Tag Archives: Housing and Economic Recovery Act

AIG’s “Victory” and the GSE Litigation

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AIG_Headquarters_New_York_City

Court of Federal Claims Judge Wheeler issued an Opinion and Order in Starr International Company, Inc. v. United States, No. 11-779C (June 15, 2015), the case that Hank Greenberg brought against the government over the terms of the bailout of AIG during the financial crisis. The judge found that the government exceeded its authority in taking an equity interest in AIG, but did not award the plaintiffs any damages.  Many will read the tea leaves of this opinion to see what they tell us about the litigation brought against the federal government by shareholders in Fannie and Freddie arising from the bailout of those two companies. I think it offers little guidance as to liability but lots as to damages.

My most important takeaway from the opinion (which seems well-reasoned to me) is that the holding is based on a close reading of the Federal Reserve Act.  The Act enumerates the powers and limitations of the Fed.  The Court held that the Act does not authorize the Fed to take equity in a company as part of a bailout.

Fannie and Freddie are regulated by the Federal Housing Finance Administration (FHFA). The FHFA’s powers and limitations, in contrast, derive from the Housing and Economic Recovery Act of 2008 (HERA), passed during the financial crisis itself.  HERA explicitly granted the FHFA broad powers as conservator.  Section 1117 of HERA authorized the Secretary of the Treasury to make unlimited equity and debt investments in the two companies’ securities through December 31, 2009.  (There is a disagreement as to whether the the Third Amendment to the Preferred Stock Purchase Agreement, discussed here, created new securities after that date, but the more general point is that HERA authorized equity investments in a way that the Federal Reserve Act did not.)

In sum, I would not read too much into the GSE litigation from the AIG litigation as it relates to the government’s ability to take equity in Fannie and Freddie.  The two cases arise under two completely different statutes.

As to the damages component of the opinion, there are many cases when a court finds for a plaintiff but only awards nominal damages.  Thus, the Court’s opinion is not particularly out of the ordinary in this regard.  Here, the Court relied on the reasoning of the Court of Appeals for the Federal Circuit in a TARP case, A&D Auto Sales, Inc. v. United States, 748 F.3d 1142 (Fed. Cir. 2014).  In that case, the Federal Circuit found that absent allegations that “GM and Chrysler would have avoided bankruptcy but for the Government’s intervention and that the franchises would have had value in that scenario,” there was no basis to argue that the government caused “a net negative economic impact” on the plaintiffs (Starr at 66, quoting A&D at 1158).

It would appear that to prove damages, the GSE litigation plaintiffs will need to overcome that bar too, even if they were to succeed in proving that the government had acted improperly in bailing out Fannie and Freddie.

The Future of Fannie and Freddie: The Definitive Panel!

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The  NYU Journal of Law & Business has published The Future of Fannie and Freddie (also on SSRN):

This is a transcript of a panel discussion titled, “The Future of Fannie and Freddie.” The panelists were Dr. Mark Calabria from the Cato Institute; Professor David Reiss from Brooklyn Law School; Professor Lawrence White from NYU Stern School of Business; Dr. Mark Willis from NYU’s Furman Center for Real Estate and Urban Policy. The panel was moderated by Professor Michael Levine from NYU School of Law. Panelists looked at economic policy and future prospects for Fannie and Freddie. My remarks focused on the goals of housing finance policy.

The actual panel occurred some time ago, but it remains current given the limbo in which housing finance reform finds itself.

Here Comes The Housing Trust Fund

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HUD has published an interim rule in the Federal Register to governing the Housing Trust Fund (HTF). The HTF could generate about a half a billion dollars a year for affordable housing initiatives, so this is a big deal. The purpose “of the HTF is to provide grants to State governments to increase and preserve the supply of rental housing for extremely low- and very low-income families, including homeless families, and to increase homeownership for extremely low- and very low-income families.” (80 F.R. 5200) HUD intends to “open this interim rule for public comment to solicit comments once funding is available and the grantees gain experience administering the HTF program.” (80 F.R. 5200)

The HTF’s main focus is rental housing, which often gets short shrift in federal housing policy

States and State-designated entities are eligible grantees for HTF. Annual formula grants will be made, of which at least 80 percent must be used for rental housing; up to 10 percent for homeownership; and up to 10 percent for the grantee’s reasonable administrative and planning costs. HTF funds may be used for the production or preservation of affordable housing through the acquisition, new construction, reconstruction, and/or rehabilitation of nonluxury housing with suitable amenities. (80 F.R. 5200)

Many aspects of federal housing policy are effectively redistributions of income to upper income households. The largest of these redistributions is the mortgage interest deduction.  Households earning over $100,000 per year receive more than three quarters of the benefits of that deduction while those earning less than $50,000 receive close to none of them.

So, the HTF is a double win for a rational federal housing policy because it focuses on (i) rental housing for (ii) extremely low- and very low-income households.

While not wanting to be a downer about such a victory for affordable housing, I will note that Glaeser and Gyourko have demonstrated how local land use policies can run counter to federal affordable housing policy. Might be worth it for federal housing policy makers to pay more attention to that dynamic . . ..

The GSE Litigation Footnote Everyone Is Talking About

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Judge Pratt (S.D.Iowa) ruled against the plaintiffs in the GSE shareholderr litigation, Continental Western Insurance Company v. The FHFA et al. (4:14-cv-00042, Feb. 3, 2015). The Judge’s order is mostly an analysis of why this case should be dismissed because of the doctrine of issue preclusion, which bars “‘successive litigation of an issue of fact or law actually litigated and resolved in a valid court determination essential to the prior judgment . . .'” (6, quoting Supreme Court precedent). The relevant prior judgment was Judge Lamberth’s (D.D.C.) opinion in a similar case that was decided last October.

While Judge Pratt did not reach the merits because he dismissed the case, he stated in a footnote

The Court notes that even if it were to reach the merits of Continental Western’s claims, including the allegedly new claims, it would agree with the well-reasoned opinion of the very able Judge Lamberth in Perry Capital that the case must be dismissed. Specifically the Court agrees that: (1) FHFA and Treasury did not act outside the power granted to them by HERA (see Perry Capital, 2014 WL 4829559 at *8–12); (2) HERA bars Continental Western’s claims under the APA (see id. at *7); (3) Continental Western’s claims for monetary damages based on a breach of contract and breach of the implied covenant of good faith and fair dealing against FHFA must be dismissed because they are not ripe and because Continental Western’s shares of the GSEs do not contractually guarantee them a right to dividends (see id. at *15–19); and (4) Continental Western’s claim for breach of fiduciary duty by FHFA is barred by HERA because it is a derivative claim and HERA grants all shareholder rights, including the right to bring a derivative suit, to FHFA (see id. at *13–15). The Court shares in Judge Lamberth’s observation that “[i]t is understandable for the Third Amendment, which sweeps nearly all GSE profits to Treasury, to raise eyebrows, or even engender a feeling of discomfort.” Perry Capital, 2014 WL 4829559 at *24. But it is not the role of this Court to wade into the merits or motives of FHFA and Treasury’s actions—rather the Court is limited to reviewing those actions on their face and determining if they were permissible under the authority granted by HERA. (19, n.6)

As I have noted before, this is not a surprising result. What remains surprising is how so many analysts refuse to see how these cases might be decided this way.

This is not to say that the plaintiffs’ cases are dead in the water. Appeals courts may reach a different result from those of the trial courts. But so many of those writing on this topic refuse to see any result other than a win for plaintiffs. Time for a reality check.

Krimminger and Calabria on Conservatorships

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When the Federal Housing Finance Agency (“FHFA”) was appointed conservator for Fannie Mae and Freddie Mac, it was the first use of the conservatorship authority under the Housing and Economic Recovery Act of 2008 (“HERA”), but it was not without precedent. For decades, the Federal Deposit Insurance Corporation (“FDIC”) has successfully and fairly resolved more than a thousand failing banks and thrifts using the virtually identical sections of the Federal Deposit Insurance Act (“FDIA”).
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The predictability, fairness, and acceptance of this model led Congress to adopt it as the basis for authorizing the FHFA with conservatorship powers over Fannie Mae and Freddie Mac in HERA. Instead of following this precedent, however, FHFA and Treasury have radically departed from HERA and the principles underlying all other U.S. insolvency frameworks and sound international standards through a 2012 re-negotiation of the original conservatorship agreement.
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     This paper will:
  • Describe the historical precedent and resolution practice on which Congress based FHFA’s and Treasury’s statutory responsibilities over Fannie Mae and Freddie Mac;
  • Explain the statutory requirements, as well as the procedural and substantive protections, in place so that all stakeholders are treated fairly during the conservatorship;
  • Detail the important policy reasons that underlie these statutory provisions and the established practice in their application, and the role these policies play in a sound market economy; and
  •  Demonstrate that the conservatorships of Fannie Mae and Freddie Mac ignore that precedent and resolution practice, and do not comply with HERA. Among the Treasury and FHFA departures from HERA and established precedents are the following:
    • continuing the conservatorships for more than 6 years without any effort to comply with HERA’s requirements
      to “preserve and conserve” the assets and property of the Companies and return them to a “sound and solvent” condition or place them into receiverships;
    • rejecting any attempt to rebuild the capital of Fannie Mae or Freddie Mac so that they can return to “sound and solvent” condition by meeting regulatory capital and other requirements, and thereby placing all risk of future losses on taxpayers;
    • stripping all net value from Fannie Mae and Freddie Mac long after Treasury has been repaid when HERA, and precedent, limit this recovery to the funding actually provided;
    • ignoring HERA’s conservatorship requirements and transforming the purpose of the conservatorships from restoring or resolving the Companies into instruments of government housing policy and sources of revenue for
      Treasury;
    • repeatedly restructuring the terms of the initial assistance to further impair the financial interests of stakeholders contrary to HERA, fundamental principles of insolvency, and initial commitments by FHFA; and
    • disregarding HERA’s requirement to “maintain the corporation’s status as a private shareholder-owned company” and FHFA’s commitment to allow private investors to continue to benefit from the financial value of the company’s stock as determined by the market. (1-3, footnotes omitted)

I am intrigued by the recollections of these two former government officials who were involved in the drafting of HERA (much as I was by those contained in a related paper by Calabria). But I am not convinced that their version of events amounts to a legislative history of HERA, let alone one that should be given any kind of deference by decision-makers. The firmness of their opinions about the meaning of HERA is also in tension with the ambiguity of the text of the statute itself. The plaintiffs in the GSE conservatorship litigation will see this paper as a confirmation of their position. I do not think, however, that the judges hearing the cases will pay it much heed.

Who Benefits from the Low Income Housing Tax Credit?

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HUD’s Office of Policy Development and Research has released a report, Understanding  Whom  the  LIHTC  Program  Serves: Tenants  in  LIHTC  Units  as  of  December  31,  2012. By way of background,

The Low-Income Housing Tax Credit (LIHTC) Program provides tax credits to developers of affordable rental housing. The tax credits are provided during the first 10 years of a minimum 30-year compliance period during which rent and income restrictions apply. The LIHTC Program, although established in the U.S. Internal Revenue Code (IRC), is structured such that state-allocating agencies administer most aspects of the program, including income and rent compliance, with the Internal Revenue Service (IRS) providing oversight and guidance. Local administration allows states to address affordable housing needs specific to their populations. (1)

 Here are some findings of note:

  • Approximately three-fourths of reported households include disability status for at least one household member.
  • 36.4 percent of reported LIHTC households had a least one member under 18 years old.
  • Nearly 33 percent of reported LIHTC households have an elderly member, and 28.6 percent of reported LIHTC households have a head of household at least 62 years old.
  • The overall median annual income of households living in LIHTC units was $17,066, ranging from $8,769 in Kentucky to $22,241 in Florida. By comparison, the median income of HUD-assisted tenants was $10,272 in 2012.
  • Approximately 60 percent of reported households nationwide had incomes below $20,000.
  • The study found that approximately 39 percent of all LIHTC households paid more than 30 percent of their income for rent, thus making them housing cost burdened. Ten percent of all LIHTC households faced a severe housing cost burden, paying more than 50 percent of their income towards rent.
  • In 23 states, HUD was able to collect some data on the use of rental assistance in LIHTC units, which can eliminate cost burden for households who have it. Approximately half of reported households receive some form of rental assistance, with the greatest use in Vermont (64 percent) and least use in Nevada (23 percent).

The Housing and Economic Recovery Act of 2008 requires that this information be collected on an ongoing basis. It should be of great value as policymakers formulate federal housing policy for low-income households going forward.

GSE Conservatorship History Lesson

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Mark Calabria, the Director of Financial Regulation Studies at the Cato Institute, has posted a very interesting paper, The Resolution of Systemically Important Financial Institutions: Lessons from Fannie and Freddie. This is a more formal version of what he presented at the AALS meeting early this month. I do not agree with all of Mark’s analysis, but this paper certainly opened my eyes about what can happen in committee when important statutes are being drafted. It opens,

There was perhaps no issue of greater importance to the financial regulatory reforms of 2010 than the resolution, without taxpayer assistance, of large financial institutions. The rescue of firms such as AIG shocked the public conscience and provided the political force behind the passage of the Dodd-Frank Act. Such is reflected in the fact that Titles I and II of Dodd-Frank relate to the identification and resolution of large financial entities. How the tools established in Titles I and II are implemented are paramount to the success of Dodd-Frank. This paper attempts to gauge the likely success of these tools via the lens of similar tools created for the resolution of the housing government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac.
An additional purpose of this paper is to provide some additional “legislative history” to the resolution mechanisms contained in the Housing and Economic Recovery Act of 2008 (HERA), which established a resolution framework for the GSEs similar to that ultimately created in Title II of Dodd-Frank. The intent is to inform current debates over the resolution of systemically important financial institutions by revisiting how such issues were debated and agreed upon in HERA. (1-2)
As an outside-the-Beltway type, I found the “legislative history” very interesting, even if it wouldn’t qualify as any type of legislative history that a judge would consider in interpreting a statute. It does, however, offer policy wonks, bureaucrats and politicians an inside view of how a Congressional staffer helps to make the sausage that is legislation. It also shows that in the realm of legislation, as in the realm of fiction, author’s intent can play out in tricky ways.

Calabria concludes,

The neglect of HERA’s tools and the likely similar neglect of Dodd-Frank’s suggest a much deeper reform of our financial regulatory system is in order. The regulatory culture of “whatever it takes” must be abandoned. A respect for the rule of law and obedience to the letter of the law must be instilled in our regulatory culture. More important, the incentives facing regulators must be dramatically changed. If we hope to end “too-big-to-fail” and to curtail moral hazard more generally, significant penalties must be created for rescues as well as deviations from statute. A very difficult question is that lack of standing for any party to litigate to enforce statutory prohibitions against rescues. (19)

I take a couple of lessons from this paper. First, tight drafting of legislation that is supposed to kick in during a crisis is key. If a statute has wiggle room, decision makers are going to stretch it out as they see fit. And second, I agree with Mark that even tight drafting won’t necessarily keep government actors from acting as they see fit in a crisis.

If Congress really want to constrain the choices of future decision makers, it will need to grant a third party standing to enforce that decision as it is unlikely that crisis managers will have the self-restraint to forgo options that they would otherwise prefer. Congress should be very careful about constraining the choices of these future decision makers. But if it chooses to do so, that would be the way to go.