picking up a few dollars for the public treasury” (57).
With his predecessors’ example in mind, Judge Wheeler sees the same dynamic at work in the Fed’s interaction with AIG: government officials going beyond what their statutes clearly authorize to extract resources for the government in exchange for the discharge of their discretionary duties. Not bribery, since the Treasury benefits, but a disallowed form of extortion nevertheless.
The problem with this thinking in the context of the Fed ought to be obvious, but Wheeler never addresses it. Namely: that a central bank is not like other instrumentalities of government, and that it might indeed have some bank-like qualities that make the matter of recovering on its loans more than just “supererogatory,” but quite mandatory and indeed central to its core functioning. But to say that Judge Wheeler does not seem terribly concerned about ensuring that the Fed has the ability to determine the shape of its own operations is perhaps to repeat myself.
None of which is to say that Judge Wheeler seems entirely off-base as he rejects the manner of the Fed’s engagement with AIG. In the next post, on to the core of his opinion and what it will mean for the Fed’s future.
In this post I want to turn to David’s thoughts about the policy recommendations with which To the Edge concludes. These come in two parts: a critique of the recommendation to establish a financial crisis emergency fund, and then a rather broader expression of skepticism about the whole game of making policy recommendations at all. I’ll take these in turn.
First, David says that the idea of a financial crisis emergency fund “seems disconnected with the project of discerning how governments can obtain legitimacy.” I suppose that is a natural first impression, and even one that I’ve sought to heighten with some provocative language: I say that what we need is a slush fund, though an accountable one. Since most people think of “slush fund” as a wholly pejorative phrase, especially with regards to legitimacy, the suggestion is meant to be a little jarring, and all the more so since “accountable slush fund” seems to most people like an oxymoron. So what am I hoping to accomplish with this suggestion, and what exactly would it entail?
To my mind, there were two leading causes why officials did so badly at legitimating the responses to the crisis. Probably most important is what I discussed in my previous post here: legitimation was just not a priority, or even a consciously pursued objective, in many cases. As Timothy Geithner’s book made clear, what thinking about legitimacy there was often took the form of, “If you solve it, it will come,” meaning that legitimacy should just take care of itself if policymakers focus on and succeed at crisis mitigation.
But next in line was that officials found they had a need for obfuscation as they availed themselves of legally dubious methods of crisis response. This is clearest in the case of the rescue of the money market mutual funds in the wake of Lehman’s demise, effected through a pledge of the Exchange Stabilization Fund (ESF). I’ve laid out the details of that maneuver in blog form elsewhere. Here I’ll stick to the bare bones: Treasury felt it needed to act so quickly that it had no time for Congress, was obliged to make a square peg fit into a round hole to do so, had great success in that maneuver in spite of its legal awkwardness, but nevertheless managed to seriously offend the sensibilities of Congress, which specifically legislated a proscription of future uses of the trick as a part of TARP.
My contention is that, under the current legal status quo, the Treasury will nevertheless have to repeat this maneuver in spirit during some future financial crisis. The guarantee program backed by the ESF turned out to be a terrific, nearly cost-free success in 2008, minimizing any potential backlash. But in a future crisis a quick action, taken by contorting the law while pretending that nothing untoward is going on, might be followed by actual losses, and the resulting brouhaha over whether crisis responders should be treated as law-breakers would be very costly in terms of legitimacy.
All of this is perfectly foreseeable, and so we ought to be able to plan for it. That’s where the Financial Crisis Emergency Fund comes in. (If you capitalize it, it starts to seem kind of real.) We ought not to require the Treasury Secretary to twist the law when he decides taking action to fight a crisis requires immediate action. Instead, we ought to make some limited pot of money explicitly available for that purpose, so that he may declare an emergency and act openly, with full public understanding of what he is doing.
By no means should that money be “no strings attached”; indeed, one of the appeals of planning is that we could attach a number of conditions to discipline the use of this money, as we find it difficult to do with less clearly spelled out, as-yet unidentified alternatives relying on legal manipulation. To ensure accountability, I suggest: “instant and comprehensive reporting, fast-track procedures for Congress to stop any outflows of money it found inappropriate, and even streamlined procedures for fining or impeaching a Secretary found to have misused the fund. In addition, time limits could be attached to restrict usage to the early, chaotic period, and of course there would be an upper dollar limit based on how much money was in the fund. Once committed, presumably it would take another act of Congress to replenish the funds.”
In short, the idea seeks to enhance legitimacy by winning a victory for realism, legal and political. Because we understand that when we fail to make provision for scrambling, it must happen in a legally underhanded way that may impair legitimacy, we should choose to plan. Doing so can facilitate public scrutiny of official actions in a way that should bolster legitimacy, which is crucial in the low-trust environment we now inhabit.
I also make some more boring suggestions in the book: more investment in clear decision-making protocols and record-keeping practices that preserve the rationales behind important choices, serious efforts to educate the public and congressional back-benchers about the nature of the responses, and the creation of special oversight bodies dedicated to ensuring the integrity of crisis response programs.
This brings me to David’s second point, which he makes in a sufficiently distinctive way to merit quoting:
One does not want to be a nihilist, but sometimes I wonder why we need to solve the problems of administration posed by a great financial crisis. Are solutions even possible? Is it interesting to, say, call for more congressional involvement next time, or more routinized accountability mechanisms? It may be that learning is possible only if it [is] accompanied with a course for future action.
Well, listen, maybe one does want to be a nihilist sometimes. When you have suggestions about how the government should make its practices more sensible, but lack flashy or grass-rootsy hooks to make those ideas cut through the noise, having a cultivated sense of resignation from the get-go may be only healthy. But for some of these relatively dull prescriptions, one isn’t hoping to inspire a movement; one is hoping that the people occupying key bureaucratic positions in the next crisis might quietly absorb some lessons that could inform them. Here’s hoping that’s you, reader.
Next time: on to the amazing (and continuing!) saga of AIG.
I'm enjoying Philip's guest blogging with us. I think I particularly like this part of his last post:
If it sounds condescending to suggest that the government barely even thought about legitimacy issues during the last crisis, perhaps it is fitting that I end with an obligatory presentation of Wallach’s Law, which is that everything is more amateurish than you think, even after accounting for Wallach’s Law. Everything: financial crisis responding and post-response analysis are no exceptions.
At the end of my review of his book, I said:
one of the reasons I like thinking about the financial crisis, and like reading books like Wallach’s about it, is because it was an enormous almost-disaster that was averted for thousands of different, interlocking reasons. The government’s response to it was both wise, unreflective, tremendously unfair, and highly successful, and a million other things as well.
We may never sort out what exactly happened, and we'll certainly never know whether it was the best possible approach, or three removed from best, or 17, or whatever. Given so many inputs, what can we say about the legal output?
I think we can say a few things. First, that the law mattered, and provided constraints, even when it shouldn't have or was just used as an excuse (ahem, Lehman Bros.). Second, one of the ways it mattered is because it cabined the government's thinking of precisely how it could get creative. We can't save a bank through X, so let's push through a merger to save it that way. We may never want the government too cabined in the middle of a crisis, but there is room to impose constraints afterwards, too. So if you're inclined, for whatever reason, to look at the world through "law only" glasses, I think you can gain some useful perspectives on what happened during that hectic period six years ago.
Though, as we found out today, they're still litigating it all!
In this and a subsequent post I want to respond to David’s review of To the Edge. David says some very generous things about the book and its willingness to “take law and governance very seriously” as it tries “to figure out what else [other than law] mattered in responding to that collapse.” But he then laments that I sometimes seem to pull up shy of “taking a position” on the legitimacy of important crisis responses, offering discussion that “is more dispassionate than judgmental,” and noting that this lack of judgment leaves it hard for the reader to know exactly how my “legitimacy inputs – law, votes, trust, and accountability” would be applied in a future crisis.
To these charges, I plead “no contest.” Anyone hoping that the book will offer a straightforward account of how crisis responders should legitimate their actions, in the eyes of Philip Wallach of the Brookings Institution or in the eyes of the nation, will be disappointed. But I don’t feel apologetic about failing to live up to those expectations; to the contrary, I’d like to mount an aggressive defense of agnosticism.
David says that I keep my “cards close to my vest,” but that isn’t quite it. The reason I first started writing the book, and indeed that I got caught up in trying to understand the ins and outs of the crisis responses at all, was that I was struck by what seemed like wanton disregard for the law as the government fashioned its bailouts. I understood why so many people were angry about public money flowing out to irresponsible bankers, of course, but I was frustrated by how little attention people (including the media and our legislators) were paying to the rule of law questions. As my research eventually got much more serious (not until after most of the dust had settled), I expected to find that there had been a lively if not prominent debate about the legal issues in real time, but I was largely disappointed. This blog and some others had been pondering various puzzles (e.g., how Delaware law would complicate Bear Stearns’ sale to J.P. Morgan, whether the Fed’s emergency lending powers really allowed it to take most of AIG’s equity as “collateral”), but it seemed that those who tried to raise concerns were either steamrolled or simply ignored in the mad rush to combat the escalating crisis. Eventually more evaluative and in-depth law review articles emerged, notable among them: David’s seminal article with Steven Davidoff; a rather inflammatory accusation of “The Illegal Actions of the Federal Reserve” by Chad Emerson; a detailed dissection of why the Fed’s actions were so troubling by Alexander Mehra; and an extended defense of the Fed by José Gabilondo.
Two things struck me about this lawyerly discussion: it was highly technical and was just about totally ignored by the policy actors fashioning reforms of the implicated laws. That isn’t meant of a slight of these pieces, but as an observation about the place of legal discussion in the efforts to sort out the aftermath of the crisis. The people in a position to do something about what had struck me as offenses to the rule of law (which mostly turned out to be less wanton, at least, than they initially seemed) apparently had other fish to fry.
As I emphasize throughout the book (and in my first post here), I do not think that the right implication to draw from this fact is that “law didn’t matter.” But the implication I drew was that it would not be a particularly useful application of my energies for me to take on the mantle of retrospective judge of legality; that would have made for some good fun in joining the lawyerly arguments, but would have had very little impact. Instead, I wanted to get away from the mindset of applying a set normative framework for legitimacy and move toward asking, well, what was it that people did care about as they formed judgments about the Fed and Treasury’s responses to the financial crisis?
As David very nicely puts it, I ended up focusing on “a tincture of legality, legislative endorsement, trust, and accountability.” As I drafted the book, I had “inherent legitimacy” as a separate category, too, and perhaps I should have left it that way; the idea was that people’s direct apprehension of an action and its results would matter quite a lot, apart from what their legislators had to say about it. Results surely matter a great deal in people’s evaluations. In the end, I rolled this into the category of “democratic legitimacy,” along with legislators’ approval. In any case, I arrived at those factors inductively, basically through examining what kinds of things people were shouting about.
Why do I think this kind of positive analysis likely to be more useful than a normative evaluation on legal or philosophical grounds? If you hang around too many academic social scientists, you might expect some kind of bloviating answer about how careful measurement, statistical analysis, and causal inference will allow thinkers to find the key to governing more effectively. If there are any policy areas in which this vision is realized, financial crisis response is not among them. To my mind, anyone claiming to weigh out the public’s responses to the responses and carefully discern the formula for legitimacy would be selling snake oil.
I think the bar is much, much lower for making a contribution to the government’s thinking about legitimation, because my impression is that government officials dealing with financial crises are in the habit of addressing legitimacy only tangentially, as an afterthought. Economists think about first- and second-best policy choices, lawyers think about how they can protect their clients, and investment-bankers-cum-Treasury Secretaries think about driving a hard bargain. Politicians think about legitimacy, but one of the most remarkable things about our past round of crisis responses was how marginal politicians were. My hope is that just providing officials at the Fed and Treasury with a vocabulary for thinking seriously about legitimacy will cause them to have a little less tunnel vision next time around.
If it sounds condescending to suggest that the government barely even thought about legitimacy issues during the last crisis, perhaps it is fitting that I end with an obligatory presentation of Wallach’s Law, which is that everything is more amateurish than you think, even after accounting for Wallach’s Law. Everything: financial crisis responding and post-response analysis are no exceptions.
Next time: onto the question of what kinds of more concrete policy recommendations I did manage to make in the book.
Many thanks to David for inviting me to grace the distinguished pages of the Conglomerate, which was a great help to me in understanding the corporate law controversies surrounding the government’s crisis responses as I wrote my book. And many thanks for the kind words he has for my book in his New Rambler review, as well as for the criticisms, some of which I will address here in the coming days.
Before getting to those, in this first post I want to revisit a discussion that David has previously noted, about the Fed’s controversial claim that it faced insuperable legal obstacles to rescuing Lehman Brothers back in September 2008. Peter Conti-Brown and I went back and forth (and back and forth) on this question. We also inspired some interesting posts from Carolyn Sissoko (here and here) and Brad DeLong (here and here). Peter recently stepped back and extracted lessons from this exchange, but rather than graciously let him have the last word I will do the same.
As I see it, the debate goes something like this. I say that we have to at least take seriously the Fed’s claim that when it looked at Lehman Brothers, it saw a hopelessly insolvent financial institution—one that did not possess sufficient collateral to secure a loan of the magnitude apparently needed “to the satisfaction of the Federal Reserve Bank.” Given that factual judgment (or estimate, really) about Lehman, it is clear that § 13(3) of the Federal Reserve Act says that they may not extend a loan.
Peter and some other respondents all seem to think that I am being far too literal in reading the law as we try to make sense of what the Fed’s Lender of Last Resort role practically entails. By their lights, the whole notion of “solvency” apart from having the support of the central bank is too indeterminate to be of any use, and by extension the same is true of the “satisfactoriness” of an institution’s collateral. (I think the logic is: If the central bank decides to throw its full support behind the institution, it will survive and return to profitability, and thus loans will get repaid with interest eventually.) Thus the law doesn’t actually provide any real guidance to the Fed in figuring out which institutions it should save, and when the Fed decides not to save an institution, it oughtn’t be allowed to blame that choice on the law. Its pronouncements doing so in the case of Lehman are to be understood as disingenuous excuses.
If I’m being honest, I have to admit that I don’t know enough about how bankers (central or otherwise) think about collateral adequacy to get inside the heads of the New York Fed officials charged with making sense of this statutory language. (Sadly, Fed officials and lawyers have not been forthcoming in clarifying their thinking in the nearly seven years since their momentous decisions.) I’d be delighted if readers with some practical experience would enlighten me. But in my ignorance, I continue to believe that Peter’s take renders a statutory constraint a nullity in a way that does not sit well with accepted practices of statutory interpretation. To put it bluntly, I think he is counseling a bad reading of the law.
Now, you might think that sounds insulting—and I suppose it does, especially since Peter has an excellent J.D. and legal experience and I just play a legal analyst in Belt-wonk-o-land—but I really don’t mean it to be! Sometimes, willfully misreading statutory language may be the right thing to do; after all, most of us think that following the law is ultimately only instrumentally valuable, and for central banks to be truly efficacious in fending off crises they may need to transcend the legal limitations that their legislative creators unwisely saddled them with. “What did the Fed’s underlying statutes require of it?” and “What should the Fed have done, given its sense that the financial system was hanging on by a thread?” need not have the same answer.
That’s what I take away from Brad DeLong’s intervention, too. Brad notes that it is important to remember that the Federal Reserve Banks are not government agencies, but government-chartered corporations, and ones that are perhaps expected to act ultra vires during crises—preferably with the tacit or, better, explicit consent of the government itself, such that no nasty legal consequences ought to flow from those legally problematic actions. He sees that this creates something a puzzle baked into the institutional and legal structure of central banks:
Robert Peel’s remarks around the Recharter of 1844 about just why they were writing the Recharter to forbid the Bank of England to do things in a crisis that they did, in fact, hope it would assume responsibility and do are, I think, very interesting…
He likewise notes that “the Legal Realists” would be dubious of seeing any such requirement, expected to be waived rather than enforced, as a genuine legal constraint.
To the extent there’s any disagreement, it’s largely terminological. I don’t have any objection to the idea that the Fed could have gotten away with making a loan to Lehman—it would have been well-nigh unthinkable for a judge to step into the middle of that transaction in any time frame that matters, even if anyone had standing, which probably they wouldn’t. (I’m sure the AIG case is popping into many people’s heads now, and I promise I’ll get to it later in my stint here). I am very ready to agree that the language in § 13(3) was almost certainly not an enforceable, effective legal constraint. I just don’t understand why that should make us pretend that the law is, in its very language, devoid of meaning or irrelevant to the situation. If the Fed’s powerful lawyers said that, given a negative assessment of Lehman’s collateral quality, the Fed was not authorized by the statute to lend, I think that would have been a correct interpretation of the statutory language. Which, to belabor the point, wouldn’t necessarily be the same as saying that the loan should not be made, all things considered.
Perhaps more substantively, I also insist that clear-eyed, all-things-considered decision-makers will take the law into account even if they don’t treat it as determinative. The law structures expectations rather than controlling actions. In this case, by setting collateral requirements, it specified exactly how far the Fed would be sticking its neck out when making a loan to a potentially failing financial institution. And that is really the right metaphor, because the question is always about whether the independent central bank is going to get its head chopped off for dutifully playing the role of financial crisis savior. Whether rightly or wrongly, Americans don’t want to live with a central bank empowered to do, literally, anything to fight off financial crises, though they surely want the crises fought off. In a sense, the law is there to make it politically risky for the central bank to embrace its awesome powers too enthusiastically.
The more I think about the problem in this way, the more enthusiastic I am about Dodd Frank § 1101 and its requirement, now 12 U.S.C. 343(3)(B)(iv), that the Fed get the Treasury Secretary’s approval for any emergency non-bank lending. The Treasury Secretary in such a situation should not be allowed to prevaricate while the Fed sticks its neck out and takes all the risk. He should either support the Fed, and in doing so bring along the President’s legitimating blessing, or clearly prevent the Fed from putting itself in a politically untenable situation in which its future depends on the public’s devotion to the idea of a non-governmental independent central bank. For better or worse, in our twenty-first century democracy, the Fed needs a sturdier base of institutional support than that.
My colleague Peter Conti-Brown is interested in Philip Wallach's legal history of the financial crisis, as am I. He's got a post up on it over at the Yale J. on Reg. blog, and go give it a look. They've debated, over there, whether the Fed had the authority to rescue Lehman Brothers; it rather famously claimed that it did not, only to give AIG a massive bailout a couple of days later:
One of the features of Philip’s stint here was a debate we had on the Fed’s claim that it lacked the legal authority to save Lehman Brothers. I say that’s a post-hoc invention; Philip thinks it’s not, or at least,not so obvious. What do we learn from this fascinating exchange?
I still think those inside the Fed—whether at the Board of Governors or the Federal Reserve Bank of New York—had the authority to do whatever they wanted with Lehman. And given the political maelstrom they faced, I’m not sure I would have done a thing differently than they did. My critique of their legal analysis is not a critique of their crisis decision-making. But the legal arguments are distracting from the bigger question, about the appropriate levels of discretion that a central bank should have in using its lender of last resort authority. What the debate with Philip has shown me is that, even if I’m not wrong—and, well, I’m not—the law is something of an omnipresence in the way the government faced the financial crisis. That omnipresence may even have brooded from time to time.
Over at the New Rambler Review (which I'm really enjoying), I've got a review of Philip Wallach's legal history of the financial crisis. The kick-off offers a riff on the crisis:
The government’s response to the financial crisis was an example of messy policymaking that occasioned a happy ending, although not everyone sees it that way. Some are unsure about the ending – they have decried the very modest meting out of punishment that followed the recovery of the economy. Others are unsure that the policymaking was messy – they are likely to think of the government’s response to the financial crisis as an inevitable manifestation of executive preeminence as the doer of last resort, institutionally capable of acting when courts and legislatures cannot.
But I will take a stable economy over a few prison sentences, especially when it is possible that you can’t have both at the same time. And you won’t convince me that the things government officials did during the crisis – last minute deals, concluded late at night and paired with creative reimaginings of underused statutes and regular resorts to Congress for more legislation – was the mark of the smooth progress of an imperial presidency.
Go over there and read the whole thing!
Greece is going to close its banks and stock market until it sorts out how to prevent its citizens from withdrawing their assets from their financial intermediaries post haste. This is a pretty old school technique - the US did some of these to prevent panic withdrawals during the Great Depression, and the UK did the same during the currency crisis of 1968, during which it also shut the London Gold Market for two weeks. New technology has made these holidays less oppressive - ATMs with withdrawal limits were kept open when Cyprus did this. But it is still quite the heavy hand of the state, and one of the first resorts when a bank run is really on. As they say, developing.
The AIG suit is over, and the shareholder who was zeroed out by the government won a judgment without damages. These kinds of moral victories are cropping up against the government: a Georgia judge just ruled that the SEC's ALJ program was unconstitutional, but easily fixed. The Free Enterprise Fund held that PCAOB was illegal, but not in any way that would undo what it had achieved. And now AIG. A right without a remedy isn't supposed to be a right at all, but it is true that this is incremental discipline of the government for business regulation excesses. That won't make any of these plaintiffs happy, however.
The Washington Post has a story on the AIG and Fannie and Freddie cases, which, as you might remember, use the Takings Clause to go after the government for its financial crisis related efforts. In theory, that's not the worst way to hold the government accountable for breaking the china in its crisis response - damages after the fact rectify wrongs without getting courts in the way. And I've written about both cases, here and here.
Anyway, the Post has checked in on the cases, and the view is "you people should be worrying more about the possibility that the government may lose.
Greenberg is asking the court to award him and other AIG shareholders at least $23 billion from the Treasury. He says that’s to compensate them for the 80 percent of AIG stock that the Federal Reserve demanded as a condition for its bailout. Judge Thomas Wheeler has repeatedly signaled his agreement with Greenberg. A decision is expected any day.
In the Fannie and Freddie case, the decision is further off, with the trial set to begin in the fall. The hedge funds are challenging the government’s decision to confiscate all of the firms’ annual profits, even if those profits exceed the 10 percent dividend rate that the Treasury had initially demanded. This “profit sweep” effectively prevents the firms from ever returning the government’s $187 billion in capital and freeing themselves from government control.
Earlier this year, Judge Margaret Sweeney refused to dismiss the case and gave lawyers for the hedge funds the right to sift through the memos and e-mails of government officials involved. Within weeks, Fannie and Freddie shares, which had been trading at about $1.50, started trading as high as $3 based on rumors that the documents revealed inconsistencies in government officials’ statements.
They checked in with me on the article, so there's that, too.