Fannie Mae, Freddie Mac Saga: FHFA Brought This On Itself

Fannie Mae, Freddie Mac Saga: FHFA Brought This On Itself

Fannie Mae

Photo by NCinDC

More news in the ever-evolving story of Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) and Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA).

Play Quizzes 4

wow…. this is a fantastic takedown of Treasury’s arguments… When your opposition uses the cases you cite to make your point to effectively bitch slap your argument, you’ve got a weak hand.  Further, given the timing of this, only a week post Treasury’s filing one cannot escape the thought they they anticipated Treasury’s arguments and were prepared in advance to respond.  Now, without even seeing the reply from $FAIRX I can’t see how the Treasury gets what it wants in a dismissal.

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First lets take a look back at the post I wrote when the government responded.

In that post I laid out the reasons I thought there was material weakness in the case the gov’t was then making:

“They use as their prime example the FDIC when it takes over banks. In those circumstances shareholders have no rights to then sue the FDIC for its actions. But I see material weaknesses in that line of thinking.

  1. The FDIC, when it takes over banks does not operate in conjunction with or partner with the US Treasury
  2. The FDIC does not give the US Treasury a controlling interest in those banks
  3. Banks are not Chartered by the US Congress
  4. Banks are not “government sponsored entities”
  5. Congress does not directly oversea banks operations
  6. When the FDIC liquidates banks, the assets are sold to other banks, not given to the US Treasury
  7. When the FDIC enters bank, it does so with an express plan, that plan is not altered unilaterally when the initial goal is in fact being accomplished
  8. When the FDIC takes over a bank,  it does not then encourage the public to continue to make investments in the securities of that bank
  9. If the bank is being rehabilitated, the FDIC does not alter terms of investments to favor one investor over every other investor
  10. The FDIC does not need gov’t approval to take over a bank, in no way could they unilaterally against towards to Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)”

Washington Federal responded to the motion today and one passage in particular tell you where they are going:

The Government next claims Plaintiffs lack “standing” to bring this action because, under HERA, it suggests, FHFA assumed all rights of the Companies’ shareholders, including the ability to bring suit. But this argument ignores a well-recognized exception applicable when a conservator has a conflict of interest because of its entanglement with “closely related” government entities. As described above, the Complaint alleges the existence of such an entanglement here. The Government further claims that Plaintiffs lack standing to recover the Companies’ lost profits. But Plaintiffs are not seeking to recover profits that belong to the Companies themselves: they are seeking to recover for the destruction of the value of their shares. Moreover, Plaintiffs can directly recover based on the Companies’ overpayment to the Government for access to Treasury funds, which caused Plaintiffs to lose the economic value and voting power of their shares.

Plaintiffs have sufficiently alleged that the conservatorships constituted an unconstitutional taking. As an initial matter, Plaintiffs’ claims are ripe for review. Indeed, the Government would force Plaintiffs to wait until their claims were barred by the statute of limitations before this Court could find them sufficiently “ripe.” More substantively, this Court has recently reiterated in Starr International Co. v. United States that Plaintiffs have a cognizable property interest in their shares. The Government’s actions clearly affected the value of those shares and Plaintiffs’ other ownership interests. Plaintiffs had reasonable-investment backed expectations that the Government would not take over the Companies for its own purposes, thereby destroying the value of their shares and their rights as shareholders. As much as the Government would like the Court to believe otherwise, the Companies were not engaged in banking and thus were not part of the “highly regulated” banking industry, where regulatory takeovers are more common. Thus, there is no basis for suggesting that Plaintiffs should have reasonably anticipated the Government’s actions here, particularly where, just months before the conservatorships were imposed, the Government repeatedly represented that there was no need to impose them because the Companies were financially sound. The Government was not “rescuing” the Companies as would be done in a traditional conservatorship. At best, it was cleaning up its own mess after directing the Companies to make high-risk investments.

As I noted before the gov’t’s attempts to paint this as a simple FDIC like action fail almost every reasonable test based on the inextricable relationship of the FHFA and Treasury. The FHFA cannot pretend to be a “non gov’t” entity.  As for the claim:

The Government’s actions were not lawful under HERA. If the Government’s argument is true, the Government could have imposed the conservatorships to do whatever it wished with the Companies. Instead, HERA established FHFA’s duty to preserve the Companies’ assets, and that duty creates a money mandating obligation. FHFA has done precisely the opposite by giving away the Companies’ assets virtually for free to Treasury.

Now, this complaint goes a step further and says the very act of the conservatorship was illegal:

HERA provides for 12 circumstances under which FHFA could place the Companies into conservatorship. 12 U.S.C. § 4617(a)(3)(A)-(L); Compl. ¶ 91. None of these statutory grounds existed with respect to either Company because:

(1) the Companies’ assets were greater than their obligations to their creditors and others, see id. ¶¶ 93-98; (

2) neither of the Companies had experienced a substantial dissipation of assets or earnings due to i) any violation of any provision of federal or state law or ii) any unsafe or unsound practice, see id. ¶¶ 99-105;

(3) neither Company was operating in an unsafe or unsound condition to transact business, see id. ¶¶ 106- 12;5

(4) neither Company was in violation of a cease or desist order, see id. ¶¶ 113-15;

(5) neither Company concealed or refused to submit any books and records, see id. ¶¶ 116-18;

(6) the Companies were able to pay their obligations and meet the demands of their creditors, see id. ¶¶ 119-24;

(7) neither Company had incurred or was likely to incur losses that would deplete all or substantially all of their capital, see id. ¶¶ 125-33;

(8) neither Company violated any law or regulation, or engaged in any unsafe or unsound practice or condition that would likely cause insolvency, a substantial dissipation of assets or earnings, or a weakening of its condition, see id. ¶¶ 134-36;6

(9) the Companies did not consent to the appointment of a conservator, see id. ¶¶ 137-40;7 (

10) neither Company was undercapitalized, see id. ¶¶ 141-48;

(11) or critically undercapitalized, see id. ¶¶ 149-51;8 and

(12) neither Company was found guilty of money laundering, see id. ¶¶ 152-53.

Thus, there was no legal basis for the Government to place the Companies into receivership or conservatorship. Compl. ¶ 92.

Now, the gov’t claims the Conservatorship was legal because the entities were “operating in an unsafe and unsound manner” ((3) above). Here is the problem with that. They operated at the direction of both Congress and their regulator OFHEO (later FHFA). So, if that is true, then to take these companies from the shareholders and effectively hand them over to the entities that created the problem, is illegal.

The gov’t also argued that the claims here were not valid under the Tucker Act. In response:’

See id. at 1353-54. Importantly, the court also held that any collusion between the FDIC and the Department of Justice that misled the plaintiffs “would make the United States responsible for the conduct of the FDIC,” thus providing a basis to exercise jurisdiction. Id. at 1354.

Applying the collusion exception in Frazer to the facts of this case, the Complaint alleges numerous acts by FHFA clearly indicating that it was in collusion with Treasury, thus requiring the United States to answer for FHFA’s conduct in its purported role as conservator. As detailed throughout the Complaint, FHFA’s actions during the ongoing, apparently indefinite conservatorships were inextricably intertwined with Treasury’s directives and goals. Both FHFA and OFHEO, its predecessor, directed that the Companies purchase and provide guarantees for subprime and other high risk securities and caused the Companies to suffer significant losses on certain portfolio holdings. Compl. ¶¶ 2, 4, 49-55. Then, after encouraging the Companies to purchase and guarantee bad mortgage debt after other financial institutions had left the market, the Government, including FHFA, ordered the Companies to warehouse additional bad debt from the books of other larger financial institutions. Id. ¶¶ 5, 14-16. At the same time, while purportedly being charged with the power to “take such action as may be . . . necessary to put the regulated entit[ies] in a sound and solvent condition[] and . . . appropriate to carry on the business of the regulated entit[ies] and conserve the assets and property of the regulated entit[ies],” 12 U.S.C. §4617(b)(2)(D), the Government set strict limits on the fees the Companies could charge to guarantee more transactions. Compl. ¶¶ 16-17. It then forced the Companies to substantially increase their loan loss reserves, thus unnecessarily reducing the value of their deferred tax assets. Id. ¶ 18.

Then, just a month after making repeated representations about the financial soundness of the Companies, FHFA, in consultation with Treasury, met in secret to decide to place the Companies into conservatorship and subsequently forced the Companies’ Boards to “consent” to them. Id. ¶¶ 68-73; 81-90. And FHFA’s actions as conservator have borne no relationship to the typical purpose of conservatorship: FHFA’s first action as conservator was to enter into the Stock Agreements with Treasury, under which the Companies were forced to accept capital infusions they neither needed nor requested in exchange for giving the Government billions of dollars in preferred stock and warrants for 79.9% of the Companies’ common stock. Id. ¶¶ 157- 60. The Third Amendment thereafter required the Companies to “sweep” their entire positive net worth to the Treasury. Id. ¶¶ 161-62.

Given FHFA’s conduct unrelated to its role as conservator and extensive collusion with Treasury, the Government cannot plausibly argue that the United States is not answerable for FHFA’s actions. This Court should conclude that it has Tucker Act jurisdiction over FHFA.

I like reading these legal filing (weird, I know).  This is particularly good and make the case I think better than the initial arguments for the illegality of certainly the Net Worth Sweep and here even the act of Conservatorship itself.  Even here had the FHFA actually acted as a Conservator, based on the principles espoused at the outset, they could have avoided the majority of the arguments for these cases. But because they effectively violated Conservatorship even on the most liberal of meanings of it by turning into a liquidator, they brought this on themselves.

This is gonna get soooo interesting.

Wash Fed v Treasury

Via ValuePlays

Updated on

Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.
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