New Suit "Injects Vigor" into GSE Conservatorship Challenges

An unsigned article in the National Law Review takes another look at the Federal Housing Finance Agency (FHFA)/Treasury Department handling of the conservatorship of Fannie Mae and Freddie Mac (the GSEs) and the law suits that have challenged that handling.  The article is prompted by a new suit filed by what appears to be a family of investors from Iowa which takes a different tack from suits filed earlier which, while they have not failed, have hit rough sledding in federal courts.

To revisit history, in 2008 the GSEs, hit by the collapse of the housing market, falling home prices, increasing defaults, and the unwillingness of investors to purchase their mortgage-backed securities, were placed in conservatorship authority of the Housing and Economic Recovery Act (HERA).  The newly created FHFA was appointed conservator and the GSEs were provided with a line of credit by the Treasury Department in return for preferred, dividend generating senior stock in both companies. Over the course of the next few years a total of approximately $117 billion in Treasury funds was used to shore up Fannie, and $70.5 billion for Freddie.  The preferred stock was the equivalent of 79.9% of the companies' common shares with the rest remaining in private hands. 

Under the terms of the Treasury/GSE agreement the GSEs were to pay 10 percent of their gross revenues to Treasury as a dividend.  As the health of the GSEs improved it was often the mere requirement of the dividend payment that caused each GSE to make further draws on the Treasury.  The two companies returned to profitability during the second quarter of 2012 and shortly thereafter FHFA and Treasury changed the terms of the bailout to "sweep" all of Fannie and Freddie's profits back to the Treasury - effectively making the companies' debt infinite and wiping out the private shareholders. Against the bailout of $187.5 billion, Washington had recouped over $228 billion from the GSEs by early 2015 with no reduction in their debt.

The article says that HERA made it FHFA's precise responsibility to work for the benefit of the shareholders. "Under standard corporate law principles, that conservator is bound, by a strong fiduciary duty to protect the corporate assets for the benefit of both common and preferred shareholders. "By working for the benefit of third party taxpayers - and to the detriment of private shareholders - the FHFA is in breach of its duties under HERA."

In the meantime, with the stock of each GSE hovering in the $1 to $3 range and eventually delisted by major stock exchanges at the insistence of FHFA, hedge funds began to buy into the companies.  Several then sued the federal government claiming, in the words of the National Review article "that the government was supposed to return the mortgage giants "to a sound financial condition," not divest them of all assets."

The lawsuits thus far have not met with a lot of success.  Last fall, suits by Fairholme Funds Inc. and Perry Capital were both dismissed by Judge Lamberth of the U.S. District Court for the District of Columbia, thereby sustaining the dividend "sweep" agreement.  Perry is appealing the ruling while Fairholme is in discovery at the U.S. Federal Claims Court.

According to the Review, the new lawsuit Saxton v. Federal Housing Finance Authority "injects additional vigor into the challenge." Thomas Saxton, Ida Saxton, and Bradley Paynter claim that the FHFA and Treasury a) systematically exceeded their limited authority under HERA, b) acted arbitrarily and capriciously, beyond the normal standards of administrative law, and, c) breached good faith and contractual obligations to the private shareholders of Fannie and Freddie.

Unlike some of the earlier suits which focused on constitutional claims, the Saxton complaint focuses on what the review calls FHFA's statutory breaches - "in particular the unprincipled actions in excess of the authority conferred by HERA. Although Fannie and Freddie were never necessarily insolvent, HERA sought to stabilize the unprecedented turbulence in the housing market. Accordingly, FHFA used authority under HERA to send the two companies into conservatorship."

The Review continues:  "Via this route, the FHFA believed it would be able to avoid challenges from shareholders that it was confiscating private wealth. As conservator, the FHFA's duty is to conserve the companies' assets for the benefit of the common and preferred shareholders with the expectation that the companies will return to sound condition in the future. Specifically, under section 1145 of HERA, the FHFA may "take such action as may be - (i) necessary to put the regulated entity in a sound and solvent condition, and (ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity."

However, rather than work as conservator to benefit Fannie Mae and Freddie Mac's shareholders, as is its obligation under traditional conservatorship law, the FHFA acted for the benefit of the U.S. government - and to the detriment of those private shareholders. In a surprise deal, the FHFA effectively wiped out the private shareholders and essentially turned the proceeds of Freddie and Fannie to the U.S. Treasury.

 "Although the political winds of the moment may make it seem popular to seize these assets and ignore the claims of Fannie and Freddie's shareholders, we cannot lose sight of the longer term ramifications. The precedent set by the FHFA is contrary to prior practice, will make long-term private sector investing a riskier proposition and will make capital access for housing less accessible, not more."  The suit "provides another opportunity to block the federal government from stripping private citizens of their assets to achieve its own political objectives.  Political expediency should not flout the rule of law."