David J. Reiss provides an overview of the Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) conservatorship litigation in a whitepaper on SSRN.

Fannie Mae Freddie Mac FHFA Federal National Mortgage Assctn Fnni Me (FNMA)

The fate of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) 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.

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)’s main business is to provide credit guarantees for residential mortgage-backed securities (“RMBS”). They are behemoths of the housing finance sector, owning or guaranteeing a combined forty seven percent of all the residential mortgages in the United States. This amounts to over 5.3 trillion dollars in mortgages. Fannie Mae and Freddie Mac are Government-Sponsored Enterprises (“GSEs”), neither government agencies nor fully-private corporations. Historically, they have been
owned by private shareholders but were chartered by the federal government.

As a result of their hybrid nature, the government granted them all sorts of privileges, rights, and exemptions. I have exhaustively reviewed these privileges in an earlier article, but let me note one privilege at the outset.4 As a general rule, banks are barred from owning equity in for-profit corporations because they are considered to be overly risky investments. But 12 U.S.C. section 1464(c)(1)(E) allows federal savings and loans to buy Freddie Mac preferred stock. The implication of this exception is that this GSE preferred stock is a safe investment for a conservative investor.6 In other words, Congress has carved out an exception to the conservative rule it had regarding investments for federal savings and loans because of Freddie Mac’s special relationship with the federal government. This preferred stock has taken on great significance in much of the post-conservatorship litigation.

For most of their existence, Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have been consistently and highly profitable. But, foreshadowing the 2008 financial crisis, the two companies began posting billions of dollars of losses in 2007. The losses jumped exponentially in 2008 to combined losses that well exceeded $100 billion.

See full article on Fannie Mae And Freddie Mac Conservatorship Litigation Overview in PDF format here, via: SSRN