AIG, the War on Terror, and Executive Power.

Whether the Fed (and/or the Treasury) acted unlawfully depends on whether the transaction with AIG falls within the statute that authorizes the Fed to make loans to non-banks during emergencies. It is clear that the transaction mixes elements of debt and equity. The Fed probably will get the residual value of AIG—everything if its assets appreciate less than 8.5%, and 80% of the balance if they appreciate more than 8.5%. The Fed probably has almost complete control as well: it kicked out the old CEO and replaced it with a new CEO and although the Fed has not yet exercised its equity warrants, clearly this new CEO knows that the Fed can, whereupon its control will become de jure as well as de facto. Still, we don’t know for sure, I suppose; in particular, I can’t tell whether some condition must be met before the Fed can exercise its warrants or whether they are limited in some other way. But if, as some have argued, AIG was worth nothing at all, then it would be pretty crazy for the Fed to accept anything less than full ownership in the substantive sense, and we can reconcile ourselves to the fact that somehow the AIG shareholders were left with an ownership stake with the comforting thought that their shares have (almost) no value. (As long as AIG is on life support, there is a non-zero probability that its value will appreciate to the point that shareholders get some return.)

What is more interesting is the strong parallel—which I hinted at before—between the current situation and the situation post-9/11. No one expects Congress to act in any meaningful sense. The executive has nearly unlimited discretion, relies on mostly secret information, and therefore its actions cannot be evaluated by outsiders. We can only trust that executive officials know what they are doing. People say, at least, we can trust Henry Paulson and Ben Bernanke. They seem competent and have the country’s interests at heart. But that’s what people used to say about Dick Cheney and Donald Rumsfeld. We really have no idea whether Paulson and Bernanke are making wise decisions, dumb decisions, or even politically motivated decisions—say, bailing out firms in which political allies have interests and not otherwise, or firms with lots of workers in politically important swing states. Sometime in the future, we may be able to evaluate their decisions, at which point our sole means of expressing our displeasure if those decisions were bad ones would be by voting against the person chiefly responsible for their appointments, George Bush—um, never mind.

Meanwhile, right now niceties of statutory construction must be ignored because the people who drafted the statutes did not anticipate the nature of this emergency though of course they knew that emergencies could happen. Back in 1932 (the most recent amendment was in 1991), Congress apparently believed that the Fed could respond to a financial crises solely by making loans so there was no need to give it the power to purchase businesses, a power that could be abused. Turns out this belief might have been wrong. Some loans may not be wise unless the lender can more or less control the borrower and can earn a portion of the upside, which just means that the Fed should have the power to purchase equity as well as debt. Going forward, all that Congress can do is provide even greater statutory discretion by expanding old authorities, so that next time round there will be no doubts about legality, and hope that the Fed does not abuse this discretion. There is, and can be, no serious debate about the best way to respond to the emergency in advance of it, and no time to have a debate during it. So Congress proves itself again an utterly helpless institution. It can whine today, hold oversight hearings tomorrow, and dutifully hand over more authority to the Fed on the next day. In the meantime, bad decisions by our government during this financial crisis, and future ones as well, will harm Americans and people around the world just as much as bad war-on-terror decisions do. Sorry, my libertarian friends; this is the world we live in. And there is no conceivable alternative.