FHFA Ruled Unconstitutional, but Net Sweep Prevails

Yet another federal court has rebuffed shareholders hoping to recover some value from their investments in the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.  A three-judge panel for the Fifth Circuit (Texas) Court of Appeals refused to stop the practice of net worth sweeps required of the GSEs, but, the plaintiffs, whether their intention or not, did succeed in getting the structure of the Federal Housing Finance Agency (FHFA) ruled unconstitutional.

FHFA v Collins was an appeal of a suit filed by GSE stockholders J. Patrick Collins, Marcus J. Liotta, and William M. Hitchcock in October 2016.  It was the latest in a long stream of lawsuits against the government regarding its 2008 seizure of the GSEs.  The original suit named FHFA and its current director Melvin H. Watt and the U.S. Department of the Treasury and then Secretary Jacob J. Lew as defendants.

The suit charges that the GSEs were involuntarily and unnecessarily placed in conservatorship at the beginning of the financial crisis.  It alleges that, in 2012 as the GSEs were becoming profitable, the FHFA director at the time overstepped his authority by agreeing to revise the original agreement between the GSEs and Treasury. That revision changed the dividend agreed to by the GSEs in exchange for access to a line of credit from the Treasury to a net sweep of all GSE net worth into the Treasury every quarter in perpetuity.  Plaintiffs allege that the change was designed to ensure the companies would never be able to emerge from conservatorship, and that the government now relies on the sweep as a major source of revenue.

The Court issued a bit of a split decision, ruling against plaintiffs on the net worth issue and in their favor on the constitutional claim. The ruling said that Congress can create an independent agency as needed, but that it cannot be insulated from meaningful oversight by the executive branch. Thus FHFA, with a sole director who can only be removed from the position for cause during his or her term, is structured in violation of the constitution. However, despite the illegality of the agency's structure, the lower court's decision to allow the net sweep to continue was permitted to stand.

The ruling not only is another blow to GSE shareholders who have brought multiple suits, it also could have implications for the Consumer Financial Protection Bureau (CFPB).  Like FHFA, CFPB was established by the Housing and Economic Recovery Act of 2008 (HERA) in response to the financial crisis, has a single director, and that  director is somewhat protected from executive oversight by a set term. CFPB is also the subject of suits challenging its legality on those points.