A Government Motion to Dismiss that Should Be Dismissed

Is the federal government running out of arguments to knock down lawsuits stemming from the Third Amendment Sweep of the revenues of Fannie Mae and Freddie Mac?

Investors Gary Hindes and David Jacobs filed suit in U.S. District Court in Delaware over the summer alleging illegal action by Treasury and focusing on the narrow issue of applicable state corporate law. Late last week the government filed a motion to dismiss the case, making broad assertions about sovereign immunity, federal power over the states and the wide latitude the Housing and Economic Recovery Act (HERA) provides the Federal Housing Finance Agency (FHFA) in acting as conservator of the GSEs. The motion also clings to the increasingly dubious idea that Fannie and Freddie needed a savior and makes an inaccurate assertion about the number of similar suits that have been tossed out.

In a call with over 200 investors and reporters Tuesday, former Delaware Supreme Court Chief Justice Myron Steele, who is representing Hindes and Jacobs, said there was nothing in the government’s motion that came as a surprise. Without delving into the details of what will be filed in response to the government’s motion early next year, Steele assured that none of the points the government made are “incapable of being countered.” A recording of the call is available here.

Steele noted that an underlying principle in such a proceeding is for the court to accept as fact points made in a complaint. In this case, Hindes and Jacobs stipulate that no bailout was needed for the GSEs. However, in the motion to dismiss the government clearly does not accept this premise and details its assessment of the uncertain condition of the GSEs that justified the government’s conduct during the conservatorship, including the Sweep. It will be interesting to see how Hindes and Jacobs tackle the government’s inconsistency in the response brief due January 16.

While the government insists the GSEs’ condition justified its actions, the government’s motion at least backs away from the assertion that Fannie and Freddie were in a “death spiral.” Remember this was part of the argument the government made in convincing U.S District Judge Royce Lamberth to dismiss shareholders’ claims in the Perry Capital suit last year.

With the suit brought by Hindes and Jacobs there is a chance to make something clear for once and for all: Treasury and FHFA were not really saviors of the GSEs. These entities did not need saving. There was never any threat that Fannie and Freddie would become insolvent by virtue of making cash dividend payments. That is because the dividends could be paid with stock and also because state law prohibits the payment of dividends if there was a chance these payments could lead to insolvency. 

More importantly, the confiscation of the GSEs revenues and depletion of their capital buffers has actually put them in a more vulnerable position than they would have been in had the government done nothing. In an amicus brief filed on behalf of Investors United in support of Perry Capital’s case, Michael Krimminger, a former Federal Deposit Insurance Corporation General Counsel, spells out precisely how the Sweep is in direct opposition to HERA’s mandate for FHFA to return the GSEs to a “sound and solvent” condition.

While the government might have finally concluded it could not use the “death spiral” argument with a straight face, it nonetheless pats itself on the back for actions taken in the fall of 2008 to stem a potential emergency and reiterates how $187.5 billion worth of taxpayer money was made available to prevent the GSEs from slipping into receivership. However, the brief ignores the fact that the $187.5 billion has not only been paid back but also that the GSEs’ revenues have provided the Treasury with an additional $50 billion.

Another leg of the government’s motion to dismiss that is wobbly is the call for the judge to glom onto “eleven nearly identical lawsuits” that have been dismissed.  First of all, the number is completely wrong.  In fact, not even two investor lawsuits have been dismissed by federal judges.  The most notable of these rulings, Lamberth’s in the Perry case, relied on a broad comparison of FHFA’s role with that of the FDIC during the savings and loan crisis of 1989 to grant the government broad discretion as GSE conservator. A key phrase asserting that the discretion of the government in the S&L crisis “applies with equal force to the mortgage finance crisis of 2008,” was in a footnote. And let’s not forget that Judge Lamberth did not seem entirely comfortable with the Sweep on substantive grounds, conceding in his opinion that the Sweep may “raise eyebrows, or even engender a feeling of discomfort.”

The other case the government cites in its motion to dismiss is a ruling by U.S. District Court Judge Robert Pratt in Iowa in a suit brought by Continental Western Insurance Company. But Pratt’s ruling earlier this year hardly shut the door on future cases. It was a very narrow ruling based on the technical consideration that Continental Western’s parent corporation is involved in the Perry Capital case. Pratt reasoned that it made sense for the substance of the case to be resolved in the appeals process rather than opening a new front.  

Even if several more judges had thrown out the suits, it would not be reason to dismiss this one. In essence, two judges sheepishly acknowledged that the government might have crossed the line in misapplying HERA but then concluded that things like this happen: Unless there is a blatant abuse of power, give the government a little room. That is hardly an overwhelming precedent to justify dismissing the Delaware suit. Let’s hope the judge in this case decides to look at the substance of the complaint rather than ducking based on a handful of highly nuanced rulings to dismiss other shareholder cases.  

Meanwhile, Treasury’s assertion of sovereign immunity has become a rather flimsy argument amid the many questions about whether the government acted in good faith. Federal Claims Court Judge Margaret Sweeney has shifted the burden back to the government to produce documents related to its rationale for the Sweep stemming from a petition by the New York Times to learn more about FHFA’s supposed independence from Treasury in the months leading up to and after the Sweep. So long as the government works so hard to shield from public view documents at the heart of the Sweep, it is hard to see how a federal judge would want to cave into the assertion of sovereign immunity.

Finally, as former Justice Steele noted, the government gave “very short shrift” to the specific points related to Delaware’s corporate law – no more than page in the motion to dismiss. He speculated that the government might be banking on a judge not getting to the meat of case if the sovereign immunity and federal prerogative arguments prevail. But Steele assured plaintiffs will be ready to argue those narrow points of state law.

In its latest move, it is clear the government continues to see itself as the savior of the GSEs and the protector of taxpayers.  Let’s hope the judge rejects the arguments for dismissal and provides an opportunity for shareholders to show the government’s actions were, in fact, harmful to the GSEs and their shareholders as well as taxpayers.