Tag Archives: Treasury

GSE Litigation Through Corporate Law Lens

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Adam Badawi and Anthony Casey have posted The Fannie and Freddie Bailouts Through the Corporate Lens to SSRN. The paper takes a look at the bailouts as if they were simple insolvent private firms. This is a helpful thought experiment even though the two federally chartered and heavily regulated firms are anything but simple, private firms. They write that while it is politically controversial to wipe out the shareholder equity in the two firms, doing so

is consistent with what often happens to stockholders of distressed companies. Indeed that is the more likely outcome when a corporation is sold or reorganized under Chapter 11 of the Bankruptcy Code. There remains little doubt that the Entities [Fannie and Freddie] were highly distressed at the time of the PSPAs [Preferred Stock Purchase Agreements] and Amendments [to the PSPAs]. Thus, while procedurally suspect, these actions did not substantively violate the norms of corporate law and finance that would apply to private companies in the same position. To the contrary, in the private context there may have been no action available that would have legally allocated any future interest in the Entities to the (junior) preferred and common shareholders. (1, footnotes omitted)

They add, that in “the private context, there would have been pressure to file for bankruptcy to liquidate the assets and eliminate the risk to creditors. And once in bankruptcy, the directors would have been entirely barred from taking actions to benefit equity at the expense of creditors.” (3) And they conclude that “the substance of Treasury’s and the Entities’ actions – in September 2008 and August 2012 – were generally in line with acceptable actions of creditors and debtors involved in restructuring distressed corporations in Chapter 11 bankruptcy or in out-of-court reorganizations.” (3-4)

I could excerpt selection after selection, but instead, I recommend that you read this interesting paper for yourself!

Appellate Court of Illinois Denies Defendants’ Motion for Presentment and Cause to Vacate Judgment was Misplaced and Had no Legal Significance

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The Appellate Court of Illinois in deciding Deutsche Bank Nat’l Trust Co. v. Cole, 2013 IL App (2d) 130450-U (Ill. App. Ct. 2d Dist. 2013) held that the trial court properly confirmed a judicial sale, as the plaintiff had no obligation to produce the originals of the mortgage and the note. Moreover under the appropriate standard, the court had subject-matter jurisdiction, and defendant failed to cogently explain plaintiff’s alleged lack of standing.

Lorie Cole, one of two property-owner defendants in a foreclosure action, appealed to this court after the confirmation of the judicial sale of the property and the denial of what the trial court treated as a motion to reconsider. This court, after considering the Cole’s appeal found that all of the issues that defendant Cole had raised were without merit, thus this court affirmed the decision of the lower court.

Tough Row to Hoe for Frannie Shareholders

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Inside Mortgage Finance quoted me in a story, GSE Jr. Preferred Shareholders Have a Tough ‘Row to Hoe’ in Winning Their Lawsuits (behind a paywall). It reads,

Expect a long and winding legal road to resolution of investor lawsuits challenging the Treasury Department’s “net worth sweep” of Fannie Mae and Freddie Mac earnings, warn legal experts.

More than a dozen lawsuits filed against the government – including 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 private equity plaintiffs allege that the Treasury’s change in the dividend structure of its preferred stock leaves the government-sponsored enterprises with no funds to pay anything to junior shareholders.

The complaints raise complex constitutional and securities law issues, according to Emily Hamburger, a litigation analyst for Bloomberg Industries. “It may be a year before the crucial questions can be answered by the courts because the parties are still in the early stages of gathering evidence,” explained Hamburger during a recent webinar.

Brooklyn Law School Professor David Reiss agrees. “The plaintiffs, in the main, argue that the federal government has breached its duties to preferred shareholders, common shareholders, and potential beneficiaries of a housing trust fund authorized by the same statute that authorized their conservatorships. At this early stage, it appears that the plaintiffs have a tough row to hoe,” notes Reiss in a draft paper examining the GSE shareholder lawsuits.

Government attorneys argue that Treasury has authority to purchase Fannie and Freddie stock when it’s determined such actions are necessary to provide stability to the financial markets, prevent disruptions in the availability of mortgage finance and protect the taxpayer. The government also argues that the plaintiffs do not have a legal property interest for purposes of a Fifth Amendment “takings” claim due to the GSEs’ status in conservatorship.

Hamburger predicted that the judges in the various suits won’t be able to ignore the “obvious equitable tensions” involved. “The government is changing the terms years after their bailout, but on the other hand, the timing and motivation of investors is going to be challenged too,” she noted.

While Reiss agrees that the junior shareholders “look like they are receiving a raw deal from the federal government,” it’s a tall order to sue the federal government even under the most favorable of circumstances. The plaintiffs will have to overcome the government’s sovereign immunity, unless it is waived, and the government has additional defenses, including immunity from Administrative Procedures Act claims, under the Housing and Economic Recovery Act of 2008.

Reiss explained that HERA states that except “at the request of the Federal Housing Finance Agency, no court may take any action to restrain or affect the exercise of powers or functions of [FHFA] as conservator or receiver.” It remains to be seen how this language might apply to Treasury’s change in the preferred stock agreement, but Reiss said it could be read to give the government broad authority to address the financial situation of the two companies.

“The litigation surrounding GSE conservatorship raises all sorts of issues about the federal government’s involvement in housing finance,” said Reiss. “These issues are worth setting forth as the proper role of these two companies in the housing finance system is still very much up in the air.”

The full paper, An Overview of the Fannie and Freddie Conservatorship Litigation (SSRN link), can also be found on BePress.

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?

Reiss on Fannie and Freddie Conservatorship Litigation

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I have posted An Overview of the Fannie and Freddie Conservatorship Litigation to  SSRN (and to BePress as well). The abstract reads:

The fate of Fannie Mae and Freddie Mac are subject to the vagaries of politics, regulation, public opinion, the economy, and not least of all the numerous cases that have been filed in 2013 against various government entities arising from the placement of the two companies into conservatorship. This short article will provide an overview of the last of these. The litigation surrounding Fannie and Freddie’s conservatorship raises all sorts of issues about the federal government’s involvement in housing finance. These issues are worth setting forth as the proper role of these two companies in the housing finance system is still very much up in the air. The plaintiffs, in the main, argue that the federal government has breached its duties to preferred shareholders, common shareholders, and potential beneficiaries of a housing trust fund authorized by the same statute that authorized their conservatorships. At this early stage, it appears that the plaintiffs have a tough row to hoe.

Reiss on Fannie/Freddie Suits

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Bloomberg BNA quoted me in No Basis for Discovery by GSE Investors, Treasury Department, FHFA Memos Say. It reads

[Reproduced with permission from BNA’s Banking Report, 102 BBR 417, 3/11/14. Copyright  2014 by The Bureau
of National Affairs, Inc. (800-372-1033) https://www.bna.com]

The Treasury Department and the Federal Housing Finance Agency March 4 said a federal judge should deny a motion for discovery in lawsuits by Fannie Mae and Freddie Mac investors, citing an agreed-upon schedule and saying the motion would do nothing to address legal questions at the core of the case (Fairholme Funds v. Federal Housing Finance Agency, D.D.C., No. 13-cv-01053, 3/4/14).

In its memo filed in the U.S. District Court for the District of Columbia, Treasury said Fairholme’s Feb. 12 motion for discovery (31 DER EE-6, 2/14/14) would be “improper” under a November scheduling order, and urged the court to dismiss the Fairholme suit and related cases.

“These cases should proceed on the agreed briefing schedule, which already provided ample time to the plaintiffs to file their substantive briefs, and the Court, upon review of a completed set of briefing with respect to the defendants’ dispositive motions, should dismiss these cases,” Treasury said March 4.

In its March 4 filing, the FHFA memo said “no discovery is necessary to assess the purely legal arguments” before the court, adding the Housing and Economic Recovery Act of 2008 (HERA) bars second-guessing of the FHFA’s actions as conservator of Fannie Mae and Freddie Mac.

Litigation Ongoing

The suit is one of several in at least two district courts and the U.S. Court of Federal Claims that challenge Treasury and FHFA action in August 2012 that restructured contracts governing preferred stock issued by the two government-sponsored enterprises.

Fairholme and other investors say the August 2012 amendment amounted to an expropriation of their assets and have variously sought damages and compensation in response.

The government has sought to dismiss the Fairholme case and others, but in its Feb. 12 motion, Fairholme said the government’s motion to dismiss was too expansive and raised questions that require access to government documents, e-mails and other materials.

Arrowood Indemnity Co., the plaintiff in a related case in the district court and a separate case in the Claims Court, Feb. 20 sought to link its own bid for discovery to Fairholme’s (36 DER EE-8, 2/24/14).

Fairholme has already prevailed on its discovery motion in the Claims Court. In a Feb. 26 order, Judge Margaret M. Sweeney granted Fairholme’s motion for a continuance to pursue discovery in that case.

March Reply Scheduled

In the district court, Fairholme is scheduled to respond to the government’s March 4 memos by mid-March.

“We are reviewing the opposition briefs filed by the defendants just yesterday, and we will respond to them in our reply brief, due on March 14,” a spokesman for Fairholme told Bloomberg BNA March 5.

High Stakes Seen

Professor David Reiss of Brooklyn Law School in New York March 5 said discovery usually occurs after motions to dismiss have been decided.

In this case, he said, “the stakes are so high and the quality of lawyering so high that there is litigation over the scheduling order itself.”

“This is a hard-fought battle and the issues are incredibly complex,” Reiss told Bloomberg BNA. “Each side characterizes their arguments as relatively straightforward, but I think the judge will have a hard time parsing out the issues, because there are different statutory regimes, policy issues and the like that must be rationalized with each other. I think this is just the beginning of a long slog,” he said.

Fannie and Freddie Boards: Caveat Fairholme

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Fairholme Capital Management has sent stern letters to the the boards of Fannie Mae and Freddie Mac (the letters are essentially the same). Fairholme’s funds have millions of common and preferred shares in the two companies and Fairholme has taken a multi-pronged to trying to wring some value out of those shares. It has sued the federal government. It has offered to buy the two companies’ mortgage guaranty operations. Now, it is threatening the board of the two enterprises with personal liability for their actions and inaction.

In regard to the cash dividends that the two companies have paid to the Treasury as a result of their Preferred Stock Purchase Agreements (as amended), Fairholme writes,

It is common sense that no Board should approve cash distributions without independent financial advice as to the effect of such payments on the Company’s safety, soundness, and  liquidity. Moreover, corporate laws generally prohibit the payment of dividends in many circumstances, imposing personal liability on Directors for illegal dividends – a liability that, pursuant to the Housing and Economic Recovery Act of 2008, is not assumed by the Conservator. (Fannie Letter, 3) (emphasis added)

This is a straightforward threat that will likely get the attention of the directors of the two companies and get them to check in with their D&O insurer before taking any further actions. But it is genuinely unclear what they should be doing at this point.

As I note in a forthcoming article, An Overview of the Fannie and Freddie Conservatorship Litigation (NYU J. Law & Bus.), the Fannie/Freddie shareholder litigation raises all sorts of complex and novel legal issues, and I am not willing to predict their outcomes. But I will go as far to say that Fairholme presents the way out of this mess as far clearer than it is — “Various solutions are simple, equitable, and need not be contentious.” (5) The ones that Fairholme has in mind likely involve large payouts for shareholders, one way or the other.

At the same time that Fairholme presents the solution as simple, it does acknowledge (as it really must) that the problem itself is not:  “we are aware of no circumstance in which the controlling shareholder and its affiliates simultaneously act as director, regulator, conservator, supervisor, contingent capital provider, and preferred stock investor.” (3-4) Yup, this is one big mess with no real precedent. I am confident, however, that the federal government has no interest in reaching a settlement with shareholders that shareholders would find acceptable. So, no end in sight to this aspect of the Fannie/Freddie situation, a far as I can tell.