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Time for an Honest Conversation: The “Death Spiral” Narrative is Bogus

Newly available facts require more skepticism from reporters and commentators when it comes to the government’s rationale for the 2012 Net Worth Sweep. The long-held assertion that Fannie Mae and Freddie Mac were in a “death spiral” and that the only way to protect taxpayers from a never-ending life-support role was to effectively take over the companies was always implausible. We now know it is absurd.

The “death spiral” narrative is a central element of the government’s counterargument to shareholders who contend the Sweep was illegal. But in a thoughtful and balanced story recapping last week’s important developments in the litigation, the Wall Street Journal’s Joe Light homed in on whether the narrative will stand up to coming scrutiny. If it can’t, the government’s case should collapse.

Last Friday, plaintiffs presented oral arguments in the appeal of U.S. District Judge Royce Lamberth’s 2014 declaration that the Housing and Economic Recovery Act gave the government wide latitude as the GSEs’ conservator and permitted the Sweep. Government attorneys assert officials at Treasury and the Federal Housing Finance Agency were trying to stave off a “circular draw,” the situation in which the companies would need more taxpayer-provided bailout funds to pay the Treasury’s dividends under amended terms of the conservatorship of the companies.

The only problem with that argument is that the talk at Treasury on the eve of the Sweep was not how dire Fannie and Freddie’s finances were but how rosy they were. Government officials knew the companies were about to start posting huge profits and would remain in the black for as far as they eye could see. There is no longer any question about this. Documents unsealed last week reveal that key officials not only knew about the change in fortunes but also took a keen interest in just how much money could soon start flowing into government coffers.

For example, Mary Miller, who had served in a number of top positions at Treasury and played a key role in negotiations with Congress over the U.S. debt limit, pointedly asked Susan McFarland, Fannie Mae’s Chief Financial Officer, how much money officials would be looking at with a change in how deferred tax assets were counted. McFarland’s ballpark estimate was $50 billion. That was a lot of money to suddenly have access to going into another tug of war with Congress over the debt.

This was just days before the Sweep was announced. Therefore, even if government officials had been operating under the assumption that Fannie and Freddie were far less flush in the first half of 2012, by the time the Sweep was announced they were fully aware of the much brighter picture. And yet, Sweep they did.

As Light pointed out, in her deposition McFarland said she figured officials suddenly saw a way to make sure the companies stayed dependent on the government. “When the [profit sweep] went into place, part of my reaction was they did that in response to my communication of our forecasts…that it was probably a desire not to allow capital to build up within the enterprises,” McFarland said. With no capital, it would be easier to wind them down.

By release of this deposition and other documents just days before the oral arguments, U.S. Court of Federal Claims Judge Margaret Sweeney intended to ensure the three judges who listened to arguments in the appeal would be fully aware of the conflicting facts. In the separate but closely related case before her, the principal of government transparency has emerged as an issue as important as the alleged violation of HERA. Judge Sweeney made sure her opinion to unseal the seven documents was available for the public to read and we hope people will read it. It is a remarkably trenchant affirmation of the rule of law and transparent governance in a democracy.

This could be a signal she that Judge Sweeney is ready to let more sunshine in. Remember, she is the midst of reviewing thousands of other documents that are part of a motion to compel plaintiffs filed late last year. Given that part of her rationale for unsealing the seven documents last week was that the day-to-day business of government from over three years ago has no business being cloaked in privileged or protected treatment, we might expect to learn a lot more in the near future about how officials were able to rationalize doing the exact opposite of HERA mandated.

Light pointed out that Judge Lamberth, in his 2014 decision to dismiss the suit, wrote, “It is understandable [for the profit sweep] to raise eyebrows, or even engender a feeling of discomfort.” But in Lamberth’s view, the law was on the government’s side and would remain so even assuming the shareholders’ narrative of events was true.

Well, it certainly looks like as though the shareholders’ narrative is true and the government’s narrative is not. If the government went around a statute, fabricated a rational for doing so and then went to unprecedented extents to hide this, then it would be a sad day in American jurisprudential history if Lamberth’s prediction was fulfilled.