What is the legal status of the AIG takeover?

I've been wondering and maybe you have been too. Here is one opinion:

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.

I thank David Zaring for the pointer to this very interesting analysis (there is a related version of this post up at Do you know more?

M. Lederman (mail):
Must say, I don't quite understand the EPA analogy. In any event, some preliminary thoughts here.
9.17.2008 9:46am
Commentor (mail):
This is the language of the statute relied upon by the Fed:

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.

It seems rather straight forward, and not imaginative, to say that this allows the Fed to open the discount window to any corporation based on security that meets the satisfaction of the Fed. In this case, the security was equity in AIG.
9.17.2008 10:28am
I don't really understand the EPA analogy, either. AIG put itself into this mess by taking substantial risks in a bloated mortgage-backed securities market. They then faced a simple choice: pay for their lack of prudence by bankruptcy, or accept a loan from the government with terms more favorable than those likely to be found in the commercial market.

In the EPA example, however, the steel industry wouldn't have put themselves into the mess. In other words, the Fed's statute doesn't involve the Fed forcing terms on AIG, quite unlike your EPA scenario.

As for the legality of the loan, it would be absurd to suggest that the Fed is not allowed to place conditions on the payment on the loan. Absent conditions, how could it even properly be termed "a loan?" Wouldn't that simply be a gift?
9.17.2008 10:30am
Casper the Friendly Guest:
Apparently the deal is on the same terms as were offered by a private party and rejected by AIG. AIG held out for a federal bail-out. The Fed couldn't let AIG fail, because the results would be disastrous, not just for this country but internationally. So instead it is sending a strong message to Wall Street - next time, take the private deal.

And Commentor is absolutely right about the legal basis.
9.17.2008 10:44am
Vintner (mail):
A related question: what's the legal reason for the gov't taking precisely 79.9% of both the private entities (aig) and quasi-private (fannie, freddie)? Would a change of 80% ownership trigger some other events, or some further responsibility on the buyer?
9.17.2008 10:48am
Cleanthes (mail):
The Wall Street Journal implies that were AIG to go under, it would have pulled Citigroup or Bank of America (and therefore also Merrill Lynch) down. And then, the Fed would not have had enough money to bail them out, putting in jeopardy the full faith and credit of the United States.
Sure, the Fed could have gone to Congress for more authority, but, gee, I betcha that would open a political can of tapeworms.
9.17.2008 10:50am

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?

Well, I suppose when Wamu starts to go belly up, the feds could invoke The Marine Mammal Protection Act.
9.17.2008 11:09am
DiverDan (mail):
In response to Vintner, it has been a few years since I looked at this (I used it in a Chapter 11 debt for equity swap to save about $80 million in NOLs), but it used to be (and I believe still is) the case that an 80% change in equity ownership triggered limitations on the use of a Corporation's Net Operating Loss carryforwards for tax purposes -- in other words, assume AIG had $4 Billion in Net Operating Losses this year that resulted in it having no federal income tax liability - assuming no changes, it could use those NOLs in future years to shelter the equivalent amount of taxable income. An 80% change doesn't cause AIG to lose the NOLs, but it puts severe limits on how much they can use in any year (it is a rather complicated formula, as I recall). In Bankruptcy, AIG could trade equity for debt (as long as it is "old and cold" debt) without triggering the limitations, but if there is an active claims trading market, any claims sold during the bankruptcy lose their status as "old and cold" debt, and AIG would run the risk of triggering limitations on its use of NOLs.
9.17.2008 11:10am
Cleanthes (mail):
To follow up: Treasury to provide cash to Fed market liquidity operations.

Who will buy these treasury bills? Would they have bought the amount necessary to bail out all the companies that would have fallen after AIG failed?
9.17.2008 11:29am
DiverDan, thanks for the information, I see the point.
9.17.2008 11:35am
A. Zarkov (mail):
My understanding is as follows. Perhaps it's wrong.

The Fed bailed out AIG by giving $85 billion in exchange for warrants. So if the Fed owns the warrants then the Fed has control of AIG and not Treasury. Any profits or losses are passed through to Treasury. The Fed is owned by member banks, so unless I'm missing something the member banks are in control not the US government. In any case, the loan is in the nature of a bridging loan, which is temporary, and the warrants are the collateral. So I'm not sure the legal status has changed.
9.17.2008 1:54pm

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