photo courtesy Mark Warner
Summer officially ended for rest of the Northern Hemisphere last week, but a panel of federal appellate judges in Washington still seems to be sweating out a ruling on an Obama administration power-and-money grab left over from the 2008 financial crisis.
The government advanced $187.5 billion to Fannie Mae and Freddie Mac when the mortgages underpinning securities that those government-sponsored entities owned turned sour. Within a few years, however, the housing market rebounded, and so did the value of the government’s investment. By 2013, five years after the crisis peaked, Uncle Sam had collected $230 billion from the two companies, which is a tidy profit for the taxpayers – but a lot more when you consider that as far as the government is concerned, Fannie and Freddie still owe the full $187.5 billion.
If you are trying to work out how $187.5 billion minus $230 billion can equal $187.5 billion, put down your pencil and save yourself a headache. The government deemed the payments it took from the two entities dividends, not loan repayments. And by the government’s reading of the situation, there is no way Fannie and Freddie can ever repay the loans short of liquidation. That’s because in 2012, with a third restructuring of the bailout terms, the government arbitrarily declared itself entitled to every nickel the two companies earn in the form of special dividends.
This would be all well and good if nobody else owned the companies. That is not the case, however. Prior to the crash, Fannie and Freddie were publicly traded, and after the bailout private shareholders were still left with just over 20 percent ownership. This is mainly because the Treasury did not want the obligation of adding the companies’ debt to the federal balance sheet if it simply took over the companies outright. So Treasury left a fraction of the company’s shares in the hands of private shareholders. At some point, these shareholders reasonably anticipated that either the companies would get out from under the bailout debt or that the companies would be liquidated or sold, with the prospect of generating some return for the private owners once the $187.5 billion debt was repaid.
The government’s current position is that those shareholders are entitled to nothing, which makes their shares worth ... nothing. A hedge fund operator that holds shares in the government-sponsored enterprises, Perry Capital, went to court to protest the effective confiscation of its investment. In 2014 a lower court judge had tossed out the case, which Perry Capital then appealed to the D.C. Circuit. A three-judge panel heard arguments in April of this year and a ruling was expected sometime this summer.
Summer has come and gone, but no ruling has been handed down yet. We can only speculate as to the reasons. Some observers would probably attribute political considerations to the judges, but that is no better than a harsh guess. It is also a complicated one, since each of the three judges were appointed by Ronald Reagan, George W. Bush and Barack Obama respectively. Nor did the judges’ questions this spring give observers a clear sense of which way the panel was inclined to rule.
The case centers largely on the 2012 restructuring, which was when the government specified that the government dividends would always equal the quarter’s profits, regardless of whether they were high or low. The government argued that this “net worth sweep” was designed to avoid making the companies’ problems worse; the shareholders argued that the change allowed the government to capture the large profits the companies made in 2013 and 2014.
While Perry Capital LLC v. Lew is arguably the highest-profile case against the government’s treatment of Fannie and Freddie’s private shareholders, Perry Capital not the only shareholder pushing back. According to the Miami Herald, plaintiffs have filed related suits in six states. One plaintiff, the Miami-based mutual fund Fairholme Fund, recently succeeded in gaining access to Treasury Department documents previously kept secret. Fairholme and the other plaintiffs are presumably watching the Perry case with interest – and, at this point, probably with impatience.
The fate of Fannie and Freddie has been fraught with politics for years – so much so that the administration that took office just as the crisis was getting underway is preparing to leave without ever deciding what it wants to do with Fannie and Freddie. There are many who would just as soon see the government get out of the mortgage finance business altogether, but that might all but kill the traditional 30-year fixed-rate mortgage. Banks would much rather lend for shorter terms at variable market rates, which is much more profitable. There are some who see Fannie and Freddie as a valuable instrument of government policy to promote homeownership among middle- and working-class families. On the other hand, it was a relaxation in the companies’ underwriting standards that helped feed the housing bubble in the first place.
So the Obama administration’s approach has been to just treat the two government-sponsored enterprises as cash cows, providing an endless supply of milk. The government could offer to buy out the private shareholders, which is what any other similar takeover would require, but that would mean bringing all of Fannie and Freddie’s obligations onto the government’s books, making explicit that all future housing market risk belongs to the American taxpayer. That is not a position Team Obama has been prepared to take. All it is prepared to take, it seems, is the money: all of the money, indefinitely.
Was the money grab legal? Maybe the appeals court will give us its view before the leaves fall, or before the election, or before the snow flies around the Capitol dome. Or maybe the topic will still be just too hot to handle.
Editor's note: An earlier version of this post incorrectly identified Perry Capital as a mutual fund, rather than a hedge fund operator. Thanks to our readers who pointed out this error.
September 26, 2016 - 12:51 pm
Perry Capital isn’t a mutual fund, I don’t think. Could be wrong.
September 26, 2016 - 4:37 pm
Without regard to the conclusions in this post, please note that the US government has warrants to purchase just shy of 80 percent of the common stock, but it has not done so. Private owners hold all the common stock, UST received senior preferred shares in return for its promise to back up the companies.
September 26, 2016 - 7:37 pm
A decent article until you get to
“On the other hand, it was a relaxation in the companies’ underwriting standards that helped feed the housing bubble in the first place”
Go back and look at the figures, F&F had much better (lower) foreclosure rates than the private label mortgages. They were FORCED to buy billions in bad loans, and then interestingly got, billions back in “fraud settlements” but that also didn’t go to paying down their “debt” So it was essentially a shell game. Hank Paulson, needed money to bail out the banks, he took it from F&F the only well run companies left standing that had cash (Fannie had $41 billion in 2008), he gave it to the banks so the weather the storm they caused. F&F then got a decent percentage of it back in fraud settlements, but F&F are nationalized, so really Treasury gets it as off the books money that is not controlled by Congress, not accounted for in the budget, so the Obama Administration then has billions to play with off the books, and since they, with the stroke of a pen say “oh no it is NOT a repayment” they never have to answer for it, or any of the other money that they forced F&F to take. In other words the Government is no better than the mob. They forced F&F to take something they didn’t need, to funnel money to the real crooks, tell F&F that they will always be in debt, and then blame F&F for not having any money. Don’t we all wish we could do the same? No, we just want the government to be honest.
F&F may have lowered their standards a bit, but nothing like the private banks. Your article falls into the same trap as most. Please do some proper research.
September 26, 2016 - 8:30 pm
This whole thing is corruption. Government was not design to write terms to take over public companies . Judges are suppose to protect people from mafia tactics, who else can force a bad deal on a company and then change it to say we will take all profits for ever, and t shareholders have no rights . Kind of sets the tone that no company or business is safe. So can a major shareholder take all the profits of a public company ? Just because you are a govt still shouldn’t give you this much power. I thought we were a free market and country?
September 26, 2016 - 8:34 pm
The relaxation of underwriting standards was forced upon the GSE’s by the government to help stabilize the financial markets.
September 27, 2016 - 4:57 am
It is important to note that the gses were not insolvent in 2008. Paulson used accounting tricks to make it seem that they needed a bailout to justify his takeover scheme. It was shady lending practices by private lenders, fraudulent ratings agencies, and exotic investment trading by greedy banks that caused the crash, NOT Fannie and Freddie. In fact, they were used as a convenient scapegoat and bagholder by those behind the scam. Then in 2012 another Goldman-Sachs man, Giethner (coincidence?) enacts the sweep to bleed them to death. Someone has to get this story mainstream before it’s too late.
September 27, 2016 - 10:38 am
You can thank Bill Clinton for the rise of TBTF banks since 1999. He repealed the Glass-Steagall Act which kept commercial banks separate from investment banks. When they were allowed to conjoin, Goldman and the others were able to manipulate markets and even financial segements of our government.
September 27, 2016 - 10:48 am
The MSM won’t touch this as long as the current administration is getting the benefit of the money.
September 27, 2016 - 1:30 pm
Fannie and Freddie are a public corporation its funds are being hijacked, leaving investors unable to profit as in other corporations under the qui use of “conservaship”. Politics is unfairly undermining the rights and depriving stockholders of their legal rights