We have been discussing my new paper, Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice, which you can download here. In my last post I made the case that the government is a control shareholder in many of the banks and automotive companies that accepted TARP bailout cash. So why does that matter? In corporate law shareholders determined to be in control of the corporation have the same duties to other shareholders as executives or members of the board of directors. Control shareholders cannot use their power to force the corporation into business decisions that will harm the value of the company for the other shareholders. In securities law, control shareholders are even jointly liable with the company for violations of the securities laws.
The government’s sovereign immunity throws a wrench into this dynamic. I won’t bore you with all the sovereign immunity analysis in the paper, but let me just say that the government takes a belt-and-suspenders approach to sovereign immunity protection for the bailout. The Tucker Act, which waives sovereign immunity for some torts by the government, doesn’t seem to fit, because fiduciary duty violations aren’t traditionally understood to be torts. Takings clause litigation, generally a difficult test to pass, would seem especially difficult here in light of the many objectives articulated by the government in the bailout legislation. Section 3 of the Securities Exchange Act, passed in 1934, includes a specific exemption for the federal government from, among other things, insider trading laws.
Does this matter? What could the government do that would be so pernicious to the value of Citigroup’s shares? Let me list a few examples. Citigroup funds Mergers and Acquisitions activity, which often results in layoffs of excess employees or factory closings at target companies to make them run more efficiently. We can expect a number of interest groups would have the government pressure Citigroup not to underwrite M&A deals that would bring value to Citigroup as a result. Citigroup has already agreed to limit its visa program to hire foreign workers. Citigroup loans money so that people can buy houses, the government subsidizes loans so that people who cannot otherwise afford to buy houses can do so. We can expect that the government will pressure Citigroup to subsidize loans to select groups at an interest rate lower than the risk of the loan would suggest, thus losing money for Citigroup and causing it to violate its fiduciary duty to its shareholders.
Government ownership in banks is prevalent around the globe, and the evidence is that this happens with reckless abandon. In Italy, for instance, banks with substantial state ownership lend at lower rates, for loans of similar terms and risk, in regions important to the ruling coalition in Parliament. Based on this evidence, we should expect to see Citigroup, and other TARP recipients, subsidize lending in battleground states as a result of the government’s controlling interest in TARP recipients combined with the sovereign immunity it enjoys.