Court Rules that Fed Exceeded Power in Bailout of AIG, But Did Not Harm Shareholders

The United States Court of Federal Claims has held that the Federal Reserve’s 2008 bailout of AIG was illegal. The class-action lawsuit against the federal government was initially filed in 2011 by Maurice Greenberg, the former Chairman and CEO of AIG. Greenberg remains a major shareholder of the global insurance company. Few legal experts gave Greenberg any chance of success when the lawsuit was initially filed.

In 2008, the Federal Reserve demanded an eighty percent ownership stake in AIG in exchange for an $85 billion loan to bail out the insurance company. At that time, AIG was on the verge of failure and needed government assistance after credit default swaps held by the company collapsed in the midst of the global financial crisis. While the government’s takeover of AIG was deemed to exceed its legal power, the judge in the case chose not to award any damages to shareholders. The lawsuit sought $40 billion in damages.

While the Greenberg led class emerged victorious in the litigation, the group immediately expressed an intention to appeal the ruling in pursuit of monetary damages. In the ruling, Judge Thomas C. Wheeler held that the law used as authorization to issue the bailout loan did not permit the Federal Reserve to require AIG to hand over control of the company. Judge Wheeler went on to note in his opinion that this 2008 action marked the first time in history that the Federal Reserve conditioned a bailout loan on receiving controlling ownership of a company. Further, Judge Wheeler maintained that AIG’s acceptance of the deal did not make it legal.

Judge Wheeler went on to also note that “there is nothing in the Federal Reserve Act or in any other federal statute that would permit a Federal Reserve Bank to take over a private corporation and run its business as if the government were the owner.” The Federal Reserve continues to emphatically insist that its actions with regard to the AIG bailout were legal.

The lawsuit was particularly surprising because all parties seemed to benefit from the 2008 bailout. The government turned a profit on its investment in AIG, the government retains no ownership of the company, and AIG avoided bankruptcy proceedings.  While the Federal Reserve’s actions were deemed illegal, Judge Wheeler found that shareholders were not at all damaged by the government’s actions because AIG would have gone bankrupt absent the bailout. If the company went through bankruptcy proceedings, shares would have likely lost all of their value. The government maintains that the terms required for the bailout loan were necessary in order to protect the nation’s taxpayers and all of those that would have been hurt by an AIG bankruptcy.

The federal court’s ruling creates precedent that it is reasonable for the Federal Reserve to act illegally when bailing out a company and not be punished; as long as the company is on the verge of bankruptcy/failure (meaning there will be no monetary harm to shareholders). There is significant debate among legal analysts in regards to the consequences of this federal court ruling on future bailouts. Many see Judge Wheeler’s refusal to award damages as a significant win for the government and as a sign of a potential trend for damage awards in bailout cases.

While it is clear that the plaintiffs intend to appeal the ruling, some speculate that the government will also appeal the decision by arguing that it dangerously restricts the government’s ability to combat and minimize the impact of future financial crises. On the other hand, it is expected that Mr. Greenberg’s appeal will emphasize the argument that the illegality of the government’s AIG takeover is “meaningless” if the government is not held accountable for its actions in the form of damages.