August 21, 2015
The AIG Case, Part 2 - Lasting Importance?
Posted by Philip Wallach

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.

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