Fannie Mae: Deep Skepticism At The 5th Circuit About The Net Worth Sweep

The government would have us believe the Federal Housing Finance Agency (FHFA) is unconstitutional in its structure but its actions are within the law. But U.S. 5th Circuit judges are wondering anew how it could possibly have been okay for FHFA, as Fannie and Freddie’s conservator, to drain the GSEs of their capital when the law mandates just the opposite.

That overarching question is probably why they agreed to a petition by plaintiffs and defendants for an en banc hearing to reconsider the case. Questions raised at that hearing this week could be good news for shareholders who have been stalwart in arguing that the 2012 Net Worth Sweep of Fannie and Freddie’s revenues was illegal.

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In July 2018, in the case of Collins v. Mnuchin, a 5th Circuit panel ruled that FHFA was essentially too independent since the President had limited authority to remove the director. For very different reasons, shareholders and the government successfully petitioned to make their cases before all of the judges on the 5th Circuit, or en banc.

Shareholders contend that the actions taken by a government agency determined to be illegally constituted are invalid. The government, which just recently abandoned its defense of FHFA’s structure, continues to insist the agency and Treasury officials were well within the law in implementing the Net Worth Sweep, regardless.

In an audio recording, judges homed in on the government’s position that the Net Worth Sweep was necessary to shield taxpayers from having to rescue the GSEs from a financial “death spiral.” While courts in a half dozen other shareholder lawsuits arising from the Sweep have given the government wide latitude in exercising its authority as conservator under the Housing and Economic Recovery Act of 2008 (HERA), the 5th Circuit's Judge Edith Jones, in particular, revealed refreshing skepticism.

A veteran of banking insolvency proceedings going back 30 years, Jones noted that HERA matches existing laws on conservatorships almost word for word. She said she could think of no case “…where a conservator effectively took all the net capital out of one of the lending institutions it was reporting to conserve, and gave it to the government.”

Another judge asked a government attorney, “But how does siphoning the companies’ net worth quarter after quarter in perpetuity, achieve the statutory command of putting them “in a sound and solvent’ condition?” For this judge “soundness is soundness.”

To be sure, it is ill-advised to predict how 16 judges will rule in the coming months on whether or not FHFA’s unconstitutional structure negates the Sweep. But Jones and other judges asked thoughtful questions that go to the legality of actions the FHFA took rather than the constitutionality of restraints on the president’s power to fire FHFA’s director. That is important. In addition, the 5th Circuit judges now have a more complete understanding of how the Sweep was designed and implemented since other federal courts rejected the government’s claims of executive privilege and forced once-concealed documents to be made public. These documents are laden with evasion and dishonesty.

Now that there is general agreement the FHFA needs to be structured so it more fully accountable to the elected branches of government, let’s hope the 5th Circuit will also make it more accountable for its actions that voided the rights of shareholders. The Sweep made little sense in 2012 and has been exposed many times since as a blatant case of unelected bureaucrats doing what they wanted. That is a bigger affront to the rule of law.