Fannie Mae: Perspectives on HERA Shareholders Can Take to the Bank – Or at Least Should by Investors Unite

During a teleconference call January 29, a House Financial Services Committee staff member with an obviously in-depth familiarity with Housing and Economic Recovery Act (HERA) of 2008 asked the authors of a new paper on the statute a pointed question.

Citing Sec. 4617(b)(2)(B) of the U.S. Code, he pressed whether that section of the law allows the government to take over the assets of mortgage market giants Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) with all powers of the shareholders.  In other words, can’t the government do pretty much as it sees fit as the conservator of these government-sponsored enterprises (GSEs)? After all, aren’t the rights of the stockholders suspended during the conservatorship?

The only problem with this line of inquiry is that it misses other key components of the law as well as the intention of Congress – the letter and the spirit of the law. A complete reading of that section of the U.S. Code makes clear that it stipulates that the Federal Housing Finance Agency, which  HERA created and vested all power in as conservator, is to do whatever is needed to “conserve and preserve” the Fannie Mae and Freddie Mac’s assets. There’s also the explicit and separate direction to conservators to takes steps necessary to put the regulated entity in a “sound and solvent condition.” In other words, a conservatorship is meant to be a temporary arrangement that anticipates restoring the Fannie Mae and Freddie Mac and stockholders continue to retain all rights in the stock’s financial worth, which, by the way, is determined by the market, not the government.

Even allowing that laws are subject to interpretation, it is hard to argue that the drafters intended the opposite of what they said was intended.  And Michael Krimminger and Mark Calabria, who recently published” The Conservatorships of Fannie Mae and Freddie Mac:Actions Violate HERA and Established Insolvency Principles,” know what the drafters intended. Krimminger, who was capping off a long and distinguished career at the Federal Deposit Insurance Corporation (FDIC) as its general counsel, and Calabria, who was a top aide to Senate Banking Committee Chairman Richard Shelby, understood more than most people in the room the statutory history and political imperatives that went into the letter and spirit of the law.

They understood Congress didn’t have to start from scratch when writing HERA.  Lawmakers looked at bank conservatorships and receiverships under the Federal Deposit Insurance Act (FDIA) and made a conscious decision to replicate the provisions aimed at protecting stakeholders. Congress embraced the long-held understanding of conservatorships should be relatively short-term proceedings with the interests of stakeholders in mind.

“Foremost in the drafters’ minds was the importance of both continuing the Companies’ operations without disruption and maintaining market confidence in the fair treatment of the Companies’ stakeholders by the government,” they wrote.

It isn’t just on the definition of conservatorship where the white paper strips naked the illegality of the Administration’s current policy of using revenues from Fannie Mae and Freddie Mac as a general government checking account.

The paper also makes a compelling case that Congress wanted FHFA to be the lead agency in the conservatorship. Lawmakers opted to limit the Treasury Department’s role. They grasped that Fannie Mae and Freddie Mac were different animals than banks. They thought about it, debated it and still decided on narrow and confined roles for Treasury and other agencies.

That’s what makes the Third Amendment “sweep” by Treasury so audacious. Back to the question on teleconference, how can Fannie Mae and Freddie Mac ever become “sound and solvent” and shareholders compensated if Treasury snatches up the Fannie Mae and Freddie Mac’s profits every quarter? What’s more, if there is no way to create a buffer against future losses, will taxpayers once again have to pick up the tab in the next crisis affecting the housing market?

Krimminger and Calabria displayed an appreciation for legal precedent and political ramifications of HERA when they wrote, “These conservatorships most certainly were not profit-making enterprises for the regulators. In contrast to Treasury’s actions in the Companies’ conservatorships, banking regulators never considered it as possible that they could impose new, harsher deals after providing assistance or initiating conservatorship or use those transactions as vehicles to strip all remaining value from the banks.  Why?  Because it is not permitted under the law and would have devastating consequences to the future of banking.”

At the January 27 hearing before the House Financial Services Committee, FHFA Director Mel Watt seemed to acknowledge this wasn’t supposed to be the way HERA worked but lamented that his hands are tied since his predecessor, Ed DeMarco and Treasury worked out the Preferred Stock Purchase Agreements at the heart of the problem. As Krimminger and Calabria can tell Watt, his hands are actually free, legally, if not politically. But neither DeMarco nor any other agency officials ever have a free hand to work out an agreement that suits them but trumps a federal statute.

The analysis by Krimminger and Calabria makes what could be the most compelling case to date how flawed and legally dubious HERA’s execution has been and will continue to be until Congress and the Administration can agree on the future of mortgage secondary market giants.

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