The federal government’s 2008 loan of $85 billion bailing out insurance giant AIG during the financial crisis was illegal but literally “harmless,” according to a recent court decision. Although the government had the right to loan AIG money to keep AIG from certain bankruptcy, the government illegally demanded that AIG make the government a part-owner by acquiring 80% of AIG’s stock. The court, however, awarded the AIG shareholders no damages, because it concluded that the shareholders had lost no money as a result of the government’s unlawful actions. The court found that the government’s loan actually helped the AIG shareholders, because it kept their stock from being completely worthless in bankruptcy.Illegal government loan terms. The terms of the government’s AIG loan went beyond what the law allowed. Although the government – as AIG’s banker of last resort – could demand that AIG pay interest on the government loan and demand collateral, the law did not allow the government to become a part-owner of AIG. It would be like a home mortgage loan in which the bank loans the homeowner money, but demands that the bank also become part-owner of the home. Worse yet, in this case, the government would remain a part-owner of AIG even after AIG had completely paid off the government loan.
The government’s loan terms were deemed unfair as well as illegal: “Operating as a monopolistic lender of last resort, the government imposed a 12 percent interest rate on AIG, much higher than the 3.25 to 3.5 percent interest rates offered to other troubled financial institutions such as Citibank and Morgan Stanley.” Also uniquely imposed on AIG was government voting control: “with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75–year history” of the law the government had based the loan on.
The issue in the lawsuit, however, was not “whether this treatment was inequitable or unfair, but whether the Government’s actions created a legal right of recovery for AIG’s shareholders.” The court agreed with the AIG shareholders on this issue, concluding that the government had acted illegally under the Federal Reserve Act.
No shareholder damages. But after concluding that AIG’s shareholders had proved that the Government was wrong, the court then reluctantly concluded that, according to legal precedent, the shareholders had not suffered any economic loss and were, therefore, not entitled to damages.
The issue here was whether their damages were to be measured by what the government gained — $22.7 billion it received from ultimately selling the AIG stock – or by what the AIG shareholders lost – the value of their AIG stock, which would have been zero when, without the government loan, AIG would have gone into bankruptcy.
According to the court, “common sense suggested” that the damages were the $22.7 billion the government had received “from selling the AIG common stock it illegally exacted from the shareholders for virtually nothing.” Legal precedent, however, focused on the AIG shareholders’ loss on the theory that, if the government has deprived a victim of something, compensation should be based on what the victim was actually deprived of.
The court followed legal precedent, concluding that the AIG shareholders had suffered no loss from the government’s illegal extraction of almost 80% of AIG’s stock. As a practical matter, the shareholders were undoubtedly better off with 20% of a company avoiding bankruptcy than they would be with 100% of a company forced into bankruptcy.
This necessary conclusion based on existing precedent, however, was not one the court welcomed. It sent the message that “Any time the Government saves a private enterprise from bankruptcy through an emergency loan, as here, it can essentially impose whatever terms it wishes without fear of reprisal.”
Whether the court’s concerns are valid will depend on the way appellate courts resolve the appeals that are sure to follow. This decision is not expected to be the final word on the AIG saga.