Now that the Senate Banking, Housing, and Urban Affairs has delayed a vote on the Crapo-Johnson proposal to reform Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) until after the Senate reconvenes from a two week recess, it looks very unlikely that there will be any GSE reform until after the mid-term election. That means that if we’re going to see any change to gradual wind down of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) this year, it will have to come from the courts.

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

Government liquidation of Fannie, Freddie may classify as ‘irreparable harm’

“As the government steps become more radical there could be the kind of irreparable harm required to justify injunctive relief, particularly with respect to the liquidation or ultimate winding up of these facilities,” said Jonathan R Macey, Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale University, who recently co-authored the paper Stealing Fannie and Freddie with fellow Yale Law professor Logan Beirne.

Macey argues that the government is violating its role as a conservator and flouting the normal standards used for winding down a private company. Conservators are meant to help conserve assets (thus the name) and work to bring a company back to profitability for the benefit of shareholders and creditors. The Federal Housing Finance Authority (FHFA) has put Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) back on solid ground (whether they are profitable or just cash flow positive is a matter of debate), but so far only for its own benefit.

Income sweeps ‘a fairly clear violation’

“In what I think is a fairly clear violation of its obligations as conservator the government amended the stock agreement that it had initial entered into with Fannie and Freddie and now forbids those entities from using excess income to return the companies to a sound and solvent condition,” says Macey.

The decisions made by the FHFA and the US Treasury differ from accepted norms in other ways as well. First, a bankruptcy court would never recommend the liquidation of a company that was operating and profitable. Even if it did, Macey says that an independent party would be appointed to manage the liquidation so that the interests of all the different stakeholders (secured and unsecured creditors, shareholders) are taken into account. In this case there is no disinterested third party, and the government has frozen everyone else out of the conversation.

Macey doesn’t necessarily expect the parties suing the US Treasury and FHFA to get injunctive relief, but if legal experts think that the government has obviously overstepped its bounds, then Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) shareholders at least have a good chance of getting some compensation for stocks that the government has declared valueless.