September 16, 2008

Can the Government Buy an Insurance Company for Cheap?

Posted by David Zaring

Apparently so. Good news if you have stock in the United States - boy can that country buy low. Anyway, as you've all probably read, the Fed opened the discount window for AIG in exchange for 80% of its stock. Amazing dilution. No, I can't recall the government having ever done this before. And yes, this sort of invitation to trade credit for equity is utterly unprecedented in the Fed's use of section 13 of the Federal Reserve Act. The below analysis of this administrative action reserves all M&A questions to other corporate experts.

There's really no statutory authority for the AIG takeover (the Fed and Paulson went to the Hill, and got nothing, not that they possibly could have in a couple of Tuesday evening hours). I won't bother noting that the DC Circuit, were it to sit in judgment on whether the Fed could buy the world's largest insurer, would undoubtedly conclude that the plain language of its governing statute (which is to make emergency loans, not require takeovers in exchange) would not permit the takeover under Chevron USA v. NRDC.

And I will wait for others to opine on whether the Fed got a good deal. Legally, the basis for Fed action - not that it is reviewable - would be that the acquisition of the petitioner is a reasonable interpetation of its ability to open the discount window to anyone.

I imagine that the legal answer to that question depends on a nice distinction between practice and plain language. Under the plain language of the statute, interpreted imaginatively, the Fed can extend credit, upon the right showing, to any company or individual, and so why not insist on conditions on the loan? Heck, why couldn't EPA, in the name of fishable swimmable rivers (that's Clean Water Act language), ban all pesticides, including dishwasher detergent, or nationalize water users like the steel industry? Maybe it can! Which might be good news for environmental activists.

The usual reason why government agencies can't so act has something to do with settled expectations - if a government agency has never done it, and never done anything like it, then it usually can't do it, no matter how broad the grant of Depression era authority.

But, in the Fed's legal defense, maybe, just maybe, the settled expectations are different here, based on the government's takeovers of Fannie and Freddie, and the pleading by AIG for government involvement. Does the very fact that the insurer hoped for Fed action suggest that the Fed could act?

Hmmm. The other defense would be that emergencies are emergencies, and when that happens the rules go out the window, and hopefullly regular elections mean that the officials the people trust are dealing with the emergency. Abraham Lincoln adopted that reasoning, and he won the Civil War. I suspect we're at the "anything goes in an emergency" stage of things. But maybe reasonable minds could disagree.

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