Opinion

Alison Frankel

Fannie, Freddie investors: Treasury plotted to nationalize shares

By Alison Frankel
March 24, 2014

Some very sophisticated hedge funds are claiming to be victims of a secret Treasury Department scheme to nationalize the government-sponsored mortgage entities Fannie Mae and Freddie Mac. In a summary judgment brief filed Friday in federal court in Washington, D.C., Fairholme Funds and Perry Capital (along with other Fannie and Freddie preferred shareholders) said they’ve obtained a Treasury memo from December 2010 that proves the government intended to wipe out the value of their shares without telling them.

“The meaning of the Treasury memorandum is crystal clear: The government of the United States established a policy to destroy private shareholder value,” the brief said.

Fannie and Freddie shareholders, as you may recall, are suing the government in both U.S. district court and the Court of Federal Claims over an August 2012 amendment to the terms of Treasury’s agreement to invest taxpayer money in Fannie and Freddie. They contend that up until the amendment, preferred shareholders believed that if Fannie and Freddie returned to profitability under the conservatorship of the Federal Housing Finance Agency, private investors would share the spoils. The 2012 amendment, they assert, illegally cut off their interests by requiring Fannie and Freddie to pay Treasury a quarterly dividend that essentially delivers all of the housing entities’ net worth to the government.

The new brief argues that Treasury was planning to eliminate any upside for investors for more than a year before the amendment was announced. In a document entitled “Action Memo for Secretary Geithner,” Treasury official Jeffrey Goldstein analyzed whether the department should require Fannie and Freddie to pay the periodic commitment fee specified in the original bailout agreement between them. As of December 2010, when the memo was written, the housing entities weren’t attracting capital and would have to draw additional funds from Treasury simply to pay Treasury the commitment fee, Goldstein said. That was a reason to waive the 2011 fee. On the other hand, he said, requiring the payment would show Treasury’s commitment to recouping taxpayers’ investment in Fannie Mae and Freddie Mac – and to cutting shareholders out of potential returns. “(It) makes clear the administration’s commitment to ensure existing common equity holders will not have access to any positive earnings from the GSEs in the future,” the memo said. (Treasury ended up waiving the 2011 fee.)

How significant is the two-page document? Friday’s brief gives the memo prominent play, and Fairholme lawyer Charles Cooper of Cooper & Kirk told me it’s a big boost for Fannie and Freddie shareholders. “It shows the basic, appalling inequity of the government’s conduct,” he said. “They decided to sacrifice completely the interests of stockholders, and they did so in secret.” Cooper said the idea of an undisclosed government policy to wipe out private investors is “extraordinarily troubling.”

Both the Justice Department, which represents Treasury, and FHFA declined comment on shareholders’ summary judgment brief and the Goldstein memo it highlights. But I suspect that the memo has considerably more public relations value than legal weight. The threshold issues in the federal district court litigation are the shareholders’ constitutional standing and the court’s jurisdiction over the claims, both of which have been challenged in motions to dismiss by Treasury and FHFA. In briefs filed in January, the Justice Department and Arnold & Porter (representing FHFA) contended that preferred Fannie and Freddie shareholders don’t have a constitutional right to sue because they haven’t actually been injured: Fannie Mae and Freddie Mac, in this argument, still haven’t repaid the entire $189 billion they received from the federal government, so there haven’t been profits to which shareholders might have been entitled. Treasury and FHFA also asserted that federal courts may not interfere with the power of the conservator of a regulated financial institution. Challenges to conservators, according to FHFA, must be filed and resolved as administrative actions before they get to U.S. District Court. On those grounds alone, the government argued, the Fannie and Freddie shareholder suits must be tossed.

Cooper & Kirk and Gibson, Dunn & Crutcher, which represents Perry Capital, do address those points at considerable length in the 106-page summary judgment motion filed Friday. Shareholders have standing to sue, they argued, because they’re injured by terms of the 2012 amendment, which preclude Fannie and Freddie from accumulating any capital so that shareholders get nothing even in a liquidation. As for jurisdiction, they said, FHFA has exceeded its powers under the law that created it, the Housing and Economic Recovery Act of 2008, and federal district courts have the power to review actions outside the scope of a conservator’s mandate. And besides, the court has jurisdiction over shareholders’ claims against Treasury regardless of whatever protection is due to FHFA, the brief said.

The Goldstein memo from 2010 has nothing to do with these fine points of constitutional and administrative law. But remember, the future of Fannie Mae and Freddie Mac is also a political issue. Earlier this month, the Senate Banking Committee announced a new bill to wind down Fannie and Freddie and replace them with a new agency. Though the committee’s leadership said that the bill, known as Johnson-Crapo, would leave it to the courts to decide the rights of Fannie Mae and Freddie Mac preferred shareholders, the National Mortgage News subsequently reported that shareholders fear the actual proposal codifies the August 2012 amendment and eliminates their financial interest.

As Congress continues to debate the future of Fannie and Freddie, preferred shareholders would much rather look like the victims of government deception – investors who relied on 2008 assurances that the government wanted the housing entities to return to profitability – than opportunists who bought stock widely regarded as worthless in the hope of profiting from a taxpayer-funded bailout. Treasury and FHFA have cast Fannie and Freddie shareholders as the latter. As soon as Treasury invested taxpayer money in Fannie and Freddie soon after they went into conservatorship, according to the government, everyone knew shares in the housing entities were worthless. But for the infusion of taxpayer cash, Fannie and Freddie would never have been able to return tens of billions of dollars to Treasury, in this view, so only taxpayers deserve a stake in those returns.

Friday’s summary judgment brief, with its invocation of a secret government nationalization, is shareholders’ response to that taxpayer-centric argument. We’ll have to see if Congress hates nationalization as much as it reveres taxpayers.

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