Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, highlights the revelation of documents concerning Fannie Mae & Freddie Mac, issues are now beyond making money on the stocks.
Congressional Intent
In 2008, the Congress passed the Housing and Economic Recovery Act. Among other requirements the Congress established a series of requirements for the Government Sponsored Enterprises (GSEs) Fannie Mae (FNMA/$1.96/Buy) and Freddie Mac (FMCC/$1.75/Buy). They include:
- The establishment of a new independent agency, the Federal Housing Finance Agency (FHFA), to oversee the activities of the GSEs.
- The GSEs were to be placed into a conservatorship that was to be overseen by the FHFA.
- The goal of the conservatorship was to bring the GSEs back to financial health and return them to private status.
In August 2012, the government claimed that the GSEs were in a death spiral and that the terms of the conservatorship had to be restructured. The government would now forego the requirement that the GSEs pay 10% on their senior preferred stocks, which were owned by the government. From this point forward, the government would collect basically the total profits of these companies, if earned, in each quarter.
In pursuant to this new requirement, for example, Fannie Mae stopped paying the $2.9 billion in quarterly payments to the U.S. Treasury. Instead, in the fourth quarter of 2012 it paid $7.2 billion. In the first quarter of 2013, it paid $58.4 billion and in the second quarter of that year it paid $10.2 billion. In sum, in the 14 quarters from Q4 2012 to Q1 2016, Fannie Mae paid $120.0 billion in dividends to the Treasury under the new arrangement instead of the $41.0 billion that would have been required under the old arrangement.
A number of lawsuits were spawned as a result of this dramatic difference in payments. The U.S. Treasury responded to these lawsuits by arguing that all information related to the government’s decision making in late 2012 was privileged and that to share it with the public would create a financial crisis. The plaintiffs demanded some 11,000 documents arguing that the government was required to be transparent and that the government may not have fairly represented decision making in 2012.
In October 2014, U.S. District Court Judge Royce Lamberth refused to hear the objections of the plaintiffs and threw out their case arguing that the profit sweep was legal. This decision was supported by another U.S. District Court in, I believe it was, Iowa.
New Revelations
Last week a court case in Kentucky was resolved in an out-of-court agreement. The United States Treasury agreed to provide what is believed to be 45-50 previously proscribed documents to the plaintiff demanding this information. A small amount of this data has been published in the New York Times. The material I read indicates the following:
- The key decisions concerning the future of the Fannie Mae and Freddie Mac were being made in the White House and the Treasury Department. This includes the decision to create the profit sweep rather than have the dividends paid at the rate of 10% on the GSE senior preferred debt. It now appears that the White House and the Treasury were directing the FHFA contrary to Congress’ demand. The FHFA was far from being an independent agency.
- The second issue that seems to conflict with the law is the management of the conservatorship is driving the GSEs into bankruptcy rather than allowing them to return to health.
- It is explicitly stated in the released documents that the GSEs will never be allowed to return as private companies. It was and is the clear intention of the White House and the Treasury to wipe out the positions of the shareholders in these companies even though the stocks continue to trade and no effort is being made to explicitly place these companies into bankruptcy.
It was further revealed that the information provided to Judge Lamberth was false. Instead of the GSEs being in a death spiral as stated to the court, government insiders were indicating that these companies were entering into 8 golden years of profitability.
The government was fully aware that these companies had turned around but had stated to the courts that they were still headed down. Since Judge Lamberth refused to hear the plaintiffs’ arguments in open court he made his decision without this knowledge.
More Documents Revealed Concerning Fannie Mae & Freddie Mac
What Happens Now?
Judge Lamberth’s decision is being reviewed by a Federal Appeals Court. That court now has the information that the judge refused to consider. It is possible that the Appeals Court will return the case to Judge Lamberth for a re-hearing. It is unknown what the Judge will do but he may not be pleased about the fact that he was misinformed by the government. In a similar situation, U.S. District Judge Andrew Hanen ordered mandatory ethics classes for Justice Department Attorneys for being “intentionally deceptive.”
This information is also being provided to Judge Sweeney in the Federal Claims Court in Washington. She may now decide that the 11,000 documents that the government has claimed are privileged should be released to the public. This will allow that case to proceed.
There is now a new bill in Congress introduced by Congressman Mick Mulvaney (R.; SC) that would allow the Fannie Mae and Freddie Mac to return to private status. (Mel Watt, the head of the FHFA had been a Congressman from South Carolina). Mr. Mulvaney’ bill has little chance of passage but it is a dramatic change in at least this one Republican’s view of the GSEs.
Ironies
It is ironic that hedge funds in seeking their personal benefit have made this information available. It is the classic evidence of Adam Smith’s “Invisible Hand” – i.e., individuals seeking their benefit will benefit the nation. What is ironic here is that these hedge funds acting in their own self-interest have provided critical information to the nation that the media should have discovered.
The positions of the New York Times and the Wall Street Journal are also ironic. The Times a supposed liberal Democratic news organization is covering this story closely and has also asked for the government to show the transparency that it demands of others. The Journal is on the other side vigorously and repeatedly defending the government. It has gone so far as to condemn the capitalist actors in this situation while implicitly extolling government ownership of the mortgage industry. The Times is attacking a Democratic Administration. The Journal is attacking capitalist investors.
Conclusion
The game has clearly changed here. The position of the government in expropriating private property without any, let alone just, compensation is less tenable.
