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More on the (Absence of) Legal Authority for the AIG deal --

Whether or not the Fed has the authority to buy/lend to AIG, the story does not end there. In order to lend/buy, the Fed needs to come up with $85 billion, which is conveniently being supplied by the Treasury Department, which is in turn borrowing it from whoever will lend money to the U.S. government, to be paid back by us or our descendants, unless the AIG deal miraculously turns out to be profitable. On what statutory authority does Treasury Act? Unlike the Fed, the Treasury does not bother to explain where its authority comes from in its press release and I have found no other sources with this information. Does anyone know? A U.S. Code section would be a nice place to start.

wm13:
Why does Prof. Posner say "miraculous"? The normal course is for these deals, e.g., Chrysler, to be profitable.

I also think it's a little disingenuous to question the Fed's authority to "lend/buy." No one has made any argument that the Fed lacks authority to lend money to AIG. The only way the Fed's authority can be questioned is by recharacterizing the transaction as a sale.

And on that last question, wouldn't the discussion be more illuminating--though, admittedly, a lot more work and maybe less fun--if someone actually read and analyzed the corpus of tax and bankruptcy cases that involve loans recharacterized as disguised sales, and compared and contrasted the facts of this transaction?
9.18.2008 10:34am
PC:
Secret signing statement?
9.18.2008 10:35am
Clint:
Statutory authority? We don't need no stinkin' "statutory authority."
9.18.2008 10:37am
A.S.:
Agree that Prof. Posner's statement "unless the AIG deal miraculously turns out to be profitable" is really uninformed.
9.18.2008 10:51am
darelf:
wm13, I think you misunderstand. It doesn't matter what the facts of the transaction details are. People have already declared it as a "sale", it is being reported as a "bailout" in the press and the "accepted wisdom" is that this will be a losing proposition which will burden the taxpayers with simply paying the $85 billion (or a large portion thereof) as some kind of "gift" letting the executives of the failed company make off with outrageously large severance packages.

Remember: facts don't matter.
9.18.2008 10:52am
John Armstrong (mail) (www):
Okay, so fill us in where the media has failed. What, precisely, is the plan for paying the money back if it's a loan? On what date can we expect AIG to have repayed the government's -- our -- money? How much profit can we expect to make on this transaction?
9.18.2008 11:01am
SenatorX (mail):
It's similar to the global warming fanatics "save the planet!" therefore anything goes. In this case it's "save the financial system" they can do whatever they want and they learned from Bear Stearns that nobody really cares if there are laws or not. Of course AIG isn't going to be profitable, if it was there would have been private buyers. They will resell AIG pieces to lucky private owners at cents on the dollar and the difference between "full value"(i.e. the bogus number claimed on the AIG books before the bailout) and the discount will be eaten by the taxpayer.

I'm sure we will see more of this too. It's looking like a Japan style future for us and none of this bodes well for housing prices
9.18.2008 11:07am
MR:
The money is to be repaid by selling off various chunks of AIG's assets. The loan nature of the transaction is reflected in the punitive nature of the interest (LIBOR + 8.5), which would be the profit we expect from the transaction. I can't remember the "date" we're looking to recover "our" money right now.
9.18.2008 11:12am
MR:
*Correction: the loan term is two years.
9.18.2008 11:13am
A.S.:
Okay, so fill us in where the media has failed. What, precisely, is the plan for paying the money back if it's a loan? On what date can we expect AIG to have repayed the government's -- our -- money? How much profit can we expect to make on this transaction?

The term of the loan is 24 months. We, the taxpayers, can expect to make a profit off the loan through payment of interest (LIBOR + 8.5%, which is ridiculously high), plus our ownership of 80% of AIG's equity. We have a security interest in all of AIG's assets. And we expect AIG to be able to pay the loan back (to the extent the loan is drawn down at all) through sales of its assets, which we control. Let's remember that, as of June 30, AIG had assets of $1,049,000,000,000.
9.18.2008 11:18am
Soronel Haetir (mail):
So watch, those assets with $1T in book value are actually worth less than $50B :)
9.18.2008 11:22am
John (mail):
I bet if the Fed wanted to syndicate that 85B loan they'd have a lot of takers, though I doubt they'd be able to offload the whole thing. The problem is that there isn't enough "loose" money around right now, which is why the Fed had to do this deal instead of private parties in the first place. But it is a very good deal and will make money for the Fed.
9.18.2008 11:34am
SenatorX (mail):
We already had the greediest people on the planet looking at AIG this week while being sweated by the Fed to make a purchase. They all said hell no and walked so we know right there AIG is a pig that's going to cost us. Our "stake" is the stake nobody else wanted. Are you saying we made this deal with AIG because the government is the smartest dealer around? They should run all the businesses then with all that value they can untap via their shrewdness.

You are left with them just being able to sit on stuff long enough that they can sell assets once there has been a recovery. We shall have to see about that.
9.18.2008 11:37am
karl newman:
SenatorX. That is pure speculation. I would suggest that they had no time to properly look at the books. They also know it is better to wait. It appear the US Gov. made a great deal on AIG and will likely make a big profit once things stabilize. The Fed is just babysitting while the parents are sick in bed...once the parents get better they will want their kid back.
9.18.2008 11:44am
Soronel Haetir (mail):
SenatorX,

Unless I am completely mistaken a private equity group offered much the same over the weekend but AIG turned it down for some reason.
9.18.2008 11:44am
PC:
which is why the Fed had to do this deal instead of private parties in the first place

iirc, a private party offered AIG the same deal, but they figured they could get a better deal from the Fed. Long live the free market.
9.18.2008 11:47am
Obvious (mail):
"On what statutory authority does Treasury Act? "

I'm sorry, Professor Posner, but doesn't that presuppose some quaint notion like "rule of law" or something?
9.18.2008 11:49am
MJG:
Jeff Lipshaw (hat tip, the Conglomerate) talks about why he looks at the AIG deal as a loan.
9.18.2008 11:50am
Henry679 (mail):
If AIG had such valuable assets, why would the market not lend to them and reap the great interest return touted above? Their have to be some Arabs or Chinese looking for something better than their dollar-adjusted recent crap returns from Uncle Sam.

Hmmmm...maybe there are some things only apologists for the ever-expanding state (or, at least, for the ever-expanding state when its chief executive is a hack from their chosen political party) can believe (or perhaps just say).

We are long into what appears to be an never-ending post-Constitutional night. This is only one more example. If we had a shred of decency we'd have long ago changed the name of the country, since it no longer operates in any meaningful way upon the principles established by its founders.

Wanna war? No need to declare 'em, just wing it.

Have a disputed Presidential election? No need to go to that messy and crude House of Representatives, the Supremes will fix it all up for you, with a non-stare decisis bit of ipse dixit.

And so on, almost endlessly. A bipartisan auto-de-fe that has been running for decades.
9.18.2008 11:53am
Cornellian (mail):
If all else fails, we can always fall back on the Commander in Chief power.
9.18.2008 12:01pm
PC:
If we had a shred of decency we'd have long ago changed the name of the country


The USSA does have a certain ring to it.
9.18.2008 12:08pm
wm13:
Wow, Jeff Lipshaw has an actual case cite and legal analysis, informed by actual practice experience. Maybe someone on this site should try that, though I know pure snark is more fun and less work.
9.18.2008 12:08pm
ejo:
SenX has a good point-if it was such a valuable property, wouldn't buyers have been breaking down the door?
9.18.2008 12:08pm
PC:
If all else fails, we can always fall back on the Commander in Chief power.


Or the AUMF since it seems to cover everything else. Are you with us or with the terroristic financial markets?
9.18.2008 12:10pm
corneille1640 (mail):

We, the taxpayers, can expect to make a profit off the loan through payment of interest (LIBOR + 8.5%, which is ridiculously high)

The government should have given them an adjustable rate loan.
9.18.2008 12:11pm
SpenceB:
[ "I'm sorry, Professor Posner, but doesn't that presuppose some quaint notion like "rule of law" or something ? " ]

{posted by "Obvious"}

____________

...yes, it's indeed a very old-fashioned notion to even mildly question the specific legal authority for Federal government actions of any type.

The 'Federal Reserve', of course, has absolutely zero authority to lend or buy to AIG.

But then the 1913 Federal Reserve Act ... and the Federal Reserve itself are completely non-constitutional (illegal) entities.

Thomas Jefferson correctly stated in 1791 that such a central bank created by Congress was without any authority under the U.S. Constitution.

Presumption of 'rule-of law' on any of the huge, current Federal
financial acrobatics is amusing.
9.18.2008 12:13pm
Adam J:
corneille1640 - it is an adjustable rate loan- the rate changes as libor changes.
9.18.2008 12:23pm
ejo:
what are these assets that are going to be spun off? is it worthless paper? what are we going to get-30 cents on the dollar?
9.18.2008 12:48pm
darelf:
Well, Alexander Hamilton thought enough of a central banking system (including the ability to make loans) that he fought for it until it was finally accepted in 1791 by the first Congress. You might remember him, since he wrote the majority of the Federalist Papers.

Whether right or wrong, we end up here, where we are. We've been wrangling with this issue since the founding.

Certainly, as the most prosperous nation in the world we have to wonder if all the second guessing is justified.
9.18.2008 12:53pm
Joe Kowalski (mail):

what are these assets that are going to be spun off? is it worthless paper?

AIG actually owns a big fleet of airliners (747's and the like) under leaseback deals with the airlines. It's estimated this business could be worth as much as $50 Billion on the high end.
9.18.2008 12:55pm
Bob The Lawyer:
LIBOR + 8.5% is actually low - the credit spread on AIG on Monday reached a peak of about 1,900%, implying that an arm's length lender would charge LIBOR + 19%. There's no doubt this is a taxpayer subsidy.
9.18.2008 12:56pm
Arkady:
Eric, here's a blog post that argues for statutory authority, and directly engages your argument that the deal is illegal: Is The AIG Bailout Legal?

A taste:


The Fed is claiming authority for the AIG bailout under Section 13(3) of the Federal Reserve Act, which provides in pertinent part:

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 ... to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange ... . 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.

There's no relevant statutory or regulatory definition of "unusual and exigent circumstances," but it should be pretty clear that the current circumstances would qualify as "unusual and exigent." Obviously, AIG is a corporation, so it satisfies the "individual, partnership, or corporation" requirement.


And contra your argument:


UPDATE: Eric Posner thinks the AIG bailout is illegal because a court would hold that the transaction is a sale rather than a loan, and the Fed doesn't have the authority to purchase an insurance company:

[T]he Fed statute does not say that the Fed can purchase businesses, and it seems reasonable to interpret the statute to forbid the Fed to purchase businesses. So here's the question, is the AIG deal a purchase or a loan? I suspect the deal is a loan in form but a purchase in substance. Unfortunately, the details are not available, but the press accounts suggest that the Fed is receiving AIG equity (more precisely, the option to obtain equity) as collateral for the loan but that it's going to exercise the option more or less automatically.

This strikes me as wrong. Sure, if this were a normal transaction executed in the course of every-day business, a court might hold that it's a sale rather than a loan. But this is, by definition, an "emergency loan," executed in "unusual and exigent circumstances.


As Instawhathisface says, read the whole thing. (If this is old news to you Eric, sorry.)
9.18.2008 12:59pm
DiverDan (mail):
You might just want to explain to the many know-nothings on this board (judging solely by the misinformed and completely uninformed posts - but it's not really their fault, CNN, MSNBC, Fox News, none of them are reporting facts on the AIG deal, just wild rantings about the "Taxpayer Bailout of Greedy Wall Street Bankers"), that LIBOR stands for London Inter-Bank Offered Rate, or the rate at which loans of various maturities are offered and accepted among major money-center banks on the London Exchange. There is not just a single LIBOR Rate - there are separate 30-day, 60-day, 90-day, and 180-day Libor Rates, as well as various other maturities up to (and beyond) 5-year. LIBOR + 8.5% is indeed a fairly hefty rate; I have in the past closed variable rate loans fixed to LIBOR secured by real estate at LIBOR + 2 or 2.5%, and financing leases on equipment where the lease rate was LIBOR +3%; LIBOR +8.5% would be a "subprime" loan (i.e., from a lender of last resort.
9.18.2008 1:02pm
Arkady:
Ah, Damn. Misread your post. You're asking for Treasury's statutory authority. The stuff is my previous post probably was old news to you. Sorry.
9.18.2008 1:07pm
deepthought:
Chrysler and Lockheed were loan guarantees--they got their funds from private banks, backed by Congressionally-approved guarantees. AIG is a direct loan from the Federal government in exchange for warrants. AIG will need to liqudate assets in order to pay it back--essentially dismember itself. If the company really is worth $1.0 trillion--great. If the market values its underlying assets less, then bad. I don't expect the government will get top dollar. The world is awash in jet airliners right now, for example, so more aren't needed.

AIG should have been allowed to fail, as the next big company that gets into trouble (like GM or BofA sometime in the future)will assume the government will bail it out, and the government will have no rational argument against it.
9.18.2008 1:12pm
commontheme (mail):
It is a bit amusing to see the mounting outrage on the AIG bailout among people who self-identify as conservative/libertarian.

Where was this outrage over the past 7 years as the executive branch disregarded inconvenient elements of the constitution and derided treaties like the Geneva convention as outdated and quaint?

If it is permissible for the Executive Branch to kidnap and torture people around the world, to imprison and torture American citizens, why can't the Fed throw a few billion dollars here and there?

Welcome to the unitary executive branch.
9.18.2008 1:18pm
CDU (mail) (www):
Welcome to the unitary executive branch.


Now this is amusing. The Federal Reserve is just the sort of agency that people who really believe in the unitary executive hate, because it's a quasi-executive agency that's not accountable to the President.
9.18.2008 1:27pm
jasmindad:
I have a question which I hope someone can answer. Suppose the Fed/Treasury action succeeds, &AIG is able to emerge as a going concern, say a year or so down the line. Suppose further at that point some of the current shareholders go to court, saying that the Fed/Treasury action was illegal, and, by arguments similar to that of Prof. Posner, convince the courts. What happens then? The shareholders get their equity back?
9.18.2008 1:31pm
commontheme (mail):

The Federal Reserve is just the sort of agency that people who really believe in the unitary executive hate, because it's a quasi-executive agency that's not accountable to the President.

Are you seriously suggesting that the President and Secretary of the Treasury were not consulted and did not approve of the Fed's actions?

Seriously?

Or that the President and the Secretary of the Treasury could not have prevented the bailout if they wished?
9.18.2008 1:58pm
CDU (mail) (www):

Seriously?

Yes. See, for example, these posts by Ilya and Michael Rappaport.
9.18.2008 2:13pm
Nunzio:
31 USC Sec 3101 - Sec 3130
9.18.2008 2:13pm
Christopher Cooke (mail):
I would imagine that Professor Yoo has written some memo somewhere justifying this, because (1) Congress passed the AUMF and (2) the President's inherent powers as Commander in Chief, permit the Treasury Secretary to go into the insurance business. Here is the Yoo-like reasoning: if the economy collapses, the government will have less revenue. If the government has less revenue, there will be less money to spend on the Global War on Terror. Ergo, the President's inherent authority as Commander in Chief permits him to underwrite insurance policies on my car.

What is so hard to understand Mr. Poser, have you not been paying attention these past 8 years?
9.18.2008 2:15pm
commontheme (mail):

Yes. See, for example, these posts by Ilya and Michael Rappaport.

And you believe the Treasury Department is also independent of presidential control?
9.18.2008 2:27pm
one of many:
I have a question which I hope someone can answer. Suppose the Fed/Treasury action succeeds, &AIG is able to emerge as a going concern, say a year or so down the line. Suppose further at that point some of the current shareholders go to court, saying that the Fed/Treasury action was illegal, and, by arguments similar to that of Prof. Posner, convince the courts. What happens then? The shareholders get their equity back?

The missing step here is the Fed exercising the warrants, in which case I doubt the dilution claim would hold, the result would be that AIG had issued a huge chunk of new stock in exchange for $85B cash equity.
9.18.2008 2:29pm
CDU (mail) (www):
And you believe the Treasury Department is also independent of presidential control?


We're talking about the Federal Reserve, not the Treasury.
9.18.2008 2:59pm
commontheme (mail):

We're talking about the Federal Reserve, not the Treasury.

uh...

On what statutory authority does Treasury Act? Unlike the Fed, the Treasury does not bother to explain where its authority comes from in its press release and I have found no other sources with this information
9.18.2008 3:01pm
titus32:
Wow, Jeff Lipshaw has an actual case cite and legal analysis, informed by actual practice experience. Maybe someone on this site should try that, though I know pure snark is more fun and less work.

I guess you get what you pay for.
9.18.2008 3:12pm
Gabriel McCall (mail):
It is a bit amusing to see the mounting outrage on the AIG bailout among people who self-identify as conservative/libertarian.

Where was this outrage over the past 7 years as the executive branch disregarded inconvenient elements of the constitution and derided treaties like the Geneva convention as outdated and quaint?


The outrage has been pretty consistent and apparent, at least among libertarians.

If it is permissible for the Executive Branch to kidnap and torture people around the world, to imprison and torture American citizens, why can't the Fed throw a few billion dollars here and there?

Anyone who thinks those actions are "permissible" in any sense other than that there isn't much he can do to stop it, isn't a libertarian.
9.18.2008 4:17pm
Fub:
one of many wrote at 9.18.2008 1:29pm:
The missing step here is the Fed exercising the warrants, in which case I doubt the dilution claim would hold, the result would be that AIG had issued a huge chunk of new stock in exchange for $85B cash equity.
Maybe I'm just uninformed, but off the top of the head I can only think of two basic rational reasons for the Fed to exercise warrants.

First, if the common actually trades significantly above warrant strike price, so the Fed (and therefore treasury and taxpayers) would make a profit exercising and selling into the open market. This strikes me as a cold day in hades, but it's theoretically possible, and I don't know the strike price.

Two, if the Fed feels need to replace the AIG board, presumably because they following some course the Fed believes they should. That would cost taxpayers. It's also a mighty big hammer, essentially do what we say or we nationalize AIG.

I expect greater financial minds than mine can cite more, and more important, reasons.
9.18.2008 6:36pm
The Alpaca Herder (mail):
Does anybody remember where those operations in that Dubai Ports World case a couple years ago went? AIG picked those up. AIG has its metaphorical fingers in so many metaphorical pies that perhaps a bit of divestment is prudent. To see AIG go down would have dragged seaport operations in quite a few ports along with it as well as other lease-back assets that hold up other industries.

Letting AIG tank would have been crippling not only in the financial sector but also the transportation sector. While having a "Consolidated Inc." business might be nice for garnering profits, it is fairly dangerous in case one part of the house drags the rest under. Mixing a bail-out with dismemberment might help stabilize more than just financial services.

I am not a lawyer and do not play one on television either. The statutory let alone constitutional authority for this is pretty sketchy. A failure like this would not only harm the financial services sector but could screw up US Postal Service mail carriage contracts due to airplane ownership issues as well as making foreign trade increasingly impossible as ships do not unload themselves. Since there is the chance for AIG to be dismembered, I have less trouble with a bailout. The only authority or reason behind doing this was that it would have been suicidal otherwise. To say that AIG is just an insurance company is to look at it through glasses painted flat black.
9.18.2008 7:50pm
Mac (mail):
What I find interesting is Harry Reid's reported comment today that he has "No idea what to do about the financial crisis". Probably the truest words ever spoken by him and most other politicians.

Isn't it nice that Congress will deal with this mess next year by holding tons of hearings and pointing fingers? Why do we even have these guys? They are all mostly useless. I am disgusted. However, the American people who are busy watching American Idol and the American press who is busy playing gotcha are to blame as well. You do get the government you deserve. I didn't think we were this bad, but I guess we are.
9.18.2008 9:12pm
Mac (mail):


WASHINGTON — Treasury Secretary Henry Paulson says the government is crafting a plan to rescue banks from bad debts that are at the heart of Wall Street's worst financial crisis in decades.

Paulson said late Thursday the plan will need congressional approval. He and Federal Reserve Chairman Ben Bernanke briefed lawmakers on the options they are considering.

Senate Majority Leader Harry Reid, D-Nev., said he expected the administration and the Fed to have a proposal to lawmakers in a matter of hours, rather than days.

Paulson, Bernanke and Securities and Exchange Commission chair Christopher Cox asked lawmakers at the session to pass legislation giving the government power to buy distressed assets.

"It will be the power — it may not be a new entity — it will be the power to buy up illiquid assets," Rep. Barney Frank, D-Mass, said.

Frank said there was "virtually unanimous agreement" among lawmakers in attendance that such legislation was needed.





Well, I guess sometimes you don't need Congress and sometimes you do. My bet is that Congress will jump at whatever is offered as our honored representatives have no clue what to do and this way they can blame someone else if it goes wrong and take the credit if it goes well.
9.18.2008 11:24pm
Ricardo (mail):
Are you saying we made this deal with AIG because the government is the smartest dealer around?

I would never want to exaggerate the competence of government but the two men closest to this deal are former investment banker and Goldman Sachs CEO Hank Paulson and former Princeton professor of economics Ben Bernanke. So between the two of them they know a thing or two about Wall Street and the world of finance.

As for why no one else wants to put up the cash to lend or buy out AIG, it just so happens that everyone is running into the same problem these days: banks are seeing their assets plummet in value and need to hoard cash and other safe assets to shore up their balance sheets. Borrowed money, if you can find it, comes at a steep premium. So no bank that wants to survive the next 12 months wants to touch this deal even if it would make them money in two or three years. In today's environment, two or three years is too long to wait for a return.
9.19.2008 12:22am
Hans Bader (mail) (www):
The multibillion dollar bailout of AIG might not even be necessary if it were not for federal accounting regulations that made it impossible for private banks to toss it a lifeline.

Former FDIC Chairman William Isaac argues in the September 19, 2008 Wall Street Journal that a logjam has been created in financial markets by the SEC through application of accounting regulations (so-called Fair Value Accounting Rules and Basel II capital rules) that he believes require that assets "be marked to unrealistic fire-sale prices" and require banks to "mark the assets to market even though there is no meaningful market." See William M. Isaac, "How to Save the Financial System," Wall Street Journal, Sept. 19, 2008, at page

Holman Jenkins in his September 17, 2008 Wall Street Journal column pointed to "accounting rules that may or may not paint an unrealistically dire picture of [banks'] existing loans . . . so these banks are not in a position to do what might be a very lucrative piece of business floating AIG the bridge loan it needed." See Jenkins, "Are We Running Out of Rescue Cash?," Wall Street Journal, Sept. 17, 2008.
9.19.2008 1:10pm
Tony Tutins (mail):
A logjam has been created in financial markets by the SEC through application of accounting regulations (so-called Fair Value Accounting Rules and Basel II capital rules) that he believes require that assets "be marked to unrealistic fire-sale prices" and require banks to "mark the assets to market even though there is no meaningful market."

An asset for which there is no market is worthless by definition. Market value == $0.00

I have a nice 1,000,000 mark note from the Weimar Republic to prove it. Although it does have collector value.
9.19.2008 4:13pm

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