If the Fed Does Wrong But Isn’t Punished, Does It Really Matter?

TND Guest Contributor:  Paul-Martin Foss |

While it was good to see the United States Court of Federal Claims rule against the Federal Reserve in the suit filed against it on behalf of AIG and its shareholders, the fact that the government was not liable to pay damages would cause any reasonable person to believe that the victory is a hollow one. The court ruled that the Federal Reserve overstepped its authority in bailing out AIG in 2008, taking an equity stake in the company in exchange for the financial assistance provided, without allowing shareholders an opportunity to approve the deal. But without having to pay any sort of damages, the Fed escaped unscathed. So what is to prevent the Fed from overstepping its authority in the future?

The court at least acknowledged this conundrum in its ruling, stating that “a troubling feature of this outcome is that the Government is able to avoid any damages notwithstanding its plain violations of the Federal Reserve Act.” So how exactly did the court come to its conclusion that the Fed owed no damages?

The plaintiffs (AIG’s shareholders) alleged that they were damaged by the Fed’s actions, but they had to prove that the Fed damaged them by taking an 80 percent equity stake in AIG. Perhaps unsurprisingly, the court found as one of its “facts” a counterfactual – that in the absence of the Fed’s bailout AIG would have gone bankrupt and the shareholders would have been completely wiped out.

While that may very well have happened, it wasn’t guaranteed. In fact, there was so much panic during that period of time that anything could have happened. The big fear with AIG’s collapse was that an AIG bankruptcy might take down many of the counterparties with which it had agreements, a potential domino effect of bankruptcies that had Wall Street incredibly nervous. Had the AIG board decided to play hardball, or had the shareholders been able to vote on any bailout agreement with the Federal Reserve, they may very well have been able to use their position as the linchpin of a potential Wall Street collapse to push for better bailout terms. For the court therefore to assume as fact a counterfactual position that just happens to be the scenario most generous to the Federal Reserve is laughable.

Another peculiarity of the ruling is that, because the Fed’s actions did not constitute a taking under the Fifth Amendment, the government could not be held liable for damages. In other words, if the government exercises its power under the Fifth Amendment it could be held liable for damages; if it oversteps its authority and does something illegal, it can’t be held liable for damages. Gee, I wonder whether future Fed Chairmen are going to adhere to the Constitution or will continue to overstep their authority? Twenty Federal Reserve Notes says its the latter.

Even the Federal Reserve’s statement on the decision seems to indicate their view that this decision was at least a partial victory for the Fed. (Emphasis added.)

The Federal Reserve strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective. The court’s decision today in Starr International Company, Inc. v. the United States recognizes that AIG’s shareholders are not entitled to compensation for that decision, and that the Federal Reserve’s extension of credit to AIG prevented losses to millions of policyholders, small businesses, and American workers who would have been harmed by AIG’s collapse during the financial crisis. The terms of the credit were appropriately tough to protect taxpayers from the risks the rescue loan presented when it was made.

While some in the media have been touting this decision as severely restricting the Fed’s bailout powers, in reality the lack of punishment means the Fed has no incentive not to continue overstepping its authority. This decision was a slap on the wrist with no real punishment, and so the Fed can continue to act in the future just as it did with AIG, at least until the court system finally (if ever) provides the Fed with some sort of punishing disincentive to keep the Fed from continuously flouting the law. Given the timeline of the AIG case, that may very well be a decade in the future, by which time the Fed will have had ample opportunity to do even more damage.

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About  Paul-Martin Foss:

Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, an Arlington, VA-based think tank dedicated to educating the American people on the importance of sound money and sound banking.

Prior to founding the Menger Center, Mr. Foss worked in the U.S. House of Representatives for seven years, including six years as Congressman Ron Paul’s legislative assistant for monetary policy and financial services, and one year as Deputy Legislative Director for Congressman Thomas Massie.

As Congressman Paul’s legislative assistant, he assisted the Congressman in his duties as Chairman of the Subcommittee on Domestic Monetary Policy by helping to develop hearing topics, agendas, and briefing Congressmen and their staffs on monetary policy topics. Mr. Foss also was responsible for the management of Dr. Paul’s monetary policy and financial services legislation, including the “Audit the Fed” and “End the Fed” bills, and was co-editor of Ron Paul’s Monetary Policy Anthology, a multi-thousand page compilation of hearing transcripts, lecture transcripts, and other documents related to Dr. Paul’s chairmanship.

Mr. Foss received his Bachelor’s degree from The University of the South (Sewanee), and Master’s degrees from the London School of Economics and Georgetown University’s Edmund A. Walsh School of Foreign Service.

This article appeared on the Carl Menger Center for the Study of Money and Banking and is reprinted with permission, “Creative Commons 4.0.”

Source: http://thenewsdoctors.com/if-the-fed-does-wrong-but-isnt-punished-does-it-really-matter/