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.

Another FHFA Win Against Shareholders

The U.S. Court of Appeals for the Sixth Circuit issued an opinion in Robinson v. FHFA et al. (No. 16-6680, Nov. 22, 2017) that is another win for the federal government in the fight with shareholders over Fannie and Freddie’s profits. The Court summarizes the issue presented as follows:

Appellant Arnetia Joyce Robinson is a stockholder in the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”; collectively, the “Companies”). During the economic recession in 2007–2008, Congress enacted the Housing and Economic Recovery Act of 2008 (“HERA”), which created an agency, Appellee Federal Housing Finance Agency (“FHFA”), and authorized FHFA to place the Companies in conservatorship. The Companies, through FHFA as their conservator, entered into agreements with Appellee Department of the Treasury (“Treasury”) that allowed the Companies to draw funds from Treasury in exchange for dividend payments and other financial benefits. The Third Amendment to those agreements modified the dividend payment structure and required the Companies to pay to Treasury, as a quarterly dividend, an amount just short of their net worth. The Third Amendment effectively transferred the Companies’ capital to Treasury and prevented dividend payments to any junior stockholders, such as Robinson. Robinson brought suit against FHFA, its Director, and Treasury, alleging that the Third Amendment violated the Administrative Procedure Act (“APA”). The district court found that Robinson’s claims were barred by HERA’s limitation on court action and that Robinson had failed to state a claim upon which relief can be granted. We AFFIRM. (2)

As I have argued previously, I think that courts have been getting these cases right — HERA granted the FHFA broad authority to act as conservator. In the words of the Court, “Congress granted to the Companies ‘unprecedented access’ to guaranteed capital from Treasury. And, in exchange, Congress also granted FHFA unparalleled authority to manage the Companies’ business.” (17) While I would not count out the plaintiffs in these cases, courts have been coming up with pretty consistent results based upon their reading of HERA.

A lot of what you read on the web about these cases is filled with a certainty about the wrongfulness of the government’s actions that borders on the fanatical. I recommend that those who want to get a sense of the legal issues at stake read the cases themselves. The judges have been struggling with the structure and text of the relevant statutes and have been making very reasonable determinations about their meaning.

But these cases are far from over. We still have to see what the Supreme Court has to say on these issues, and plaintiffs may get a more sympathetic hearing there.

Reiss on GSE Transfer Taxes

Law360 quoted me in Fannie, Freddie Look Unstoppable In Transfer Tax Fight (behind a paywall).  It reads in part,

Class actions against Fannie Mae and Freddie Mac over hundreds of millions of dollars in unpaid transfer taxes in states and cities around the country continue to pile up, but experts say any attempt to challenge the housing giants’ exempt status is likely futile as court after court rules in their favor.

The Eighth Circuit on Friday joined the Third, Fourth, Sixth and Seventh circuits in ruling that Fannie Mae and Freddie Mac are exempt from local transfer taxes when it ruled in favor of the government-sponsored enterprises, or GSEs, after reviewing a suit brought by Swift County, Minnesota.

Swift County, as with a multitude of counties, municipalities and states before it, sought to dispute Fannie and Freddie’s claim that while they must pay property taxes, they are exempt from additional taxes on transfers of assets. But in what some experts say has come to seem like an inevitable answer, the Eighth Circuit found in favor of Fannie and Freddie.

“The federal statutes that set forth the charters of Fannie and Freddie are pretty clear that the two companies have a variety of regulatory privileges that other companies don’t,” David Reiss, a professor at Brooklyn Law School, said. “One of the privileges is an exemption from nearly all state and local taxation.”

The legal onslaught against the GSEs began in 2012 after U.S. District Judge Victoria A. Roberts ruled in March that they should not be considered federal agencies. In a suit filed by Oakland County, Michigan, over millions in unpaid transfer taxes, Judge Roberts rejected the charter exemption argument and, citing a 1988 U.S. Supreme Court ruling in U.S. v. Wells Fargo, found that “all taxation” refers only to direct taxes and not excise taxes like those imposed on asset transfers.

Counties, municipalities and states across the country were emboldened by the decision. Putative class actions soon followed in West Virginia, Illinois, Minnesota, Florida, Rhode Island, Georgia and elsewhere as plaintiffs rushed to see if they could elicit a similar ruling and recoup millions of dollars allegedly lost thanks to the inability to tax Fannie and Freddie’s mortgage foreclosure operations.

But Judge Roberts’ decision was later overturned by the Sixth Circuit, as were other similar orders, though many district judges found in favor of Fannie and Freddie from the start.

*     *    *

Many cases remain in the lower courts as well, but experts say the outcomes will likely echo those that played out in the Third, Fourth Sixth, Seventh and Eighth circuits, because the defendants’ chartered exemption defense appears waterproof.

“I find the circuit court decisions unsurprising and consistent with the letter and spirit of the law,” Reiss said. “I am guessing that other federal courts will follow this trend.”

This Note and Mortgage Are Unenforceable

The Bankruptcy Appellate Panel of the Sixth Circuit issued a thoughtful opinion in In re: Dorsey, File No. 14b0002n.06 (March 7, 2014) but it leaves me dissatisfied. As Elizabeth Renuart and Dale Whitman have each demonstrated, courts have had a hard time parsing how UCC Article 3 relates to the enforceability of mortgage notes. That is not the problem with this opinion — the Court carefully applies UCC Article 3, but still concludes that the possessor of the note could not establish that it was a Person Entitled To Enforce it. As a result, the Court concludes that the possessor of the note cannot enforce the note and as a result, the mortgage is “no longer enforceable under Kentucky law.” (12)

Because of the complexity of the analysis, I refer interested readers directly to the opinion itself, which is as clear as can be expected for such a technical subject. But I will note that the Court’s result means that a party that holds the note itself and has much circumstantial evidence that the note was transferred to it by the original lender under the note can forfeit the entire value of the note and mortgage. I generally believe that lenders should be held to strict standards when seeking to enforce the terms of a mortgage loan. But in this bankruptcy proceeding, the possessor of the note is left with nothing and the borrower is granted a windfall — the entire mortgage debt has been extinguished. This does not seem to be consistent with the principles of equity.

I am curious to know what others think, particularly bankruptcy experts. Perhaps I am missing something.


[HT April Charney]