DOJ: Fannie, Freddie shareholder demands endanger housing market
The Justice Department really, really, really does not want to turn over documents disclosing the government’s projection of profits at Fannie Mae and Freddie Mac, nor its policy plans for the mortgage giants. In a filing this week in the U.S. Court of Federal Claims, the head of Fannie and Freddie’s conservator, Melvin Watt of the Federal Housing Finance Agency, warned that if FHFA has to produce that material to preferred shareholders suing for a share of Fannie and Freddie’s profits, the entire housing market — nay, the entire U.S. economy! — will be destabilized. That’s an awfully dire prediction for what amounts to a discovery dispute.
The government is asking Judge Margaret Sweeney for a protective order restricting the discovery it must produce to preferred shareholders of Fannie Mae and Freddie Mac, who contend that the Treasury Department illegally appropriated their fair allocation of profits when FHFA and Treasury agreed in August 2012 to amend the terms of Treasury’s bailout investment in Fannie and Freddie. The so-called “net worth sweep” diverted all Fannie and Freddie profits back to the government, leaving nothing for preferred shareholders. Led by the hedge funds Fairholme and Perry Capital, those shareholders have sued the United States in both federal district court in Washington, where they’re trying to block the alleged appropriation, and in the Court of Claims, where they’re hoping to recover some of the tens of billions of dollars they claim they will be due when Fannie and Freddie are liquidated. (The litigation, to be clear, doesn’t involve common stock in Fannie and Freddie, in which activist investor Carl Icahn has just sunk about $50 million, apparently in the hope that common shareholders will recover something when Congress figures out how to reform the mortgage investment market.)
The preferred shareholders, as I’ve reported, have already turned up in their federal district court case what they regard as evidence that Treasury planned all the way back in 2010 to wipe out the value of their shares. But Fairholme and its lawyers at Cooper & Kirk believed they’d won the right to much newer and more sweeping materials in February, when Judge Sweeney ruled in the Court of Claims that preferred shareholders are entitled to see government documents that would help them refute the Justice Department’s arguments for tossing the case. Among other things, Sweeney wrote, shareholders needed to know whether FHFA was acting as an arm of the U.S. government when it agreed to divert all Fannie and Freddie profits to Treasury and whether the government expects the mortgage entities to continue to generate profits.
But that information, according to the government, could well interfere with long-running negotiations in Congress to resolve the fate of Fannie Mae and Freddie Mac. The Justice Department informed Fairholme on May 2 that it objected to all 19 of the broad categories of documents Fairholme was demanding. (The government was also none too pleased that Fairholme served subpoenas directly on Fannie and Freddie, as acting deputy director Kenneth Dintzer of Justice’s Civil Division informed Judge Sweeney at a status hearing on May 7.)
In its most recent filing, Justice explained the supposed peril of disclosing information to Fairholme and its ilk, with the help of declarations from FHFA director Watt and Treasury official Michael Stegman. Between them, the two warned that disclosing the government’s projections for Fannie and Freddie would disrupt delicate negotiations, unsettle Fannie and Freddie employees and reverberate disastrously in the mortgage market. “The disclosure of forward-looking, non-public information could result in an array of consequences such as sharp spikes or declines in the cost of obtaining credit for borrowers and large shifts in the demand for mortgage-backed securities,” Watt said in his declaration. “This result would undermine FHFA’s ability to direct the conservatorships and detract from Congress’s goal of maintaining stability in the federal housing markets.” Stegman added that turning over policy documents to Fairholme would undermine the executive branch’s ability to develop policies and strategies — an eventuality that the Deliberative Process Privilege is supposed to avert.
“Indeed, because policy efforts in the area of housing finance reform are ongoing, the documents covered by these requests continue to be created as an ongoing matter,” Stegman said. “If other agencies feel that they cannot share information with Treasury without it being subject to disclosure in the future, they may cease communicating freely with Treasury.”
The government also made a non-policy argument for restricting Fairholme’s discovery, arguing that the Housing and Economic Recovery Act of 2008, which established FHFA, precludes shareholders from exercising any right to money damages for as long as Fannie Mae and Freddie Mac remain in conservatorship. Under HERA, Justice wrote, Fairholme and other shareholders don’t have the legal grounds to sue in the Court of Claims.
You can see from a footnote in Justice’s filing why the government hates the idea of disclosing anything to Fairholme. As the brief explains, the hedge fund bought all of its preferred shares in Fannie Mae and Freddie Mac after the August 2012 agreement that diverted all profits to Treasury. Fairholme, in the government’s account, wasn’t taken aback by a sudden change in shareholder rights: It acquired its stake because it was betting it would succeed in litigation. That’s in contrast with some of the other preferred shareholders suing the United States, the government said, which still own shares they held before the 2012 policy change.
Judge Sweeney has heard similar arguments from the government before, in opposition to Fairholme’s original motion for discovery. Obviously, she didn’t buy them the first time around, but she wants another round of briefing on how broad Fairholme’s requests should be. On Wednesday, she ordered the two sides to propose a joint schedule by the end of this week.
The fate of the U.S. economy hangs in the balance.
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