Tag Archives: dividends

Hope for GSE Shareholders

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Judge Lamberth issued an opinion in Fairholme Funds, Inc. v. FHFA (Civ. No.13-1439) (Sept. 28, 2018) that gives some hope to the private shareholders of Fannie Mae and Freddie Mac. These shareholders have been on the losing end of nearly every case brought against the government relating to its handling of the conservatorships of the two companies.  Readers of this blog know that I have long been a skeptic of the shareholders’ claims because of the broad powers granted the government by the Housing and Economic Recovery Act of 2008, passed during the height of the financial crisis, as well as the highly regulated environment in which the two companies operate. This highly regulated environment means that GSE profits are driven by regulatory decisions much more than those of other financial institutions. As such, Fannie and Freddie live and die by the sword of government intervention in the mortgage market.

Judge Lamberth had dismissed the plaintiffs’ claims in their entirety, but was reversed in part on appeal. In this case, he revisits the issues arising from the reversal of his earlier dismissal. Once again, Judge Lamberth dismisses a number of the plaintiffs’ claims, but he finds that that their claim that the government breached the duty of good faith survives.

The opinion gives a road map that shareholders can follow to success. The judge identifies allegations that, if true, would be a sufficient factual basis for a holding that the government breached the implied covenant of good faith and fair dealing. It is plausible that the preponderance of proof may support these allegations. Some evidence has already come to light that indicates that at least some government actors had good reason to believe that Fannie and Freddie were on the cusp of sustained profitability when the government implemented the net worth sweep. The net worth sweep had redirected the net profits of the two companies to the U.S. Treasury.

Judge Lamberth highlights some of aspects of the plaintiffs’ argument that he found compelling at the motion to dismiss phase of this litigation. First, he notes that absence of “any increased funding commitment” is atypical when senior shareholders receive “enhanced disbursement rights,” as was the case when the government implemented the net worth sweep. (21) He also states that the plaintiffs would not have expected that the GSEs would have extinguished “the possibility of dividends arbitrarily or unreasonably.” (22)

While this opinion is good news for the plaintiffs, it is still unclear what their endgame would be if they were to get a final judgment that the net worth sweep was invalid. Depending on the outcome of regulatory and legislative debates about the future of the two companies, the win may be a pyrrhic one. Time will tell. In the interim, expect more discovery battles, motions for summary judgment and even a trial in this case. So, while this opinion gives shareholders some hope of ultimate success, and perhaps some leverage in political and regulatory debates, I do not see it as a game changer in itself.

In terms of the bigger picture, there are a lot of changes on the horizon regarding the future of the housing finance system. The midterm elections; Hensarling and Corker’s departure from Congress; and the Trump Administration’s priorities are all bigger drivers of the housing finance reform train, at least for now.

AIG Suit Strengthens Government Powers

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photo by Tim Evanson

Law360 quoted me in Greenberg’s AIG Loss Strengthens Gov’t’s Crisis Powers (behind a paywall). It reads, in part,

The Federal Circuit’s decision reversing Maurice R. “Hank” Greenberg’s win in his campaign against the U.S. government over its bailout of American International Group Inc. was the latest in a string of defeats for investors challenging financial crisis bailouts, and could further strengthen the government’s hand in future crises, experts say.

The Federal Circuit on Tuesday rejected claims by Greenberg, AIG’s former chief executive, and his current company, Starr International Co. Inc., that the government engaged in an unconstitutional taking of property when it demanded and received 80 percent of the giant insurance company’s stock in exchange for an $85 billion bailout in September 2008.

Although the appellate panel overturned a lower court ruling by rejecting Greenberg’s standing to sue, it came in the wake of a series of rulings against shareholders in Fannie Mae and Freddie Mac. Those shareholders are seeking to overturn a President Barack Obama-era move to sweep profits from the bailed out mortgage giants back to the U.S. Department of the Treasury rather than into shareholder dividends, cases courts have repeatedly rejected.

Those wins mean that courts are giving the government wide latitude to respond to a financial crisis, even if some shareholders are harmed, said David Reiss, a professor at Brooklyn Law School.

“There’s now a lot of judges who have come down to effectively say, ‘The government had very broad authority to address the financial crisis, and we’re not going to second-guess that,'” he said.

Greenberg’s campaign against the Federal Reserve, the Treasury Department and other arms of the U.S. government stems from the effort to bail out AIG in 2008 after it was brought to the brink of insolvency due to the failure of credit default swaps held by its structured finance unit.

In exchange for the $85 billion loan that the Federal Reserve Bank of New York ultimately extended, AIG and its board agreed to hand over nearly 80 percent of its equity and fire its top executives.

Greenberg, who left AIG in 2005 under a cloud, and his current firm Starr International were the largest shareholders in the world’s largest insurer, and argued in a 2011 lawsuit that the government had engaged in an illegal taking of shareholder property.

Federal Claims Judge Thomas C. Wheeler agreed with at least part of Greenberg’s argument in a June 2015 decision, saying that the Fed had placed unduly tough terms on AIG in exchange for the bailout loan, with those terms exceeding the central bank’s authority under Section 13(3) of the Bank Holding Company Act.

However, Judge Wheeler did not award any damages to Greenberg and shareholders in the class action, arguing that their shares would have been worth nothing without the government’s action.

Both Greenberg and the government appealed, and the Federal Circuit on Tuesday reversed Judge Wheeler’s holding on the question of whether the government exceeded its authority by placing tough terms on the bailout.

However, the opinion did not focus on the government’s actions but on the question of standing. Greenberg and his company did not have it, so the rest of his argument was moot, the panel said.

    *     *     *

While the Federal Circuit did not address the substance of Greenberg’s claims, the U.S. Supreme Court might.

Greenberg and Starr said Tuesday they plan to take their case to the U.S. Supreme Court. If the high court takes up the case, despite a lack of a circuit split on the issue of lawsuits over financial crisis-era bailouts, they could set the terms under which the government acts in a future financial crisis.

But even without a Supreme Court ruling in their favor, the government should feel that it is on stronger legal ground during a financial crisis with its two wins at the appellate court level, Reiss said.

“Companies who are looking to reverse government actions at the height of the financial crisis … are having a really tough row to hoe,” he said.

Stressing out on Fannie and Freddie

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The Federal Housing Finance Agency issued Projections of the Enterprises’ Financial Performance (Stress Tests) (Apr. 30, 2014). This is a pretty technical, but important, document. The Background section provides some needed context:

This report provides updated information on possible ranges of future financial results of Fannie Mae and Freddie Mac (the “Enterprises”) under specified scenarios, using consistent economic conditions for both Enterprises.

*     *     *

. . . the Dodd-Frank Act requires certain financial companies with total consolidated assets of more than $10 billion, and which are regulated by a primary Federal financial regulatory agency, to conduct annual stress tests to determine whether the companies have the capital necessary to absorb losses as a result of adverse economic conditions. This year is the initial implementation of the Dodd-Frank Act Stress Tests.

In addition to stress tests required per the Dodd-Frank Act, this year as in previous years, FHFA worked with the Enterprises to develop forward-looking financial projections across three possible house price paths (the “FHFA scenarios”). The Enterprises were required to conduct the FHFA scenarios as they have in the past, in conjunction with the initial implementation of the Dodd-Frank Act Stress Tests.

*     *     *

The projections reported here are not expected outcomes. They are modeled projections in response to “what if” exercises based on assumptions about Enterprise operations, loan performance, macroeconomic and financial market conditions, and house prices. The projections do not define the full range of possible outcomes. Actual outcomes may be very different. (4, emphasis in the original)

 The stress test results are as follows:

Dodd-Frank Act Stress Tests Severely Adverse Scenario

  • As of September 30, 2013, the Enterprises have drawn $187.5 billion from the U.S. Treasury under the terms of the Senior Preferred Stock Purchase Agreements (the “PSPAs”).
  • The combined remaining funding commitment under the PSPAs as of September 30, 2013 was $258.1 billion.
  • In the Severely Adverse scenario, incremental Treasury Draws range between $84.4 billion and $190.0 billion depending on the treatment of deferred tax assets.
  • The remaining funding commitment under the PSPAs ranges between $173.7 billion and $68.0 billion. (3)

FHFA Scenarios

  • In the FHFA scenarios, cumulative, combined Treasury draws at the end of 2015 remain unchanged at $187.5 billion as neither Enterprise requires additional Treasury draws in any of the three scenarios.
  • The combined remaining commitment under the PSPAs is unchanged at $258.1 billion.
  • In the three scenarios the Enterprises pay additional senior preferred dividends to the US Treasury ranging between $54.0 billion to $36.3 billion. (3)

There are a number of important points to keep in mind when reviewing this report. First, it addresses just four scenarios out of the the multitude of possible ones. But hopefully the Severely Adverse Scenario gives us a sense of the outer limits of what a crisis could do to the Enterprises and the taxpayers who backstop them.

Second, the report is another corrective to arguments that the federal government’s bailout of the Enterprises can be measured by the amount of money that they actually advanced to the two companies, as opposed to a measure that also accounts for the additional amount that the federal government is committed to provide them if their financial situation takes a turn for the worse.

Finally, as I have noted before, there is an important political battle for control of the narrative of the bailout of the Enterprises. The only narrative during the crisis itself was that the federal government bailed out the two companies because they were insolvent. Revisionist histories, put forward in the main by private shareholders of the two Enterprises, challenge that narrative. The shareholders put forth another version of history: the federal government effectively stole  solvent, viable Fannie and Freddie from them. It will be important for objective third parties to document the truth about this in accordance with Generally Accepted Accounting Principles. From my understanding of the facts, however, it is clear that the two companies were as good as dead when the federal government put them into conservatorship in 2008 and started advancing them tens of billions of dollars year after year until their fortunes turned around in 2012.

Fannie and Freddie’s Debt to Treasury

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Larry Wall of the Federal Reserve Bank of Atlanta has posted one of his Notes from the Vault, Have the Government-Sponsored Enterprises Fully Repaid the Treasury? It opens,

Have U.S. taxpayers been fully compensated for their bailout of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac? The Treasury is reported to have argued that “the value of Treasury’s commitment to the GSEs was “incalculably large,'” with the implication that it could never be repaid. Richard Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution [and who discloses that he consults “with several hedge funds with positions in Fannie and Freddie”], responded that “the level of the Treasury commitment was not ‘incalculably large’: it was $188 billion, all of which will shortly be repaid.” The significance of Epstein’s argument is that if Treasury has been fully compensated for its bailout of Fannie and Freddie, a case can be made that the future profits of the two GSEs should go to their private shareholders.

As an accounting matter, one could argue that Epstein is correct; the dividends equal the amount of Treasury funds provided to the GSEs. And as a legal matter, the issue may ultimately be resolved by the federal courts. However, as an economic matter, the value of the government’s contribution clearly exceeds $188 billion once the risk borne by taxpayers is taken into account.

In this Notes from the Vault I examine the value of the taxpayers’ contribution to Fannie and Freddie from an economic perspective. My analysis of these contributions is divided into three parts: (1) the GSEs’ profitability prior to the 2008 conservatorship agreement (bailout), (2) the value of the taxpayer promise at the time of the bailout, and (3) support of new investments since they were placed in conservatorship. (1)

The article goes on to explain each of these three parts of the taxpayers’ contribution and concludes,

The claim that the taxpayers and Treasury have been fully repaid for their support of Fannie Mae and Freddie Mac is based on an accounting calculation that does not withstand economic analysis. The claim that Treasury’s commitment has been fully repaid attributes no dividend payments to Treasury starting in 2012, attributes no value to the government guarantee to absorb whatever losses arose in the pre-conservatorship book of business, and arguably reflects Treasury setting too low of a dividend rate on its senior preferred stock. Moreover, the profits that are being used to pay the dividends did not arise from the contributions of private shareholders but rather entirely reflect risks borne by the Treasury and taxpayers. Thus, the Treasury claim that the value of the aid was “incalculable” is an exaggeration; the value surely can be fixed within reasonable bounds. However, the implication of this claim, that the GSEs cannot repay the economic value on behalf of their common shareholders, is nevertheless accurate. (2)

This article offers a useful corrective to the story one hears from those representing Fannie and Freddie’s shareholders. They have constructed a simple narrative of the bailout of the two companies that ignores the way that the two companies’ fortunes have been intrinsically tied to the federal government’s support of them. That simple narrative just nets out the monies that Treasury fronted Fannie and Freddie with the payments that the two companies made back to Treasury.  After netting the two, they say, “Case closed!” Wall has demonstrated that there are a lot more factors at play than just those two.

I would also highlight something that Wall did not: the federal government actually determines the level of profits that Fannie and Freddie can make by setting the fees the two companies charge for guaranteeing mortgages. So, the federal government could wipe away future profits by lowering the guaranty fees. And wiping away those profits would make those outstanding shares worthless.

So the question remains: what is the endgame for the investors who have brought these lawsuits?