When an economic wildfire starts, should privately owned financial property that is seized by the government to mitigate widespread damage amount to a “taking” or a financial firebreak? This question lies at the heart of a cascade of lawsuits that have been filed in the aftermath of the Financial Crisis of 2008. The Fifth Amendment to the U.S. Constitution (“[N]or shall private property be taken for public use, without just compensation”) forbids the taking of private property for public use without just compensation or due process of law. However, applicable to the creation of firebreaks, there is a public necessity exception to the right to just compensation: U.S. law has long held that the government is not liable when it acts to “destroy the property of a few [so] the property of many and the lives of many more could be saved.”
During the Financial Crisis, the U.S. Government bailed out American International Group (“AIG”), Chrysler, General Motors, Ford, the Federal National Mortgage Association (“Fannie Mae”), and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). In the last few years, former owners of terminated auto franchises, Fannie Mae and Freddie Mac stockholders, and AIG stockholders have filed lawsuits claiming that the U.S. Government’s actions amounted to Fifth Amendment takings of their property, seeking billions of dollars in compensation.
Even assuming the bailouts did amount to takings, there is sharp disagreement about whether claimants should be compensated. The opposing views can be characterized as “Non-Compensators” and “Compensators.”
The “Non-Compensator” View
As the U.S. Government instituted the bailouts because they “feared that the nation’s and the world’s economies were on the brink of a monumental collapse,” Non-Compensators argue that its rescuing of companies whose failure would cause a world-wide catastrophe should fall under the public necessity exception to the Fifth Amendment requirement for just compensation. Non-Compensators point to the Government’s authority to destroy “real and personal property, in cases of actual necessity, to prevent the spreading of a fire or to forestall other grave threats to the lives and property of others.”
Further rationales for non-compensation include the following: (i) often, the property at issue would have been destroyed regardless of Government actions—e.g., if a house is destroyed to stop a wildfire that would have destroyed that house regardless, the owner can hardly complain; (ii) crises often lead to particularly acute collective action problems that justify swift action without compensation; (iii) such vulnerability is inherent in the obligations of ownership and membership in a community. As “the increasingly interconnected nature of economic activity places certain firms at a nexus point where the consequences of failure can induce economic…damage every bit as fast-moving as a wildfire,” Non-Compensators argue we should treat the Government bailouts as financial firebreaks—as actions of “necessity” that require no compensation.
The “Compensator” View
Compensators, on the other hand, argue that the availability of relief for takings claims can bolster the legitimacy of public action that stems from a financial crisis; takings law can thus prohibit the Government from forcing a few firms or individuals “alone to bear public burdens, which in all fairness and justice, should be borne by the public as a whole.”
Behind the Compensator view is the belief that the shareholder plaintiffs may not have lost all economic value had AIG or Fannie & Freddie filed for bankruptcy—shareholder value may not have necessarily been subordinate to the claims of creditors.
Compensators argue that dismissing shareholder suits will insulate Government action from review, and thereby facilitate the use of crisis to subvert government for private ends. They emphasize that the suits have already served an important purpose by uncovering information about how and why the Treasury, Federal Reserve and other key actors (e.g. Ben Bernanke, who testified in the AIG case) made their decisions. Having shareholder lawsuits go through the judicial review process is, itself, helpful because providing the public with more information about the response to the Financial Crisis will increase government transparency and accountability.
Recent Shareholders Lawsuits Seeking Just Compensation
While the courts treated the earlier cases as misguided, quickly dismissing the Chrysler, General Motors, and initial AIG complaints, they are now taking the cases very seriously.
In the fall of 2008, the Federal Reserve Bank of New York saved AIG from insolvency by lending it $85 billion, demanding in return a 79.9% equity stake in AIG. In 2011, Starr International Company, Inc., one of AIG’s largest shareholders, filed suit challenging the federal takeover of AIG. Starr argued that the Government illegitimately forced AIG to issue over 562 million shares for a payment of only $500,000, diluting the value and voting power of Starr’s holdings. Starr alleged that this amounted to an illegal exaction and a taking. An illegal exaction occurs “when the Government requires a citizen to surrender property the Government is not authorized to demand as consideration for action the Government is authorized to take.”
In 2015, the U.S. Court of Federal Claims held that the Government action was an illegal exaction: In demanding the 79.9% equity stake in AIG, the Government acted beyond its authority because there was no law that authorized the Government to demand equity or voting control as consideration for a loan.
The Court went on to explain that Fifth Amendment taking claims are based upon authorized actions by Government officials, whereas illegal exaction claims are based upon unauthorized actions of Government officials. Thus, because the Government’s actions were unauthorized, the actions necessarily did not amount to a taking. However, the Court awarded no damages, which has led some to characterize the decision as merely a pyrrhic victory for the shareholder.
2- Fannie Mae and Freddie Mac
In September 2008, the Government saved Fannie Mae and Freddie Mac (“Fannie & Freddie”) from insolvency by putting them in conservatorships, promptly making billions of dollars in emergency capital available to Fannie & Freddie in exchange for preferred shares of their stock. In return, Fannie & Freddie agreed to pay the Treasury a quarterly dividend of 10% of the total amount of funds it borrowed, but they often had to borrow more cash from the Treasury just to make those payments. In 2012, after providing $187.5 billion of rescue financing to Fannie & Freddie, the Government revised the transaction, amending stock purchase agreements to transfer all Fannie & Freddie net worth and future earnings to the Treasury. In effect, the Government inserted itself as the residual claimant to the company, at the expense of the shareholders who otherwise would have received funds.
In 2013, Fairholme Funds, a mutual fund that owns shares in Fannie & Freddie filed suit to recover the profits the Treasury reaped when Fannie & Freddie returned to economic stability. In 2014, a federal trial court dismissed most of Fairholme’s claims. Remaining is the claim that the Government actions constituted a taking of the property interest the shareholders might have had.
Throughout the litigation, the Government has withheld over 11,000 documents arguing that they are subject to various claims of privilege and cannot be disclosed. In October 2016, the Court of Federal Claims held that the Government improperly withheld the disclosure of 56 of the documents the Court had sampled. Last month, the Federal Circuit Court of Appeals upheld but qualified that decision, ruling that 8 of the 56 documents could be withheld on the basis of presidential privilege, or privilege of the deliberative process.
As the AIG and Fannie & Freddie cases show, the Takings Clause of the Fifth Amendment has emerged as an important vehicle for evaluating government action following the Financial Crisis. Although the shareholders’ taking claim failed in the AIG case, the fact that both of the cases went to and are currently in trial shows the claims are being taken more seriously than those preceding them. The cases also reveal courts’ increasing willingness to be skeptical of government bailouts.
The fact that courts have not yet awarded compensation to shareholder plaintiffs bringing Financial Crisis-related takings claims is arguably a good thing for taxpayers that do not want huge sums of federal funding to go towards compensating investors whose stock values were diluted or diminished by the bailouts. Even without compensation to the plaintiffs, the increasing trend towards judicial review of the takings claims is arguably serving four other important purposes:
(1) the increased information disclosure the cases have resulted in will lead to further transparency and accountability in government decision-making;
(2) by assessing the legality of regulators’ intervention, courts can minimize the distortions in existing law that might otherwise be caused by crisis-period decision-making;
(3) court decisions can promote further governmental accountability by signaling to the public that the relevant actors overstepped their bounds, if they did; and
(4) finally, when a court rules conduct is unauthorized or amounts to a taking, it articulates the rule of conduct going forward—this raises the likelihood that the legal boundaries of government action will be respected in future economic crises.
The U.S. Court of Appeals for the Federal Circuit will hear oral arguments for the Fairholme case against Fannie & Freddie, Fairholme Funds v. U.S. on March 10, 2017.