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.”