Tag Archives: GSE litigation

AIG’s “Victory” and the GSE Litigation

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AIG_Headquarters_New_York_City

Court of Federal Claims Judge Wheeler issued an Opinion and Order in Starr International Company, Inc. v. United States, No. 11-779C (June 15, 2015), the case that Hank Greenberg brought against the government over the terms of the bailout of AIG during the financial crisis. The judge found that the government exceeded its authority in taking an equity interest in AIG, but did not award the plaintiffs any damages.  Many will read the tea leaves of this opinion to see what they tell us about the litigation brought against the federal government by shareholders in Fannie and Freddie arising from the bailout of those two companies. I think it offers little guidance as to liability but lots as to damages.

My most important takeaway from the opinion (which seems well-reasoned to me) is that the holding is based on a close reading of the Federal Reserve Act.  The Act enumerates the powers and limitations of the Fed.  The Court held that the Act does not authorize the Fed to take equity in a company as part of a bailout.

Fannie and Freddie are regulated by the Federal Housing Finance Administration (FHFA). The FHFA’s powers and limitations, in contrast, derive from the Housing and Economic Recovery Act of 2008 (HERA), passed during the financial crisis itself.  HERA explicitly granted the FHFA broad powers as conservator.  Section 1117 of HERA authorized the Secretary of the Treasury to make unlimited equity and debt investments in the two companies’ securities through December 31, 2009.  (There is a disagreement as to whether the the Third Amendment to the Preferred Stock Purchase Agreement, discussed here, created new securities after that date, but the more general point is that HERA authorized equity investments in a way that the Federal Reserve Act did not.)

In sum, I would not read too much into the GSE litigation from the AIG litigation as it relates to the government’s ability to take equity in Fannie and Freddie.  The two cases arise under two completely different statutes.

As to the damages component of the opinion, there are many cases when a court finds for a plaintiff but only awards nominal damages.  Thus, the Court’s opinion is not particularly out of the ordinary in this regard.  Here, the Court relied on the reasoning of the Court of Appeals for the Federal Circuit in a TARP case, A&D Auto Sales, Inc. v. United States, 748 F.3d 1142 (Fed. Cir. 2014).  In that case, the Federal Circuit found that absent allegations that “GM and Chrysler would have avoided bankruptcy but for the Government’s intervention and that the franchises would have had value in that scenario,” there was no basis to argue that the government caused “a net negative economic impact” on the plaintiffs (Starr at 66, quoting A&D at 1158).

It would appear that to prove damages, the GSE litigation plaintiffs will need to overcome that bar too, even if they were to succeed in proving that the government had acted improperly in bailing out Fannie and Freddie.

Fannie and Freddie Begin a New Stage

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The Federal Housing Finance Agency has ordered Fannie and Freddie to begin making contributions to the Housing Trust Fund and to the Capital Magnet Fund.  These two funds were created pursuant to the Housing and Economic Recovery Act of 2008, the same statute that authorized placing the two companies in conservatorship. In 2008, FHFA Acting Director DeMarco suspended payments into the two funds because the two companies were being bailed out by the federal government. Now that the two companies are on firmer financial footing, the FHFA has lifted the suspension. The suspension will go back into effect for a company if it has to make a draw from Treasury under the Senior Preferred Stock Purchase Agreement, that is if the company does not have enough excess monies to make the payments into the two funds from its own income.

This action is not so surprising, given Watt’s past statements. It does, however, have some interesting implications. In terms of the GSE shareholder litigation, these allocations reduce the enterprises’ capital by a not insignificant amount; if shareholders were to win one of their lawsuits, monies placed in these two funds would be unavailable to them. In terms of housing finance reform, this action signals that the companies have moved beyond their crisis stage into a more stable one. It also emphasizes that the FHFA can take big steps on its own when it comes to housing finance reform, notwithstanding Congressional gridlock. All in all, it feels like the beginning of a new stage in the lives of the two companies.

The FHFA has issued an Interim Final Rule and Request for Comments relating to the payments into the two funds. The rule “implements a statutory prohibition against the Enterprises passing the cost of such allocations through to the originators of loans they purchase or securitize.” (1) Comments are due 30 days after the interim final rule is published in the Federal Register.

Investors Unite for High GSE-Fees

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Investors Unite, a “coalition of private investors . . . committed to the preservation of shareholder rights for those invested in” Fannie Mae and Freddie Mac sent a letter to FHFA Director Watt pushing for higher guarantee fees (g-fees). The technical issue of how high g-fees should be set actually contains important policy implications, as I had blogged about earlier.

Tim Pagliara, the Executive Director of Investors Unite, writes,

g-fees were historically determined by the GSEs and FHFA does not have a mandate as conservator to run the GSEs as not-for-profit entities. We urge you to adhere to a set of principles that takes into account the critical purpose of setting appropriate guarantee fees while respecting the rights of all economic stakeholders, including the GSE’s shareholders. Ideally, after undoing the 2012 sweep, when setting guarantees fees, FHFA should also take into full consideration that:

1. Fannie Mae and Freddie Mac have profit-making purposes onto which public mandates are layered, and they should charge guarantee fees that earn an appropriate market-based return on the capital employed, whether taxpayer capital or private capital. This is an absolutely critical factor “other than expected losses, unexpected losses and G&A fees” that should be considered when determining g-fees.

2. Increasing guarantee fees will provide more cash flow with which the GSEs can build capital and be restored to “safe and solvent condition.” Maximizing returns is not only consistent with, but arguably required by, the conservatorship.

3. FHFA as conservator has legal duties to the direct economic stakeholders – including all shareholders – that must be respected alongside the interests of other parties.

4. Earning an appropriate return on capital is entirely consistent with the conservatorship and affordable housing mandates. There is no conflict here between the GSEs building capital and setting aside funds for affordable housing. Indeed, it is only when the GSEs have earned their way back to a “safe and solvent condition” that they can sustainably meet their public affordable-housing mandates. After the GSEs have adequate capital, the suspension of those mandates can be reversed, i.e. the affordable housing support can be turned back on.

5. Keeping guarantee fees low to support the housing market in general, including homeowners and homebuyers that are well off and do not need help, is not as important as charging higher guarantee fees (a) to build a capital base to protect against future credit losses, and (b) to redistribute a portion of earnings to targeted constituencies that  particularly need financial support.

6. Guarantee fee rates should be tied to sound underwriting standards. If FHFA directs the GSEs to relax underwriting standards, it is essential that guarantee fees be adjusted upwards to account for the greater credit risk assumed in doing so.

Ultimately, g-fees profits should be allowed to stay within the housing market and should be set at levels that help ensure safety and soundness of the GSEs, that protect long-term health of the housing market, and that respect the rights of all economic stakeholders-including the GSE’s shareholders. (1-2, emphasis added)

This letter goes to the heart of the g-fee debate and the GSE litigation, as far as I am concerned.  The g-fee level will determine whether Fannie and Freddie shares have any value at all. A low g-fee means no profits and no value. A high g-fee means profits and shareholder value. I agree with Pagliara that g-fees should reflect “sound underwriting.” The FHFA should therefore clearly outline the goals that the g-fee is intended to achieve. I may disagree with Pagliara as to what those goals should be, but sound underwriting is key to any vision of a sustainable housing finance market.