Ask any first year law student “what did you learn in school today” and you’ll probably get some version of the answer: “duty-breach-causation-harm.” While this applies specifically to tort claims, it seems axiomatic, even for non-lawyers, that you can’t sue someone who hasn’t hurt you. Or can you?

Former AIG CEO Hank Greenberg caused a ripple of shock in late 2011 when he filed suit against the U.S. government, alleging that the government’s 2008 bailout and subsequent take-over of AIG was unlawful, and claiming $40 billion in damages. Despite skepticism throughout the legal community, the case not only survived dismissal, but went on to a full trial, during which such heavyweights as Tim Geithner, Hank Paulson, and Ben Bernanke took the stand. 

Throughout the trial, Judge Thomas Wheeler seemed sympathetic to the claims that Greenberg brought on behalf of Starr International Company, an AIG shareholder. Few believed that AIG had any alternative to the government’s money, except bankruptcy. In bankruptcy, shareholders (like Starr) are paid last out of whatever remains after all the company’s debts are paid. Which typically (and most likely in AIG’s case) means not paid at all. Would the judge really grant Starr a $40 billion judgment – against the U.S. government – when the alternative was bankruptcy?

No. But that doesn’t mean the government got off scot free either. Judge Wheeler found that the federal government committed an illegal exaction. That is, it took something it had no right to take. (This, the judge carefully notes, is not the same as a “takings” under the Fifth Amendment. When there is a takings, the government lawfully uses its authority to take private property for public use and then must pay the owner “just compensation” for that property. An illegal exaction means the government took properly unlawfully.) 

In bailing out AIG, the Federal Reserve Bank of New York (FRBNY) issued the company a loan for $85 billion. In exchange, the FRBNY took an 80 percent equity stake. This stock was not posted as collateral for the loan, but would remain in the government’s hands even after the loan was repaid.

The FRBNY claimed it acted under a provision in the Federal Reserve Act that gives the bank the authority to act as a lender of last resort in “unusual and exigent circumstances” and to establish an interest rate for the loan. But, the court noted, this does not allow the bank to do anything it wants in “exigent circumstances;” it can do only those things it is authorized elsewhere in the Act to do. And taking equity stakes in companies is not one of those things. “[T]here is nothing in the Federal Reserve Act or in any other federal statute that would permit a Federal Reserve Bank to take over a private corporation and run its business as if the Government were the owner,” found the court. “A Federal Reserve Bank has no right to control and run a company to whom it has made a sizeable loan.”

Judge Wheeler’s opinion is peppered with zingers, calling the government’s terms for AIG’s bailout “punitive,” “draconian,” “harsh,” and “unprecedented.” Ultimately, however, he admits his hands are tied. “In the end,” he writes, “the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value.” The result is that there is no economic harm to Starr and therefore no damages can be awarded. The court noted “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…Simply put, the Government often may ignore the conditions and restrictions of [the Act] knowing that it will never be ordered to pay damages.”

So Hank Greenberg won without winning. And yet, in the midst of a crisis, the government overstepped its bounds and was subsequently called to account. Although Judge Wheeler seems to believe that the government may act with impunity in this arena because it won’t be ordered to pay damages, there is now a case on the books that calls the FRBNY’s actions illegal. Its lawyers will be hard-pressed to justify this type of action in the future. And may be more careful about coloring outside the lines in general.