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New Fannie and Freddie Shareholder Suit Filed in Kentucky

The latest legal challenge by a Fannie and Freddie shareholder lays out a jaw-dropping series of premeditated actions by government officials to tap a potential revenue stream, and makes clear that the government’s actions during the conservatorship were not merely inconsistent with the law but in direct opposition to the law.

The complaint filed by Arnetia Joyce Robinson in a U.S. District Court in Kentucky asserts that the Federal Housing Finance Agency (FHFA) and the U.S. Department of the Treasury have far exceeded legal contours set forth in the Housing and Economic Recovery Act (HERA).  The case being brought in Kentucky is in the Sixth Circuit, so it will not be controlled by the outcome of cases pending in other circuits.   

Like previous investor suits, this complaint spells out how FHFA and Treasury quickly abandoned HERA’s requirement to restore Fannie and Freddie to a “sound and solvent” condition and to “preserve and conserve” the values of these institutions. The suit also exposes the government’s naked usurpation of legal authority that did not exist in implementing the Third Amendment Sweep in 2012. We have buttressed these contentions on many occasions by showcasing the analyses from some of the nation’s foremost legal experts and policymaking veterans.

This latest legal action by a citizen to assert her legal rights merits renewed consideration of one fact in particular: Fannie and Freddie were never in financial distress or in need of a government bailout but top government officials maneuvered them into that position just the same.

While both Fannie and Freddie recorded losses in 2007 and in the first two quarters of 2008 as the market value of their holdings dropped during the housing crisis, they continued to generate, “… enough cash to easily pay their debts and retained billions of dollars of capital that could be used to cover any future losses,” the complaint notes.

In other words, neither company was in danger of insolvency.  One of the reasons for this was that Fannie and Freddie had taken a more conservative approach in their business model than banks and other financial institutions.  The assessment that Fannie and Freddie were financially healthy was confirmed by both Treasury Secretary Paulson and FHFA Director Lockhart in the summer of 2008.

In fact, the GSEs’ solvency likely motivated the series of strange moves that followed and put their anticipated revenues under government control for the foreseeable future.  At the very time the public was told Fannie and Freddie were solvent, Treasury officials promoted the short-selling of Fannie and Freddie stock by leaking word of an imminent conservatorship, the complaints stipulates.  Suddenly, they looked to be in a shakier financial situation than they actually were. By early September, Fannie and Freddie had no choice but to agree to be placed under conservatorship under FHFA’s control.

What happened next has also been brought to light previously but it merits another review with the filing of this suit. FHFA painted the GSEs’ prospects in a pessimistic light without reason. This triggered write-downs of significant tax assets and the establishment of large loan loss reserves. Under this contorted accounting arrangement, Fannie and Freddie reported non-cash losses to Congress.  It looked as though FHFA officials could not justify seizing control of Fannie and Freddie without creative accounting.

This unorthodox treatment of loan loss reserves became evident relatively quickly as the market began to recover and the earnings of Fannie and Freddie increased. They were quite profitable by the summer of 2012.  At that point, FHFA and Treasury moved in concert to expropriate the companies’ net worth – the Third Amendment Sweep.  The arrangement guarantees they cannot be made safe and solvent – the exact opposite of what was supposed to occur under the “temporary” conservatorship created by HERA.  As the complaint sums up well, FHFA had stopped acting as conservator and “… indeed it has acted as an anti-conservator—because conservators are not allowed to use the companies under their care as ATM machines.”

Any person who concludes that Fannie and Freddie’s saga should not have unfolded this way is not alone. Ms. Robinson is a retired bank manager. With insights from her professional experience, she figured Fannie and Freddie would be good investments in 2008. After all, they had higher mortgage standards than banks. It made sense that, as the economy recovered and grew, these investments would be a source of steady retirement income

Seven years after the financial crisis of 2008, it is easy to conflate the financial realities of specific sectors of the economy.  However, this suit reminds us that it is unfair and inaccurate to lump Fannie and Freddie together with other financial service entities. The complaint demonstrates that government officials muscled these institutions into a conservatorship even though it was not at all evident they needed to be rescued.  The bitter irony is that Fannie and Freddie operated more prudently than big banks but have ended up being treated worse for it.