December 3, 2014
Fundweb quoted me in Stateside: My Kingdom for a House. It reads in part,
History repeats itself. In 1483, Richard III seized the British crown from his 13-year-old nephew on a trumped up legal sophistry. One justification was to prevent a return to the chaos of the War of the Roses, considered likely to resume under a child king. (Many historians believe he subsequently murdered those princes in the tower to dispense with future claims.)
Five centuries later, the issue of confiscation returns in the form of US government actions taken to stabilise the financial system during the 2008 credit crisis. The usurpation argument repeats that the end justifies the means and the rule of law may be subverted in perceived emergencies for the common good. Recent legal cases are challenging that principle, with momentous long- term consequences for the nation.
Specifically, in 2008, Congress enacted the Housing Economic and Recovery Act, which authorised loans to mortgage agencies Fannie Mae and Freddie Mac known as government-sponsored entities. The HERA law placed the GSEs in a conservatorship, giving the US government senior preferred shares in the companies, which paid the government a 10 per cent dividend.
Eventually, the GSEs became immensely profitable again, having now repaid $30bn more to the government than the original loan. In 2012, the conservator passed a third amendment, which transformed the 10 per cent preferred dividend to a sweep of all profits, forever.
Richard Bove, vice-president equity research at Rafferty Capital Markets, responds: ”If the government has the right to override any contract and can appropriate private property for itself, then contracts mean nothing in the US and the government is like Richard III.”
Politics of populism
Ultimately, the government may determine whether the GSEs survive or in what guise or how their profits are distributed.
“Politicians are carrying out what people want them to do. The public and the media maintain that if the bankers are harming society and the economy, there is no limitation on what the government can do,” says Bove. But beware. Investor confidence further erodes each time the government steps in to act unilaterally in the name of crisis control. The determinant is whether or not the country needs the GSEs to continue to underwrite mortgages and the answer is probably yes. Without them, there will be no one to under-write 30-year mortgages, “the monthly cost of owning a home will go up, prices will go down and it will kill housing in the US,” Bove insists.
Mel Watts, who was appointed this year as a new conservator, may represent a new direction for reshaping the GSEs. His recent speeches suggest he may be planning to merge the two agencies and liberate them from conservatorship status.
David Reiss, professor at Brooklyn Law School, points out another drawback to leaving the GSEs in limbo for six years. Executives, employees and others are now running for the exits, with turnover at the top. The agencies back 60 per cent of residential US mortgages but no longer know who they are. “It’s not healthy for homeowners or taxpayers,” says Reiss.
Investment War of the Roses
A number of hedge fund investors have rebelled, challenging the conservator’s behaviour. Marquee names include Perry Capital, Fairholme Funds and Pershing Square Capital Management. Their claims generally derive from assertions that the conservator illegally expropriated shareholder profits. The plaintiff hedge funds represent a motley crew, some of whom bought the stock after 2009, knowing they were picking up lottery tickets, and others well predating the conservatorship. From the sidelines, smaller investors watched keenly and joined the big boys’ ranks.
“People bought the stock only knowing that Icahn, Berkowitz and Ackmann had positions, so they followed like lemmings,” says Bove. To compound the confusion, most conventional wisdom from commentators lined up on one side. Many were openly remunerated by the shareholders, like New York University’s Richard Epstein.
Reiss adds that, “with no public speakers of equivalent prestige on the other side, it seemed inconceivable the investors might lose, which was a perfect set up for falling hard”.
Indeed they fell, with the recent ruling by Judge Royce Lamberth in the Perry hedge fund case. The court dismissed the suit with complex arguments but one theme undergirded the judge’s ruling: the government had acted forcefully in a financial emergency, authorised by Congress, which he hesitated to unwind.| Permalink