Legal Scholar Shows GSEs Shareholders’ Case Stronger than AIG’s
- July 8, 2015
If there are parallels one can draw between legal battles arising from two landmark government interventions of 2008 – one related to the insurance giant AIG and the other to Fannie Mae and Freddie Mac – it is this: Shareholders of Fannie Mae and Freddie Mac, who legally have the stronger case, are getting the short end of the stick.
Last month, U.S. Federal Court of Claims Judge Thomas Wheeler ruled, essentially, that the federal government exceeded its legal authority and imposed unduly harsh conditions on AIG’s shareholders when it moved to prevent the company’s collapse at the height of the 2008 financial crisis. Meanwhile, shareholders of Fannie Mae and Freddie Mac continue to await justice.
In a tour de force analysis of legal principles applicable to both cases legal scholar Richard Epstein, writing this week in Forbes, explains it is a, “…great iniquity in the current state of affairs … that the weaker case has gotten the more favorable treatment.”
In short, the federal government owed nothing to AIG but the Federal Housing Finance Agency, as conservator of Fannie and Freddie, had an explicit obligation to protect the GSEs’ shareholders.
Epstein observed that Wheeler’s decision has received “extensive coverage and praise” for taking to task the Federal Reserve Bank of New York for its “illegal actions and abuse of authority.” But Epstein, the Laurence A. Tisch professor of Law at NYU, points out a problem with the argument that the Fed “abused its monopoly power to extract an impermissible set of concessions from AIG.” He writes:
“That claim has a deep paradox because it is widely accepted that the federal government had no duty whatsoever to come to the aid of AIG, at which point its only recourse would have been in a court of bankruptcy. Indeed, Wheeler’s decision offered no belated consolation to the shareholder’s of Lehman Brothers, which the government let die just a few days before it arranged for the elaborate bailout of AIG.
“In dealing with this abuse argument, Wheeler, like [Federal District Court Judge] Engelmayer, offers very detailed description of the how AIG was rapidly deteriorating by the hour before the bailout. Wheeler also explained how, as Section 13(3) required, that the government looked for private lenders to take up the slack. When none came forward on the terms that the government proposed, it took over the deal that put it on the hook for $85 billion.
“At this point, it is hard to see how there is any abuse of a monopoly position, given the private benchmark of these private firms. Indeed, the case against the abuse of monopoly position gets still stronger when it is recalled that the initial loan called for interest at LIBOR + 8.5 percent in September, which was thereafter reduced to LIBOR + 3 percent less than two months later. Instead, it looks as though Engelmayer was correct in insisting that the AIG directors, with full control over the company, were within their purview to accept a hard take-it-or-leave-it-offer when no better alternative was available. Unless there was some fiduciary duty for the Fed to deal with AIG on terms equal to that of other companies – why, then, has the Fed misbehaved in making this offer?”
This is in sharp contrast to the situation with Fannie Mae and Freddie Mac:
“At no point in the Fannie/Freddie litigation has anyone argued that the government abused its monopoly power in dealing with an independent board. They didn’t have to. Their claim was that once the Federal Housing Finance Agency (FHFA) forced out the independent directors of Fannie and Freddie, the Director of FHFA owed explicit fiduciary duties to the shareholders under the Housing and Economic Recovery Act of 2008 (HERA), and therefore had to negotiate on their behalf with the government. The issue of “independence” casts a large cloud over the initial bailout arrangement given the serious conflict of interest that arose because FHFA was in cahoots throughout with Treasury on the deal. At that point the burden should be on FHFA and Treasury to prove the entire fairness of the deal, which no one attempted to do then or at any time thereafter.”
So there’s the explicit difference between AIG and the GSEs: AIG’s independent board accepted the Fed’s deal, tough terms and all, whereas the government “forced out” the enterprises’ directors and installed its own “director” in the form of the FHFA. At that point, the FHFA’s responsibilities were to shareholders but, as all know, FHFA was working with Treasury not to conserve Fannie’s and Freddie’s assets but to seize them entirely just a few years later when the companies returned to profitability.
“These explicit fiduciary duties on FHFA were still in full force at the time the two sides agreed to the full dividend sweep under the Third Amendment of August 2012. At this point, there is no question of a fair value exchange, as both companies were left penniless once the agreement was put into place. For these purposes, nothing in the Fannie and Freddie litigation turns on choosing between Engelmayer and Wheeler on the monopoly issue. The case against FHFA and Treasury is far stronger.”
Epstein, who is also a senior lecturer at the University of Chicago Law School and a senior fellow at the Hoover Institution, lights into U.S. District Judge Royce Lamberth, who tossed out the case of the GSEs’ shareholder. Epstein contends Lambeth “eagerly embraced every procedural argument meant to insulate FHFA and Treasury from judicial scrutiny” in his ruling against GSE shareholders.
The article is thorough, and again, we urge you to spend some time with it, especially as the shareholder lawsuits continue to evolve.