Court Issues Decision in “20 Percent of Something is Better Than 100 Percent of Nothing” Case

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Judge Thomas C. Wheeler of the U.S. Federal Court of Claims has issued a decision in one of the most watched cases directly tied with the government response to the 2008 financial crisis.  In Starr International Company, Inc. v. The United States, Starr International challenged the bailout of AIG in which the federal government took shareholder equity and management control. Prior to the crisis, Starr (whose controlling shareholder is former AIG executive Hank Greenberg) was a major shareholder in AIG. The resulting bailout considerably diminished the value of other shareholders’ holdings, and they sued.

Specifically, the court considered two issues:

  • Whether the Federal Reserve Bank of New York possessed the legal authority to acquire a borrower’s equity when making a loan under Section 13(3) of the Federal Reserve Act, 12 U.S.C. § 343 (2006); and
  • Whether there could legally be a taking without just compensation of AIG’s equity under the Fifth Amendment where AIG’s Board of Directors voted on September 16, 2008 to accept the Government’s proposed terms.

If Starr won on either question, the court would need to determine damages to the shareholders.

The 37-day trial contained a number of high profile witnesses including former Treasury Secretary Henry Paulson and former Treasury Secretary and New York Federal Reserve Bank President Timothy Geithner.

In its analysis, the court made some key findings.  As to question 1, the court held for Starr.  The court’s rationale is very blunt about the government’s actions in this matter.

The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance. In September 2008, AIG’s international insurance subsidiaries were thriving and profitable, but its Financial Products Division experienced a severe liquidity shortage due to the collapse of the housing market. Other major institutions . . . encountered similar liquidity shortages. Thus, while the Government publicly singled out AIG as the poster child for causing the September 2008 economic crisis, the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions.

Many entities engaged in these [credit default swap] transactions, not just AIG. The Government’s justification for taking control of AIG’s ownership and running its business operations appears to have been entirely misplaced. The Government did not demand shareholder equity, high interest rates, or voting control of any entity except AIG. Indeed, with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act.

Furthermore, the court noted that the Government realized a “significant benefit in nationalizing AIG.” The takeover resulted in a “profit of $22.7 billion to the U.S. Treasury.” “AIG’s benefit was to avoid bankruptcy, and to ‘live to fight another day.’” Finally, the court noted that there is nothing in Federal law that would permit the Federal Reserve Bank to take over a private corporation and run it as if the Government was the owner. Based on that rationale, the court found in favor of Starr in the illegal extraction claim. However, under that theory, the court also held that because the government’s activities were illegal, there can be no Fifth Amendment claim.

As to damages, the court noted that Federal Circuit precedent required Starr to show economic loss. The court then stated that “[t]he analysis here leads to the conclusion that, if the Government had done nothing to rescue AIG, the company would have gone bankrupt, and the shareholders’ equity interest would have been worthless.” As such, the court awarded no damages.

The holding on liability presents some interesting questions about possible tools that the U.S. Government can employ in the event of another financial crisis. Starr has appealed the damages ruling to the United States Court of Appeals for the Federal Circuit.