Greenberg’s Limited Win a Blow to Schwarzman’s Dodd-Frank Fight

Hank Greenberg
Former American International Group CEO Hank Greenberg. Photographer: Evan Sung/Bloomberg

Hank Greenberg’s legal victory could turn out to be a loser for Wall Street in its fight to soften financial rules.

By successfully arguing that the Federal Reserve broke the law when it propped up American International Group Inc., Greenberg added another bailout deterrent to a series of provisions implemented since the 2008 crisis that make it harder for the government to rescue financial firms.

“The chances of a repeat AIG-style transaction are very low,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc. “To the extent there is any thought of constructing one in a crisis, this decision adds a significant speed bump, if not a stop sign.”

With bailouts facing obstacles, regulators are likely to double down on the logic behind the Dodd-Frank Act: Make it harder for companies to take risks, and be ready to take them down if they make fatal mistakes. Any Wall Street hopes for rolling back Dodd-Frank rules become tougher as a result.

That’s bad news for financial-industry executives who’ve tried with mixed success over the past five years to roll back regulations that they say are making markets less liquid and hurting economic stability.

‘Warning Shot’

Blackstone Group LP Chief Executive Officer Stephen Schwarzman last week zeroed in on requirements that banks hold big capital cushions and the Volcker Rule ban on lenders making market bets with their own capital. Such measures “may well fuel the next financial crisis as well as slow economic growth,” he wrote in a Wall Street Journal opinion piece.

JPMorgan Chase & Co. CEO Jamie Dimon has similarly argued that volatility in Treasury markets last October was a “warning shot” to investors, and the next financial crisis could be exacerbated by a shortage of those securities.

U.S. Court of Claims Judge Thomas Wheeler handed Greenberg a partial victory Monday, ruling that while the Fed had power to make an emergency loan to AIG, it didn’t have the authority to take shares in exchange for the rescue funds. Greenberg, AIG’s former CEO who sued over the 2008 bailout, was awarded no damages, because Wheeler said shareholders probably would have gotten nothing without the government rescue.

“If there were a bailout tomorrow and the legal rules were not clear, this would lead to a lot of second-guessing and theoretically should reduce the implied expectations of bailouts,” Josh Stirling, an analyst with Sanford C. Bernstein. “This should lead investors to be more skeptical about an implicit government backstop.”

‘Prevented Losses’

The Fed defended its 2008 actions as “legal, proper and effective” in a Monday statement, saying the bailout “prevented losses to millions of policyholders, small businesses, and American workers who would have been harmed by AIG’s collapse.”

Congress had already restricted the Fed’s emergency lending powers when it passed Dodd-Frank in 2010. The central bank still hasn’t completed rules detailing how it will implement those changes.

The AIG rescue isn’t the only government action from the crisis facing a legal challenge. The U.S. Justice Department is fending off investor lawsuits over a decision to divert Fannie Mae and Freddie Mac profits to the Treasury Department.

Shares of the mortgage-finance companies, which were seized by the government in 2008 and received $187.5 billion in taxpayer funds to stay afloat, rose Monday after the AIG ruling. Fannie Mae gained 2.8 percent to $2.58 and Freddie Mac increased

2.7 percent to $2.48.

The ruling doesn’t necessarily help Fannie Mae and Freddie Mac investors because it shows “how hard it can be to convince a judge to turn billions of dollars over to investors,” Jaret Seiberg, a Guggenheim Securities analyst, said in a note Monday.

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If regulators once again find themselves facing a cataclysmic threat to the financial system, the Greenberg decision makes it even clearer that they would have to go outside the law to prop up failing companies. Whether they’d find a way to do that -- or would want to -- could be the defining moment of a future crisis.

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