Tag Archives: FHFA

More on GSE Litigation

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Inside Mortgage Finance did a longer story on the GSE litigation that profiled my take on it, Expert: GSE Shareholder Suits at ‘Early Stage’ of a Long Process; Litigation No Barrier to Dissolution, Says Group.

Look for the various lawsuits filed by private owners of Fannie Mae and Freddie Mac stock against the federal government to take a “very long time to be decided,” as the courts may take up to a year to resolve just the introductory motions, according to a legal expert. Beyond that, the litigation over shares in the two government-sponsored enterprises could stretch out to the U.S. Supreme Court.

Brooklyn Law School Professor David Reiss, speaking during a Bloomberg Industries webinar last week, noted that lawsuits stemming from the savings and loan debacle of 20 years ago give a sense of the possible timeframe, but litigation brought by disenfranchised Fannie and Freddie investors against the government offers an entirely different and deeper set of legal complexities.

“These are factually and legally complex cases and don’t trust anyone who thinks this is a slam dunk for any one of the parties,” said Reiss. He added that neither the government nor shareholders of the two government-sponsored enterprises can cut a deal and settle for anything short of total victory.

“I think we have plaintiffs that are going to go all the way on this because they have a lot at stake and they have a lot of resources to pursue their claims. You have a government that doesn’t have an incentive to settle like a normal private party does. They’re not worried about litigation costs or time, so I foresee this going on for a very, very long time,” said Reiss.

More than a dozen lawsuits filed against the government – led by hedge funds Perry Capital and Fairholme Capital Management – are pending in federal district court in Washington, DC, and in the Court of Federal Claims. The shareholder plaintiffs allege that the Treasury’s 2012 change in the dividend structure of its preferred stock leaves no funds to pay dividends to junior shareholders.

The government in its pending motion to dismiss gives some clear indication as to the tactics it will take to derail the various shareholder suits, Reiss explained. The government’s brief states that not a single plaintiff is entitled to recover anything – either on their individual or derivative claims – in light of the extensive powers that the Housing and Economic Recovery Act vests in the Federal Housing Finance Agency in its capacity as conservator to the GSEs.

“Until we have some motions to dismiss decided, we’re not really going to know how wide a scope these cases will have,” he said. “Only when we having a ruling on a summary judgment motion, will we have a sense of the real issues in contention. I will say that we are at an absolutely early stage.”

With the “entire range of private, administrative and constitutional principles” due to be called into question through the litigation, Reiss said there’s a great deal of uncertainty how the courts will decide the issue, including whether the Supreme Court will hear the inevitable appeal by plaintiffs or the defendant.

Although the pending shareholder litigation and investors’ claims of a government taking “must be taken seriously,” there’s no barrier – either from a legal or safety and soundness standpoint – preventing Fannie and Freddie from being dissolved, the Heritage Foundation argued in an issue brief.

“Protecting property rights, however, does not mean that taxpayers and consumers must continue to be put at risk by these government-sponsored housing giants,” said Heritage. “The ongoing lawsuits need not impede and should not distract Congress from the critical task of dissolving these economically dangerous institutions.”

Each of the GSE charters explicitly grants Congress the power to dissolve the corporations free of any conditions. After dissolution, Heritage notes that creditors would be paid off, with any remaining assets divided among shareholders, taking into account the priorities of different classes of shares.

“Because the United States is a defendant in the lawsuits, the litigation can proceed independently of the GSEs’ dissolution,” said Heritage. “If shareholders prevail on their takings claim, or any other monetary claim, they would still be able to receive full restitution for any legitimate claims.”

Reiss on GSE Litigation

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Inside Mortgage Finance profiled me in Legal Expert: GSE Shareholder Plaintiffs, U.S. Want ‘Total’ Victory (behind a paywall). It reads,

Look for the various GSE shareholder lawsuits against the federal government to take a “very long time to be decided” with the courts taking up to a year to resolve just the introductory motions and an ultimate appeal to the U.S. Supreme Court.

That’s the view of one legal expert speaking during a recent Bloomberg Industries webinar on Fannie Mae and Freddie Mac litigation. Brooklyn Law School Professor David Reiss noted there are some parallels to the savings and loan lawsuits brought by owners against the federal government 20 years ago. But the attorney stressed that the litigation from the Fannie and Freddie investors against the government offers an entirely different and deeper set of legal complexities.

“These are factually and legally complex cases and don’t trust anyone that thinks this is a slam dunk for any one of the parties,” predicted Reiss. He added that neither the government nor GSE shareholders can cut a deal and settle for anything short of total victory.

In its motion to dismiss, the government argues that the plaintiffs – hedge funds that have speculated in the junior preferred – are not entitled to recover anything, either on their individual or derivative claims, in light of the extensive powers that the Housing and Economic Recovery Act granted to the Federal Housing Finance Agency in its capacity as conservator.

With the “entire range of private, administrative and constitutional principles” due to be called into question in this litigation, Reiss said there’s a great deal of uncertainty over how the courts will decide the issue, including whether the Supreme Court will hear the inevitable appeal by plaintiffs or defendant.

Reiss in Bloomberg Industries Q&A on Frannie Litigation

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Bloomberg Industries Litigation Analyst Emily Hamburger interviewed me about The Government as Defendant: Breaking Down Fannie-Freddie Lawsuits (link to audio of the call). The blurb for the interview is as follows:

As investors engage in jurisdictional discovery and the government pleads for dismissals in several federal cases over Fannie Mae and Freddie Mac stock, Professor David Reiss of Brooklyn Law School will provide his insights on the dynamics of the lawsuits and possible outcomes for Wall Street, the U.S. government and GSEs. Reiss is the author of a recent article, An Overview of the Fannie and Freddie Conservatorship Litigation.

Emily questioned me for the first half of the one hour call and some of the 200+ participants asked questions in the second half.

Emily’s questions included the following (paraphrased below)

  • You’re tracking several cases that deal with the government’s role in Fannie Mae and Freddie Mac, and I’d like to go through about 3 of the major assertions made by investors – investors that own junior preferred and common stock in the GSEs – against the government and hear your thoughts:
    • The first is the accusation that the Treasury and FHFA’s Conduct in the execution of the Third Amendment was arbitrary and capricious. What do you think of this?
    •  Another claim made by the plaintiffs is that the government’s actions constitute a taking of property without just compensation, which would be seen as a violation of the 5th Amendment – do you think this is a stronger or weaker claim?
    • And finally – what about plaintiffs asserting breach of contract against the government? Plaintiffs have said that the Net Worth Sweep in the Third Amendment to the Preferred Stock Purchase Agreement nullified Fannie and Freddie’s ability to pay dividends, and that the two companies can’t unilaterally change terms of preferred stock, and that the FHFA is guilty of causing this breach.
  • Is the government correct when they say that the section 4617 of the Housing and Economic Recovery Act barred plaintiff’s right to sue over the conservator’s decisions?
  • Former Solicitor General Theodore Olson, an attorney for Perry Capital, has said that the government’s powers with respect to the interventions in Fannie and Freddie “expired” – is he correct?
  • Can you explain what exactly jurisdictional discovery is and why it’s important?
  • Do we know anything about what might happen if one judge rules for the plaintiffs and another judge rules for the government?
  • Is there an estimate that you can provide as to timing?
  • Are there any precedents that you know of from prior crises? Prior interventions by the government that private plaintiffs brought suit against?
  • How do you foresee Congress and policymakers changing outcomes?
  • What do we need to be looking out for now in the litigation?
  • How does this end?

You have to listen to the audiotape to hear my answers, but my bottom line is this — these are factually and legally complex cases and don’t trust anyone who thinks that this is a slam dunk for any of the parties.

 

Watt’s up with Fannie and Freddie

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There has been a lot of press coverage of FHFA Director Watt’s first public speech since taking on his job. Watt emphasized that

we must ensure that Fannie Mae and Freddie Mac operate in a safe and sound manner.  It means that we’ll work to preserve and conserve Fannie Mae and Freddie Mac’s assets.  And it means that we’ll work to ensure a liquid and efficient national housing finance market.  Our job at FHFA is to balance these obligations . . ..

He also set forth three goals for his FHFA:

Strategic Goal 1: MAINTAIN, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets. 

Strategic Goal 2: REDUCE taxpayer risk through increasing the role of private capital in the mortgage market.

Strategic Goal 3: BUILD a new single-family securitization infrastructure for use by the Enterprises and adaptable for use by other participants in the secondary market in the future.

These goals are all totally reasonable for the FHFA to pursue. But it is also clear that Director Watt is taking the FHFA in a direction that is quite different than the one pursued by his predecessor, Acting Director DeMarco.  DeMarco had taken the position that the best way to protect taxpayers was to be pretty tough on everyone else. “Everyone else” included defaulting and underwater homeowners as well as originating lenders who had sold Fannie and Freddie tons of mortgages that did not comply with the reps and warranties that the parties had agreed to about the quality of those mortgages. DeMarco’s strategy was much criticized but also quite coherent.

Watt has made it clear that he is going to be more flexible with homeowners. He highlighted a pilot program in Detroit that will include “deeper loan modifications.”  He has also made it clear that he is going to be more flexible with lenders, relaxing rep and warranty standards for mortgages that Fannie and Freddie purchase from lenders. These may be very good policies to pursue, but it would be helpful if he set forth a clearer vision of how safety and soundness is best balanced with liquidity and efficiency. Federal housing finance policy typically goes off the rails when its goals get all mixed up. Director Watt should ensure that FHFA’s safety and soundness goals are clearly set forth and that other goals for Fannie and Freddie are designed to work in harmony with them.

Reiss on FHFA Leadership of Housing Finance Reform

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Law360.com quoted me in FHFA Set To Take The Lead In Housing Finance Reform (behind a paywall). It reads in part,

With hopes for a legislative fix for the U.S. housing finance market fading after six key Democrats reportedly refused to support a reform bill pending in the Senate Banking Committee, the Federal Housing Finance Agency will become the central player in reshaping the market and set the terms for any future changes.

The Banking Committee’s leaders — Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho — were unable to scare up the overwhelming support their housing finance reform bill needed in a last-gasp effort at getting a vote from the full Senate. That leaves the bill’s prospects of getting to President Barack Obama prior to the midterm elections at near zero and the FHFA, the conservator for Fannie Mae and Freddie Mac since 2008, as the biggest player in reshaping the U.S. housing market.

“It was always my operating assumption that it was going to be exceedingly difficult to get congressional consensus. Most of the action was going to take place by way of the actions at the FHFA,” said former Republican Rep. Rick Lazio, now a partner at Jones Walker LLP.

The lack of legislation also throws a wild card into the equation, since FHFA head Mel Watt has essentially been silent about his intentions for the FHFA since he won Senate confirmation in December.

“Hopefully, Watt will have a positive vision of the future of the two companies,” said Brooklyn Law School professor David Reiss.

More than five years after Fannie Mae and Freddie Mac were placed under FHFA conservatorship after receiving a more-than-$187 billion taxpayer bailout in the fall of 2008, Congress has yet to act on creating a new system for home purchases and eliminating the two companies.

And then, beginning last spring, Congress kicked into gear.

First, Sen. Bob Corker, R-Tenn., and Sen. Mark Warner, D-Va., introduced a bill that Johnson and Crapo would use as the basis for their own legislation, leaving a limited role for government in guaranteeing the mortgage market.

Soon after, the House Financial Services Committee passed its own housing finance reform bill looking to eliminate the government’s role in the housing market entirely.

Johnson and Crapo released their bill, which would eliminate Fannie and Freddie within five years and replace it with a mortgage insurance agency modeled on the Federal Deposit Insurance Corp., in March. They scheduled a markup and vote on the bill for late April.

But the two senators delayed the vote at the last minute when it became clear that while they had the 12 votes needed to pass the bill out of the 22-member committee, they lacked the 16 to 18 votes needed to force Senate Majority Leader Harry Reid to bring it up for a vote.

Johnson and Crapo said they would continue negotiations with six undecided Democrats, but according to media reports, those negotiations foundered on worries about access to affordable housing in the bill.

Undeterred, Johnson vowed to bring the bill up for a vote next week.

“Those involved in the negotiations have indicated they are interested in continuing to work together to try and find common ground, so the Banking Committee will keep working after favorably reporting out the bill next week,” Sean Oblack, a Democratic spokesman for the committee, said in a Thursday statement.

Still, the failure to get overwhelming support for the Johnson-Crapo bill essentially dooms the prospects for housing finance legislation this year, Lazio said.

“The administration will probably wait until early next Congress to make a decision about whether they think reform is possible,” he said.

But reform efforts will not stop, since the FHFA has a large amount of discretion over the futures of Fannie Mae and Freddie Mac.

“The regulator here is very powerful,” Reiss said.

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Reiss on Bloomberg Terminals regarding GSE Litigation

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I was quoted on the Bloomberg Terminals (behind a very expensive paywall!) on May 6th about the Fannie and Freddie litigation:

Even if the Junior Preferred Shareholders get the Court to void the Third Amendment to the PSPA, they cannot force the companies to issue dividends so that shareholders receive a payoff. And if the government were to lower the guarantee fee that the two companies can charge or if it were to remove the government’s guarantee of the two companies, Fannie and Freddie’s profits would dissipate altogether.

Given that junior preferred shareholders have developed a multi-pronged strategy to squeeze as much value out of their shares as possible, it is worth attempting to determine the possible endgames that they have in mind. It is hard for me to identify a litigation outcome that results in money in their pockets for the reasons stated above. So the litigation strategy must be part of a broader strategy that involves lobbying over housing finance reform in Congress, lobbying the FHFA and other regulators or negotiating with the two companies. Given the amount of money at stake and the depth of the pockets of the junior preferred shareholders, one can imagine that they are playing a very long-term game, one that might last longer than all of the current decision-makers in DC right now. Some disputes arising out of the S&L crisis took many, many years to resolve so there is reason to think that the junior preferred shareholders have a multi-year or even decades-long perspective on this. And the farther away we are from the events of the 2000s and the emotions that they elicit from decisionmakers, the more likely it is that the junior preferred shareholders can negotiate a favorable result for themselves.

The Second Frannie Bailout: Who Could’ve Known?

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There is a good chance that five or so years from now, Fannie and Freddie will be in the midst of another bailout. This next crisis will be directly caused by the Executive and Legislative branches of the federal government. But members of those branches will say, “Nobody could have known that this crisis was going to happen, nobody is at fault.” That won’t be true, but nobody will be punished in any case. That’s because the crisis will result from inaction, that most fearsome of government flaws.

Who is the Cassandra, warning us of this impending crisis? None other than Donald Layton, the CEO of Freddie. You may think that he is speaking merely from self-interest and you would probably be right. But his self-interest happens to align with the truth in this matter.

In a letter to FHFA Director Watt, Layton writes:

the ability of Freddie Mac to continue to support the mortgage markets and the U.S. economy duling an unprecedentedly lengthy transition period should be one of the most important objectives of a housing finance reform proposal, such as the Johnson-Crapo Bill. The existing Bill draft does not focus on this issue and so, in my personal but experienced opinion, leaves the risk of a failure in Freddie Mac’ss Core Policy Function unacceptably high. With certain specific changes, none of which alter the fundamental nature of the future state envisioned or even the key aspects of the transition, l believe this risk can be reduced, although it would still remain high. (7)

Layton highlights the extraordinary complexity of Freddie’s activities in an appendix to the letter. The highlights include the fact that Freddie Mac guarantees  “about  17% of all U.S. mortgage debt outstanding;” 1,400 Servicers and 2,000 Sellers work with Freddie; and Freddie manages 44,600 REO properties. (8)

Layton states that “It goes without saying that Freddie Mac cannot deliver upon its Core Policy Function, its support of the transition to a future state, or its support of Conservatorship initiatives without experienced and knowledgeable people in place at the executive level, at the Subject matter expert level and at the “been-here-a-long-time-to-know-how-everything-works level.” (3) He believes that departures are likely to cripple the company as experienced staff move on to other, more stable opportunities, leaving behind the quagmire that life in a GSE has become.

The Executive and Legislative branches are not really moving toward some kind of resolution of the Fannie and Freddie conservatorships, although we are now five years past the initial crisis. There is a good chance that the federal government will not move us to the next phase of housing finance in the next couple of years. Operations at the two GSEs will thus continue to suffer and will likely build up to a new crisis. And it will be a totally predictable crisis.

I am the kind of person who likes to say, “I told you so.” But the stakes here are so humungous and so important for the health of the economy, that I could take no pleasure in saying I told you in 2014 that our entire housing finance edifice was going to crumble a second time in a decade. But it will, if nothing is done to prevent it today.