GSE Shareholders Floored, Again

The United States Court of Appeals for the Eighth Circuit issued an opinion in Saxton v. FHFA (No. 17-1727, Aug. 23, 2018). The Eighth Circuit joins the Fifth, Sixth, Seventh and D.C. Circuits in rejecting the arguments of Fannie and Freddie shareholders that the Federal Housing Finance Agency exceeded its authority as conservator of Fannie Mae and Freddie Mac and acted arbitrarily and capriciously. The Court provides the following overview:

     The financial crisis of 2008 prompted Congress to take several actions to fend off economic disaster. One of those measures propped up Fannie Mae and Freddie Mac. Fannie and Freddie, which were founded by Congress back in 1938 and 1970, buy home mortgages from lenders, thereby freeing lenders to make more loans. See generally 12 U.S.C. § 4501. Although established by Congress, Fannie and Freddie operate like private companies: they have shareholders, boards of directors, and executives appointed by those boards. But Fannie and Freddie also have something most private businesses do not: the backing of the United States Treasury. 

     In 2008, with the mortgage meltdown at full tilt, Congress enacted the Housing and Economic Recovery Act (HERA or the Act). HERA created the Federal Housing Finance Agency (FHFA), and gave it the power to appoint itself either conservator or receiver of Fannie or Freddie should either company become critically undercapitalized. 12 U.S.C. § 4617(a)(2), (4). The Act includes a provision limiting judicial review: “Except as  provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.” Id. § 4617(f). 

     Shortly after the Act’s passage, FHFA determined that both Fannie and Freddie were critically undercapitalized and appointed itself conservator. FHFA then entered an agreement with the U.S. Department of the Treasury whereby Treasury would acquire specially-created preferred stock and, in exchange, would make hundreds of billions of dollars in capital available to Fannie and Freddie. The idea was that Fannie and Freddie would exit conservatorship when they reimbursed the Treasury.

     But Fannie and Freddie remain under FHFA’s conservatorship today. Since the conservatorship began, FHFA and Treasury have amended their agreement several times. In the most recent amendment, FHFA agreed that, each quarter, Fannie and Freddie would pay to Treasury their entire net worth, minus a small buffer. This so-called “net worth sweep” is the basis of this litigation. 

     Three owners of Fannie and Freddie common stock sued FHFA and Treasury, claiming they had exceeded their powers under HERA and acted arbitrarily and capriciously by agreeing to the net worth sweep. The shareholders sought only an injunction setting aside the net worth sweep; they dismissed a claim seeking money damages. Relying on the D.C. Circuit’s opinion in Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017), the district court dismissed the suit.

What amazes me as a longtime watcher of the GSE litigation is how supposedly dispassionate investors lose their heads when it comes to the GSE lawsuits. They cannot seem to fathom that judges will come to a different conclusion regarding HERA’s limitation on judicial review.

While I do not rule out that the Supreme Court could find otherwise, particularly if Judge Kavanaugh is confirmed, it seems like this unbroken string of losses should provide some sort of wake up call for GSE shareholders. But somehow, I doubt that it will.

Countercyclical Regulation of Housing Finance

Pat McCoy has posted Countercyclical Regulation and Its Challenges to SSRN. The abstract reads,

Following the 2008 financial crisis, countercyclical regulation emerged as one of the most promising breakthroughs in years to halting destructive cycles of booms and busts. This new approach to systemic risk posits that financial regulation should clamp down during economic expansions and ease during economic slumps in order to make financial firms more resilient and to prick asset bubbles before they burst. If countercyclical regulation is to succeed, however, then policymakers must confront the institutional and legal challenges to that success. This Article examines five major challenges to robust countercyclical regulation – data gaps, early response systems, regulatory inertia, industry capture, and arbitrage – and discusses a variety of techniques to defuse those challenges.

Readers of this blog will be particularly interested in the section titled “Sectoral Regulatory Tools.” (34 et seq.) This section gives an overview of countercyclical tools that can be employed in the housing finance sector:  loan-to value limits; debt-to-income limits; and ability-to-repay rules. McCoy ends this section by noting,

The importance of the ability-to-repay rule and the CFPB’s exclusive role in promulgating that rule has another, very different ramification. It is a mistake to ignore the role of market conduct supervisors such as the CFPB in countercyclical regulation. The centrality of consumer financial protection in ensuring sensible loan underwriting standards – particularly for home mortgages – underscores the vital role that market conduct regulators such as the CFPB will play in the federal government’s efforts to prevent future, catastrophic real estate bubbles. (44)

While this seems like an obvious point to me — sensible consumer protection acts as a brake on financial speculation — many, many academics who study financial regulation disagree. If this article gets some of those academics to reconsider their position, it will make a real contribution to the post-crisis financial literature.