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The Net Worth Sweep’s Moral and Practical Deficiencies

A new paper by John Berlau at the free-market oriented Competitive Enterprise Institute, not surprisingly, takes a dim view of the historic and persistent roles of Fannie Mae and Freddie Mac in the home mortgage market. It takes an equally dim view of the government’s lack of respect for the rights of shareholders in the course of its nine-year-old conservatorship of the companies.

Berlau argues that Congress and the Trump Administration should take two steps to enable a fully private mortgage market to function. One is to do away with what he sees as the distortive influence of rules and regulations included in the Dodd-Frank Act.  But the first step he recommends is for the government to, “respect the property rights of GSE shareholders and offer them some form of compensation.” He wrote:

There are moral and practical reasons for compensating GSE shareholders. If government abrogates contracts in this case, why would investors make substantial investments in mortgage securities in the future? If investors see any market as prone to arbitrary government takeovers, they will be very reluctant to invest in this sector. Investors will not buy into a transitional privatization scheme, if they think the government can abrogate their property rights at the first sign of things going south. In its GSE phase-out legislation, Congress should set up a commission to determine the value of GSE shares, and once the commission makes its determination, the government should compensate GSE shareholders accordingly.

“Moral and practical” aptly summarizes why shareholders need to be made whole. The suits brought by groups of investors are based on violations of specific statutes and the Constitutional prohibition of “taking” private property for public use without “just compensation.” That alone should have prevented the Net Worth Sweep from being conceived and implemented in the first place. But Berlau’s insights merit more than a passing acknowledgement.

Indeed, it is immoral for government to run rough shod over the financial lives of countless Americans. Investors Unite members who made what seemed like a sound investment decision to better prepare for retirement, education costs and other needs have been wronged in a moral sense by the abrupt and arbitrary policy pivot of the Net Worth Sweep. Never have shareholders in a private company endured such reckless mistreatment at the hands of their government.

With regard to the practical considerations, Berlau is in good company in warning that the conduct of the conservatorship and Net Worth Sweep in particular send a terrible signal to investors in financial institutions.

It is impossible to rationalize the government’s decision to vacate the rights of private shareholders and take steps so clearly outside the letter and spirt of the law. Whether it is through a commission or simply allowing the market to reset stock prices once Fannie and Freddie are properly capitalized and the conservatorship terminated, the first step in charting the future course of federal housing policy should be based on certain moral and practical principles. The Trump Administration would send the market the right signal by following the law and restoring the rights of shareholders.