Tag Archives: government-sponsored entity

Hypothetically Reforming Fannie and Freddie

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Ben Turner

S&P issued a report, Fannie, Freddie, and the FHLB System: Plus Ca Change . . . The report opens, “Despite reform talk in the years since the U.S. housing crisis, Standard & Poor’s Ratings Services believes the likelihood of extraordinary government support for key U.S. housing government­-related entities (GREs) Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB) system remains “almost certain” in case of need.” (1) Notwithstanding the fact that S&P expects that this extraordinary support will last well into the next presidential administration, S&P “can envisage three “tail risk” scenarios in which such support could become less likely under certain conditions, but view each of these scenarios as improbable.” (1) The three scenarios, which S&P characterizes as plausible, albeit improbable, are

  • An electoral sweep, with favorable macroeconomic conditions and few competing legislative priorities;
  • Court judgments, pursuant to shareholder lawsuits, forcing the legislators’ hand; or
  • A renewed housing market crisis, with one or more of these GREs viewed as more cause than cure. (4)

In the first scenario, “an election gives one party control of all three legislative actors (the president, House of Representatives, and Senate), precluding the need for bipartisan compromise to enact major reforms to Fannie and Freddie via legislation.” (4)

In the second, Fannie and Freddie shareholders win lawsuits that stem from the “U.S. Treasury’s decision to modify, in 2012, the Preferred Stock Purchase Agreements (PSPAs) governing the terms of its financial support to Fannie and Freddie . . ..” (4)

The final scenario,

is a renewed housing market crisis, on a scale at least similar to that of 2008. Like the other two scenarios, we don’t view this as likely, at least in the coming few years . . . perhaps as a result of the unfortunate confluence of several negative surprises- ­­including, for example, overreaction to Federal Reserve monetary policy normalization, terms­-of­-trade shocks (geopolitical conflicts that cause a rapid and dramatic spike in energy costs, perhaps), fresh financial sector  problems that suddenly tighten the sector’s funding costs, and an abnormally long spell of bad weather. (5)

This seems like a pretty reasonable analysis of the likelihood of reform for Fannie and Freddie. But that should not stop us from bemoaning Congressional inaction on this topic. Obviously, Congress is too ideologically driven to bridge the gap between the left and right, but the likelihood that we are building toward some new kind of crisis increases with time. I can’t improve on S&P’s analysis in this report, but I’m sure unhappy about what it means for the long-term health of our housing finance system.

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The Government Takeover of Fannie and Freddie

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Richard Epstein has posted a draft of The Government Takeover of Fannie Mae and Freddie Mac: Upending Capital Markets with Lax Business and Constitutional Standards. The paper addresses “the various claims of the private shareholders, both preferred and common, of Fannie and Freddie.” (2) He notes that those claims have

now given rise to seventeen separate lawsuits against the Government, most of which deal with the Government’s actions in August, 2012. One suit also calls into question the earlier Government actions to stabilize the home mortgage market between July and September 2008, challenging the constitutionality of the decision to cast Fannie and Freddie into conservatorship in September 2008, which committed the Government to operating the companies until they became stabilized. What these suits have in common is that they probe, in overlapping ways, the extent to which the United States shed any alleged obligations owed to the junior preferred and common shareholders of both Fannie and Freddie. At present, the United States has submitted a motion to dismiss in the Washington Federal case that gives some clear indication as to the tack that it will take in seeking to derail all of these lawsuits regardless of the particular legal theory on which they arise. Indeed, the brief goes so far to say that not a single one of the plaintiffs is entitled to recover anything in these cases, be it on their individual or derivative claims, in light of the extensive powers that HERA vests in FHFA in its capacity as conservator to the funds. (2-3, citations omitted)

Epstein acknowledges that his “work on this project has been supported by several hedge funds that have hired me as a legal consultant, analyst, and commentator on issues pertaining to litigation and legislation over Fannie and Freddie discussed in this article.”(1, author footnote) Nonetheless, as a leading scholar, particularly of Takings jurisprudence, his views must be taken very seriously.

Epstein states that “major question of both corporate and constitutional law is whether the actions taken unilaterally by these key government officials could be attacked on the grounds that they confiscated the wealth of the Fannie and Freddie shareholders and thus required compensation from the Government under the Takings Clause. In addition, there are various complaints both at common law and under the Administrative Procedure Act.” (4)

Like Jonathan Macey, Epstein forcefully argues that the federal government has greatly overreached in its treatment of Fannie and Freddie. I tend in the other direction. But I do agree with Epstein that it “is little exaggeration to say that the entire range of private, administrative, and constitutional principles will be called into question in this litigation.” (4) Because of that, I am far from certain how the courts should and will decide the immensely complicated claims at issue in these cases.

In any event, Epstein’s article should be read as a road map to the narrative that the plaintiffs will attempt to convey to the judges hearing these cases as they slowly wend their way through the federal court system.