More Documents, More Proof of a Scheme to Illegally Pilfer Fannie and Freddie

As they have for years, government lawyers continue to insist that the Net Worth Sweep was critically necessary to relieve Fannie and Freddie from a purported “death spiral” in which the GSEs would have to make draws on the Treasury commitment simply to pay dividends back to the Treasury. The reasoning was laid out in a brief that Treasury filed just last month in the Eighth Circuit Court of Appeals.

That’s their story and they’re sticking to it. There is just one problem: It is not true. The latest set of documents unsealed in Fairholme Funds’ suit over the Net Worth Sweep further proves that government officials executed a carefully conceived plan to seize the companies’ earnings in order to wind them down – not restore them – in direct contravention of the Housing and Economic Recovery Act.

The “death spiral” argument, which was previously shown to be bogus, was not even persuasive to some officials at Treasury. On August 13, 2012, just as the Sweep was announced, one official said the rationale “[d]oesn’t hold water” because the Companies’ “business won’t reduce in the immediate future.”

Indeed, many of the newly unsealed documents show that officials from the Treasury Department and the Federal Housing Finance Agency clearly saw that Fannie and Freddie’s future profits would far exceed the prevailing 10% cash dividend rate in effect before the Net Worth Sweep. In other words, the GSEs could make the payments and still have profits left over. Officials knew that no further money would be needed from Treasury to make dividend payments. Quite the opposite was true.

Here is a sample of what the government has been able to hide until now:

A June 25, 2012, memo recapping a meeting between FHFA Acting Director Edward DeMarco, Treasury Secretary Geithner, and Treasury Under Secretary for Domestic Finance Mary Miller states that DeMarco did not see an urgent need to amend the existing agreements because “…the GSEs will be generating large revenues over the coming years, thereby enabling them to pay the 10% annual dividend well into the future even with the caps.”

Even allowing that the companies were doing well enough to make the dividend payments, can we assume top Obama Administration officials knew that the Net Worth Sweep would result in a windfall for the federal government? The answer is yes.

On August 13, 2012, Jim Parrott, a top housing finance advisor at the White House, emailed a colleague saying, “…[w]e are making sure that each of these entities pays the taxpayer back every dollar of profit they make, not just a 10% dividend” and that “[t]he taxpayer will thus ultimately collect more money with the changes.” 

There are more like this. For example, a July 20, 2012, email from a Treasury official emphasizes that the Net Worth Sweep will provide “a better outcome” for Treasury given the projections of robust profits from Fannie and Freddie.

A Q&A document prepared in anticipation of the Net Worth Sweep’s rollout also noted that Treasury would be “in a better position” going forward because “the GSEs would be making a binding contractual commitment to turn over profits to taxpayers, as opposed to the current discretionary dividend.”

Administration officials touted their goal of “winding down” the GSEs. The new set of documents reveal once again that Treasury officials understood the Sweep would prevent the Companies from rebuilding capital. Talking points from August 15, 2012, state: “…by taking all of their profits going forward, we are making clear that the GSEs will not ever be allowed to return to profitable entities.”

As is well known, the companies were back on their feet and returning to profitability by the summer of 2012, but apparently FHFA and Treasury wanted to downplay that as much as possible. Mario Ugoletti, a senior FHFA official who acted as liaison with Treasury, wrote to DeMarco and other FHFA officials on August 17, 2012, that “other than a transitory buffer, [the Net Worth Sweep] does not allow the Enterprises to build up retained surplus, which may give the impression that they are healthy institutions.” 

More than that, it appears FHFA even pressured Fannie and Freddie to make accounting decisions about loan loss reserves and deferred tax assets that had no policy rationale other than to make it appear as though Fannie and Freddie would remain more dependent on Treasury than was actually the case. For example, in an email exchange in June 2011, FHFA officials observed that Freddie was taking loan loss reserves in excess of what its own financial models supported but that Freddie would “face some hard questioning from FHFA” if it sought “to take down the reserves in the current clime.”

Less than a year later, Fannie reported to FHFA that updated financial models were “likely to result in a further decline of the [loan loss] allowance as they will include recent history that reflects improved performance.”

Freddie had a similar report on its loan loss analysis at the same and predicted such losses would peak in mid-2012 and improve thereafter. 

Going back even further, an analysis of Freddie’s financial condition in August 2008 for FHFA by BlackRock stated that Freddie’s “long-term solvency does not appear endangered – we do not expect Freddie Mac to breach critical capital levels even in stress case.” On the eve of the Sweep’s announcement, a Treasury official observed in an email that Fannie’s second quarter 2012 performance was “much stronger than we thought.”

Again, with these documents we see companies that were not, in fact, a danger to themselves or taxpayers. But the extralegal decision had been made to wind them down and deplete all their capital to the sole benefit of Treasury. Therefore, officials were at work for a long time to justify the unlawful policy.

All the while, officials were cognizant of the fact that HERA required FHFA, as conservator, to preserve and conserve the Companies’ assets and restore them to soundness and solvency. However, this mandate was willfully ignored.

This new trove of documents conclusively shows that the Net Worth Sweep was designed solely to boost Treasury’s coffers and prevent the GSEs from rebuilding capital or exiting conservatorship. As we know, the Obama Administration’s plan worked. Treasury has usurped $130 billion more than it would have received absent the Net Worth Sweep, and the GSEs will be left with zero capital by the end of this year.

There is little discussion about the shareholders in the companies, except for this excerpt from a draft Q&A prepared for the announcement of the Sweep.

[Beth] How does this change impact other preferred and common shareholders, including community banks? Does this mean their investments are worthless?

– The preferred and common stock of the GSEs do not have rights while the GSEs are in conservatorship. These amendments do not change that.

– Because all positive net worth will be swept to Treasury going forward, preferred and common shareholders should not expect to receive any material dividends or economic gains while the PSPAs are in effect.

Shackling Fannie and Freddie in a perpetual conservatorship has been a boon for Treasury but bad for all taxpayers, who remain increasingly exposed to these two essential mortgage insurers.  No additional documents are needed to prove that.