Harvard HERA Analysis Calls For Judicial Review In Fannie Mae Litigation

Harvard HERA Analysis Calls For Judicial Review In Fannie Mae Litigation

Fannie Mae

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Harvard HERA Analysis Calls For Judicial Review In Fannie Mae Litigation by Todd Sullivan, ValuePlays

I’ve gone ahead and marked up the pdf with the relevant sections.  Now a bit about the author. It is important because whenever stuff like this comes up, those who disagree will instantly go to the author’s bias in an attempt to mitigate their conclusions. So, who is Ms. Steel?

Ally is a 3L from Maryland, and a graduate of Tulane University. Before law school, she worked in politics and on Capitol Hill, including for President Obama’s 2008 campaign, and the U.S. Senate campaigns of Senators Patty Murray, Maria Cantwell and Tim Kaine. Most recently, she served as the Press Secretary on the Senate Budget Committee. At HLS she also serves as the Executive Policy Editor of the Harvard Law and Policy Review and on the board of the Women’s Law Association.

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Yup, no “plaintiff bias” here. If anything, one would expect a viewpoint, given her past political affiliations, that more closely aligns with the viewpoint of the administration. That she takes a view perfectly counter to that is telling….kudos to her for her intellectual honesty.

For those who want crib notes:

  1. HERA does NOT exclude judicial review when conflict of interest exists
  2. Delta is the case law that covers this
  3. It is clear both FHFA and Treasury have a conflict (on multiple levels)
  4. Therefore, judicial review of the 3rd amendment of this is warranted

There is much much more but that is the very abbreviated version of her conclusions

Fannie Mae, Freddie Mac, And Fairness: Judicial Review Of Federal Conservators

by Ally Coll Steele


In the fall of 2008, the worst financial crisis since the Great Depression hit the United States, leaving millions of Americans unemployed and resulting in the loss of trillions of dollars in wealth. In an effort to stabilize the collapsing economy, the federal government spent an estimated $16 trillion to “bail out” hundreds of large private institutions—ranging from banks, to auto manufacturers, to insurance companies. As a part of this effort, Congress enacted the 2008 Housing and Economic Recovery Act (“HERA”), pursuant to which the federal government became the conservator of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (together, “the GSEs”). Subsequently, the government provided Fannie Mae and Freddie Mac with a combined $187.5 billion4 in order to ensure the solvency of the failing housing market underlying the crisis.

These government bailouts occurred in varying arrangements and resulted in extensive litigation over the legality of the government’s actions. These lawsuits raise important questions about the proper role of judicial checks on executive power after the federal government assumes control of failing or undercapitalized institutions. Recently, for example, the Court of Federal Claims held in Starr Int’l Co. v. United States that the government’s rescue and takeover of the American International Group, Inc., (“AIG”) during the 2008 financial crisis constituted an illegal exaction.

This Note explores the role of the traditional shareholder derivative lawsuit to challenge executive agency action in the context of the government takeover of Fannie Mae and Freddie Mac. Derivative suits—a traditional corporate law tool—permit shareholders to sue on behalf of a corporation for harm done to the corporation by its fiduciaries, such as its officers, directors, or controlling shareholders. This Note highlights one recent government transaction—the “net sweep” amendment entered into by the Department of Treasury (“Treasury”) and the Federal Housing Finance Agency (“FHFA”) in 2012—as an example of how derivative suits can provide a key mechanism for the public to ensure fairness and accountability of executive agency action.

Part II provides a brief history of the events leading up to the government takeover of Fannie Mae and Freddie Mac and describes the details of the net sweep amendment. Part III analyzes whether HERA permits judicial review of derivative suits during conservatorship and concludes that courts should review such claims when the federal agency faces a conflict of interest in a transaction. After determining that Treasury and FHFA faced such a conflict of interest when they enacted the net sweep amendment, Part IV turns to the merits of the net sweep amendment derivative claims. Using corporate law principles, it determines that the transaction would likely fail judicial fairness review. The Note concludes that the net sweep amendment highlights the importance of the derivative suit mechanism as a way to check federal conservator power.

The Government Takeover Of Fannie Mae And Freddie Mac And The Enactment Of The Net Sweep Amendment

Fannie Mae and Freddie Mac are GSEs, initially chartered by Congress to increase liquidity in the residential mortgage market. These GSEs raise money—from sources such as pension and mutual funds—in order to buy mortgages so that lenders can then use the freed-up capital for additional loans to borrowers. Although Congress created the GSEs, they are considered “government-sponsored,” rather than “government-owned,” because they have functioned as public companies since 1989. While the mortgages purchased by Fannie Mae and Freddie Mac are not officially government-insured, a perception exists that they “carry an implicit government guarantee [because] the companies are so large that the government would never let them fail.” At the time of HERA’s enactment, the GSEs were owned by preferred and common stockholders and listed on the New York Stock Exchange. In their corporate bylaws, Fannie Mae elected to follow Delaware corporate law, while Freddie Mac elected to follow the corporate law of Virginia, where its principal office is located.

By the summer of 2008, the U.S. economy was in apparent decline, fueled largely by instability in the housing market. Pervasive subprime mortgage lending caused widespread home foreclosures, and as a result, about one in four U.S. homebuyers-approximately 11 million in total-faced foreclosure between 2008 and 2012. The average household lost almost $100,000 in property and retirement portfolio values from 2008 to 2009 alone, exacerbating the broader economic recession. This decline in the housing market impacted Fannie Mae and Freddie Mac significantly, and the value of their assets began to deteriorate in 2008. While the GSEs attempted to raise capital in the private markets to offset these losses, their efforts were largely unsuccessful.

Anticipating the severe ramifications a Fannie Mae or Freddie Mac collapse would have on the fragile housing market—and therefore on the U.S. economy as a whole—Congress passed HERA in July 2008. Modeled after the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), enacted in response to the savings and loan crisis of the 1980s, HERA established the independent Federal Housing and Finance Agency (“FHFA”), and tasked it with overseeing and regulating Fannie Mae and Freddie Mac. HERA modeled FHFA’s regulatory power over the GSEs after those granted in FIRREA to the Federal Deposit Insurance Corporation (“FDIC”) to assume control of failing banks and financial institutions. In September 2008, pursuant to this authority, FHFA placed Fannie Mae and Freddie Mac into conservatorship, where they remain today. As conservator, FHFA assumed “all rights, titles, powers, and privileges” belonging to the GSEs, as well as their stockholders, officers, or directors.

See full PDF below.

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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 RealMoney.com 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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