So he won.

Photographer: Jonathan Fickies/Bloomberg

Hank Greenberg's Chutzpah vs. Fed's Panic

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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After seven years, the federal government has finally received its comeuppance. U.S. Judge Thomas C. Wheeler gave the Federal Reserve a severe tongue lashing, a tsk-tsking for the central bank’s financial-crisis overreach.

That ought to teach ‘em.

The actual result of the case is to confirm the status quo. In “emergencies,” restraint on government adds up to precisely nothing.

Consider the case at hand involving the bailout of the giant insurance company American International Group at the height of the 2008 panic.

Wheeler was confronted with an intriguing question of law: What are the limits of government intervention in the economy during times of crisis? It was a case with no good guys, only flawed actors, a suit I like to think of as Chutzpah v. Panic.  You may know the case by its formal name, Starr International Co. v. U.S. (11-cv-00779). In more common parlance, it was also referred to as that crazy suit former AIG head Hank Greenberg filed against the feds.

On the one hand, in the cool light of hindsight, this was a clear case of government overreach. The Fed regulates the banking system, and has no jurisdiction over insurance companies. But during the financial crisis the Fed stepped in, covered AIG's liabilities and claimed majority ownership.

As Wheeler wrote, “The Board of Governors and the Federal Reserve Banks . . . did not have the legal right to become the owner of A.I.G. There is no law permitting the Federal Reserve to take over a company and run its business in the commercial world as consideration for a loan.”

On the other hand, you have a company that was one of the worst and most reckless actors in the financial industry -- and that was the least of the problems in this litigation. Before the government bailout, AIG was hurtling straight off a cliff toward bankruptcy, all by its own hand. Its shareholders were destined to get wiped out. As Wheeler noted: “The inescapable conclusion is that A.I.G. would have filed for bankruptcy. In that event, the value of the shareholders’ common stock would have been zero.” Hence, Greenberg’s demand for $40 billion in compensation was why his claim represented pure chutzpah. (For more on AIG, see this, this, this, this, this, this and of course this).

Complicating matters more, we know the AIG takeover was a debacle. The Special Inspector General of the government's bailout program already told us the Federal Reserve Bank of New York screwed up the AIG rescue. The feds even wanted a national security exemption for AIG, to keep the whole mess secret. That was how much panic there was at the time.

In theory, the ruling may limit the Fed’s ability to deal with the next crisis. In practice, during a genuine panic, there are no rules. That is the most significant dicta of the case. The government overstepped its authority during what was considered to be an emergency. To prevent this, you can sue the government; seven years later, a pyrrhic victory is yours.

Consider how flexible the First Amendment becomes during times of war. Think of how much privacy rights shrunk after the  terrorist attacks. How do we get the internment of 120,000 U.S. citizens of Japanese descent during World War II? How do we ignore our own treaties against torturing prisoners?

There is that word again: Panic.

The Fed certainly panicked as AIG (not to mention the entire financial system) teetered. The answer to the complaints was “Go ahead and sue us.” So Greenberg did. His victory was in name only.

What might this mean in the next financial crisis? Maybe a day of delay. Assume a plaintiff can find a friendly judge to issue a favorable ruling based on the Starr International case. It probably wouldn't take the government more than a day to find an appellate court to overrule the judge on an emergency basis. Only after that takes place, can the plaintiffs begin their appeals. And as we just learned, that will take about seven years.

In an emergency, the government often ignores what courts say. The Constitution isn't a suicide pact -- that's the phrase you will hear at such a time.

Best of luck. Maybe there's a pyrrhic victory in your future.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net