New Suit "Injects Vigor" into GSE Conservatorship Challenges

An unsigned article in the National Law Review takes anotherrnlook at the Federal Housing Finance Agency (FHFA)/Treasury Department handlingrnof the conservatorship of Fannie Mae and Freddie Mac (the GSEs) and the lawrnsuits that have challenged that handling. rnThe article is prompted by a new suit filed by what appears to be arnfamily of investors from Iowa which takes a different tack from suits filedrnearlier which, while they have not failed, have hit rough sledding in federalrncourts.</p

Tornrevisit history, in 2008 the GSEs, hit by the collapse of the housing market,rnfalling home prices, increasing defaults, and the unwillingness of investors tornpurchase their mortgage-backed securities, were placed in conservatorship authorityrnof the Housing and Economic Recovery Act (HERA).  The newly created FHFA was appointedrnconservator and the GSEs were provided with a line of credit by the TreasuryrnDepartment in return for preferred, dividend generating senior stock in bothrncompanies. Over the course of the next few years a total of approximately $117 billion in Treasuryrnfunds was used to shore up Fannie, and $70.5 billion for Freddie.  The preferred stock was the equivalent of 79.9%rnof the companies’ common shares with the rest remaining in private hands.  </p

Under the terms of the Treasury/GSErnagreement the GSEs were to pay 10 percent of their gross revenues to Treasury asrna dividend.  As the health of the GSEsrnimproved it was often the mere requirement of the dividend payment that causedrneach GSE to make further draws on the Treasury. rnThe two companies returned to profitability during the second quarter ofrn2012 and shortly thereafter FHFA and Treasury changed the terms of the bailoutrnto “sweep” all of Fannie and Freddie’s profits back to the Treasury -rneffectively making the companies’ debt infinite and wiping out the private shareholders.rnAgainst the bailout of $187.5 billion, Washington had recouped over $228rnbillion from the GSEs by early 2015 with no reduction in their debt. </p

The article says that HERA made it FHFA’srnprecise responsibility to work for the benefit of the shareholders. “Underrnstandard corporate law principles, that conservator is bound, by a strongrnfiduciary duty to protect the corporate assets for the benefit of both commonrnand preferred shareholders. “By working for the benefit of third partyrntaxpayers – and to the detriment of private shareholders – the FHFA is inrnbreach of its duties under HERA.”</p

In the meantime, with the stock of eachrnGSE hovering in the $1 to $3 range and eventually delisted by major stockrnexchanges at the insistence of FHFA, hedge funds began to buy into therncompanies.  Several then sued the federalrngovernment claiming, in the words of the National Review article “that therngovernment was supposed to return the mortgage giants “to a sound financialrncondition,” not divest them of all assets.”</p

The lawsuits thus far have not met withrna lot of success.  Last fall, suits by Fairholme Funds Inc. and Perry Capital were both dismissedrnby Judge Lamberth of the U.S. District Court for the District of Columbia,rnthereby sustaining the dividend “sweep” agreement.  Perry is appealing the ruling while Fairholmernis in discovery at the U.S. Federal Claims Court. </p

According to the Review, the newrnlawsuit Saxton v. Federal HousingrnFinance Authority “injects additional vigor into the challenge.” ThomasrnSaxton, Ida Saxton, and Bradley Paynter claim that the FHFA and Treasury a)rnsystematically exceeded their limited authority under HERA, b) actedrnarbitrarily and capriciously, beyond the normal standards of administrativernlaw, and, c) breached good faith and contractual obligations to the privaternshareholders of Fannie and Freddie.</p

Unlike some of the earlier suits whichrnfocused on constitutional claims, the Saxton complaint focuses on what thernreview calls FHFA’s statutory breaches – “in particular the unprincipledrnactions in excess of the authority conferred by HERA. Although Fannie andrnFreddie were never necessarily insolvent, HERA sought to stabilize thernunprecedented turbulence in the housing market. Accordingly, FHFA usedrnauthority under HERA to send the two companies into conservatorship.”</p

The Review continues:  “Via this route, the FHFA believed it wouldrnbe able to avoid challenges from shareholders that it was confiscating privaternwealth. As conservator, the FHFA’s duty is to conserve the companies’ assetsrnfor the benefit of the common and preferred shareholders with the expectationrnthat the companies will return to sound condition in the future. Specifically,rnunder section 1145 of HERA, the FHFA may “take such action as may be – (i)rnnecessary to put the regulated entity in a sound and solvent condition, andrn(ii) appropriate to carry on the business of the regulated entity and preservernand conserve the assets and property of the regulated entity.”</p

However, rather than work asrnconservator to benefit Fannie Mae and Freddie Mac’s shareholders, as is itsrnobligation under traditional conservatorship law, the FHFA acted for thernbenefit of the U.S. government – and to the detriment of those privaternshareholders. In a surprise deal, the FHFA effectively wiped out the privaternshareholders and essentially turned the proceeds of Freddie and Fannie to thernU.S. Treasury.</p

 “Although thernpolitical winds of the moment may make it seem popular to seize these assetsrnand ignore the claims of Fannie and Freddie’s shareholders, we cannot losernsight of the longer term ramifications. The precedent set by the FHFA isrncontrary to prior practice, will make long-term private sector investing a riskierrnproposition and will make capital access for housing less accessible, not more.”  The suit “provides another opportunity tornblock the federal government from stripping private citizens of their assets tornachieve its own political objectives.  Politicalrnexpediency should not flout the rule of law.”

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