Investors: U.S. stole Fannie-Freddie profits

Lawyers for investors in Fannie Mae and Freddie Mac earlier this month asked a federal appeals court to at least revive their claims that the U.S. stripped the companies of billions of dollars of profits, depriving shareholders of dividends, if not to go further and rule the transfer of profits to the government was unlawful.

Government attorneys countered that the Federal Housing Finance Agency, which has effectively controlled the mortgage giants since their 2008 bailout, was acting within the authority it was granted by Congress when it implemented the so-called net-worth sweep in 2013 that sent the companies’ profits to the U.S. Treasury Department. They also argued that without the government’s infusion of almost $190 billion, the companies would have collapsed.

Fannie Mae and Freddie Mac back about two-thirds of the $6.46 trillion U.S. residential mortgage market. Outside of that core business, they each also have investment portfolios and finance commercial real estate.

A three-judge panel of the U.S. Court of Appeals in Washington on April 15 heard almost three hours of argument over the sweep and whether to reverse a 2014 trial court decision to reject individual and institutional investors’ claims the government had breached contracts and violated the Constitution by taking property without compensation.

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“The net-worth sweep was a massive, and we submit lawless, expropriation of Fannie Mae and Freddie Mac,” which rendered them insolvent “zombies,” said former U.S. Solicitor General Theodore Olson, arguing on behalf of hedge fund manager Perry Capital LLC of New York and Miami-based Fairholme Funds.

The appellate argument capped a tumultuous week for Fannie Mae and Freddie Mac. Shares of the government-sponsored enterprises, or GSEs, climbed more than 40 percent at midweek after the judge in a related case decided to unseal evidence the investors’ lawyers sought to cite before the panel. By April 15, Freddie Mac shares were up about 25 percent and Fannie Mae about 30 percent.

U.S. Circuit Judge Patricia Millett, a 2013 appointee of President Barack Obama, sharply questioned lawyers for both sides about the scope of FHFA’s conservatorship over Freddie and Fannie and whether it had strayed into the role of a receiver undertaking a de facto liquidation. Joining her on the bench were circuit judges Janice Rogers Brown, a 2005 nominee of President George W. Bush, and Douglas H. Ginsburg, a 1986 selection of President Ronald Reagan.

They offered no clear indication of when or how they would rule.

The government’s defense rests largely upon HERA, the Housing and Economic Recovery Act of 2008, which created the FHFA, empowered it to act as a conservator – or as receiver – for the mortgage companies and provided only limited avenues for legal challenges. At that time, the Federal National Mortgage Association, also known as Fannie Mae, and the Federal Home Loan Mortgage Corp., or Freddie Mac, owned or guaranteed more than $5 trillion in residential mortgages, about half the U.S. market, according to a government court filing.

In exchange for that capital commitment, the U.S. took a controlling interest in each business and assured itself a senior position in the event one or both were liquidated. It also allocated to itself, at least initially, quarterly dividends equal to 10 percent of its liquidation stake value.

For a time, that commitment was open-ended, enabling Fannie and Freddie to ultimately draw $187 billion to prevent their insolvency while paying the government its guaranteed dividend.

That situation changed with the amendment announced in August 2012, which replaced the fixed dividend obligation “with a requirement that the enterprises pay, as a dividend, the amount, if any, by which their net worth exceeds a capital buffer,” lawyers for the U.S. said in court papers. That buffer is slated for elimination in 2018. •

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