True, the Fed statute says that loans can be issued with conditions. As a commenter asks, what loan doesn’t have conditions? See here also. But the 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. Here’s an analogy. Suppose that I lend you $100 and we agree that all of the equity in your business will be collateral for the loan. The contract provides, however, that you must pay me interest of a gazillion dollars, due one second after closing, and that if you fail, that counts as a default, whereupon the collateral is mine. The parties use the loan form but substantively a sale occurs. A court would almost certainly interpret the transaction as a sale, not a loan, if tax or other legal consequences turned on the distinction. If the AIG loan is like this, then it’s illegal. So: why aren’t our rule-of-law friends yowling?
The AIG Deal.
Who has standing to sue?
Ok, but isn't this just a gentler form of receivership or conservatorship, akin to the stuff we see from the FDIC all the time? At least, that's how I read the structure of the transaction:
"A senior Fed staffer said the most likely outcome was an orderly liquidation of AIG, though it was possible that the firm could survive as an ongoing business."
Financial Times, 17 September 2008
It seems to me that the goal here is not to "sustain the market" via taxpayer dollars and nationalization. The ownership stake was merely the necessary step to expedite the winding down process, which is much different than the government actually stepping in to 'prop' markets.
And by the way, this deal doesn't result in a taxpayer loss of $85 billion. The loans terms carry a somewhat brutal interest rate, suggesting the Fed has every intention of making AIG give it back. This is really just a bridge loan to carry the company through until its assets can be stripped. For those worried about the moral hazard, that still means that those "wealthy Wall St. financiers" are going to take a hit.
As to ownership, Eric correctly notes that the Fed doesn't own AIG yet--it has an option on something under 80% of the common equity. What other incidents of ownership it may have don't seem to be public (i.e., it might have the right to select board members, or management)--at least I haven't seen them.
If the assets are liquidated it is hard to see how the loan principal and interest will not be paid. The option may well be valueless (since AIG's equity may be), but it is there to provide the threat of an actual takeover, I suppose, if management does not take steps to repay the loan, by liquidation or otherwise.
Of course it is a sale. Of course it is extraordinary, unprecedented. Is it illegal? Perhaps, but that shows the limits of the law: Who's going to stop them? In times of true crisis, fantasy legal-land yields to reality. As it has even been and so it shall ever be.
Is the "legal" alternative of passively watching a disorderly failure a better alternative than managing an orderly failure?
This is a Chapter 11 without the formalities with some small hope that something(?) will happen to allow AIG to survive. How exactly that can happen when the assets will be lopped off one after another is "above my pay grade."
So boo hoo. The law loses.
Marty: Assuming that the statutory prohibition can be fairly implied. Who has standing to sue?
Huh? Could Prof. Posner please point to press acounts that say this?
The press acounts I've read state do not state that the equity "as collateral for the loan" - instead, they say that they collateral for the loan is all of AIG's assets. The equity is just the price that AIG had to pay to obtain the loan.
It is perfectly reasonable to expect that a lender will ask for a fee when extending a loan. Virtually every loan I've ever seen is the same (I'm a corporate lawyer who represents both lenders and borrowers). Heck, you even normally pay a fee when you get home mortgage. That fee isn't "collateral for the loan" (as Prof. Posner asserts here) - it's just a plain old fee.
Could Prof. Posner please point to where he is getting this information?
"It will receive warrants entitling it to a 79.9% stake in AIG. The two-year loan, secured against AIG’s insurance businesses, carries an interest rate of LIBOR plus 850 basis points (hundredths of a percentage point). The government will install new management and will have veto power over all important decisions, including asset sales and payment of dividends."
Economist, 17 September 2008
This suggests that Prof. Posner is right that the interest is technically an elective interest. The above also makes clear that the government is indeed exercising some extensive powers that are "incident to ownership."
I may be stretching the bounds of creativity here, but how about a displaced executive? They certainly suffer a concrete harm from the government's (putatively) illegal action. It's too bad that the Fed doesn't have powers akin to the "FDIC Superpowers" to shield it from any litigation.
It seems like the diluted equity holders might have standing to sue, perhaps suing their own board the first time that someone tries to count votes or allocate distributions to equity, if any assets make it that far down the chain. (Could they just sue the Fed now? I doubt it.)
Would they be worse off if they sued and won now? Almost certainly. Would winning the lawsuit later perhaps trigger some other conditions in the loan instrument that were worse for them? Perhaps.
Look at it this way: If AIG is a festering damaged leg on the body of the financial industry, the question came down to how to take it off in the field. Do we use a shotgun and hope for the best or do we use surgical tools and try to control the spread of the gangrene?
But given the market's reaction so far today, the true form of the deal has obviously not gone entirely unnoticed.
But I still don't see any evidence supporting Prof. Posner's view of matters. As I pointed out above, the equity is not collateral, as Posner states, but rather is simply a fee for making the loan. Moreover, the example Posner provides is nothing at all like the situation here - there interest rate here is high, but not a "gazillion dollars" and the loan isn't due "one second after closing" but rather in 24 months. I'm truly puzzled why Posner's example is supposed to be apporpriate to explain this situation.
BTW, my theory on why the Fed got an option, rather than just 79.9% of AIG's stock, is that the Fed is going to wait to exercise the option until it sees what's left of AIG after the firesale. If AIG is left with a lot of obligations and hardly any assets, then the Fed won't want to exercise the option and be in a position of controlling an enterprise that is underwater.
All of this is not to say that I have any definite thoughts on whether the statute authorizes the Fed to charge a fee for making a loan. I have no idea about that.
If you have a comment about spelling, typos, or format errors, please e-mail the poster directly rather than posting a comment.
Comment Policy: We reserve the right to edit or delete comments, and in extreme cases to ban commenters, at our discretion. Comments must be relevant and civil (and, especially, free of name-calling). We think of comment threads like dinner parties at our homes. If you make the party unpleasant for us or for others, we'd rather you went elsewhere. We're happy to see a wide range of viewpoints, but we want all of them to be expressed as politely as possible.
We realize that such a comment policy can never be evenly enforced, because we can't possibly monitor every comment equally well. Hundreds of comments are posted every day here, and we don't read them all. Those we read, we read with different degrees of attention, and in different moods. We try to be fair, but we make no promises.
And remember, it's a big Internet. If you think we were mistaken in removing your post (or, in extreme cases, in removing you) -- or if you prefer a more free-for-all approach -- there are surely plenty of ways you can still get your views out.