Judge’s ‘Paint By Numbers’ Decision Will Not Deter Shareholders

In dismissing a suit over the Net Worth Sweep on September 9, U.S. District Judge Karen Caldwell declared a federal agency acting as conservator has the right to plunder privately held assets.  As absurd as that sounds, it could help make the case that the Net Worth Sweep amounts to the taking of property which is the focal point of another shareholder suit before the U.S. Court of Federal Claims.

One reason why Judge Caldwell’s opinion is objectionable is that she too readily dismisses the statutory history that underlies the Housing and Economic Recovery Act (HERA) with regard to the powers of a government conservator. Experts who were involved in crafting HERA have detailed how Congress consciously drew heavily from the Federal Deposit Insurance Act (FDIA) and Financial Institutions Recovery, Reform and Enforcement Act of 1989 (FIRREA) to define the powers and duties of the Federal Housing Finance Agency (FHFA), created by HERA.

With HERA and its predecessors, Congress authorized a conservatorship to help financial institutions get back on their feet. If the institutions could not be returned to solvency, the government could put them into receivership and supervise the fair distribution of whatever assets remained.  Judge Caldwell’s presumption of FHFA’s wide latitude completely ignores the distinction between conservatorship and receivership.

On top of that, the ruling dances over the fact that FHFA, at Treasury’s behest, acted in direct opposition to returning the enterprises to solvency. Congress gave FHFA the power to do what is “necessary to put the [Companies] in a sound and solvent condition” and “appropriate to . . . preserve and conserve [their] assets.” 12 U.S.C. § 4617(b)(2)(D). It could not be clearer that Congress intended FHFA to put Fannie and Freddie back on solid financial footing.

In addition, in order to figure out if FHFA’s actions were “necessary” or “appropriate” it is important to understand the agency’s reasoning and intentions. But Caldwell brushes aside the responsibility of the government to explain its rationale for the Sweep and declares, essentially, that the government can do whatever it wants, regardless of the reason. Even if one were to accept the fact that no rationale is needed – and that is a big “if” – it is preposterous to assume HERA gave FHFA the authority to actively prevent Fannie and Freddie from rebuilding capital or resuming normal business operations.  Conservatorships have never been created to guarantee companies could not preserve and conserve assets.

Another reason why the ruling is flawed is because it is based on the assumption that FHFA “may” preserve and conserve Fannie and Freddie’s assets. In essence, Judge Caldwell believes HERA provides no mandate or duty for FHFA to facilitate the restoration of the enterprises’ solvency.  This is deeply disturbing.  It stands to reason that Congress stipulated FHFA’s authority because it wanted the agency to use that authority. Laws do not lay out duties, authorities and powers with the assumption agencies will put them aside and freelance based on the ideological caprices or political agenda of agency personnel. In essence, “may” implies that the agency should not do anything else.  But Judge Caldwell’s interpretation would open the flood gates for government agencies to act without restriction during conservatorships.

There are a number of technical but no less important issues that are also of concern. One is the conclusion that Treasury did not exceed its authority under HERA because the Net Worth Sweep was merely an amendment to Treasury’s existing securities rather than a purchase of new securities.  In fact, Congress mandated that FHFA be independent and explicitly restricted Treasury’s authority. The Sweep was not just a technical amendment to Treasury’s existing securities, it was a significant enough change to nature of shareholders’ economic interest to constitute a “purchase” of new securities. This exceeded Treasury’s authority.  

In addition, Judge Caldwell suggests if there was power grab by Treasury, then FHFA – but not shareholders – could sue.  Of course, as documents the government has been forced to make public in recent months have shown, FHFA’s independence has been thoroughly and deliberately undermined by Treasury so the idea of an inter-agency suit cannot be taken seriously.

Caldwell’s paint by numbers decision largely echoes the reasoning of U.S. District Court Judge Royce Lamberth’s when he threw out suits by investors in October 2014. Let us not forget, however, that Lamberth himself acknowledged in that opinion that the Sweep could “raise eyebrows” even as he concluded the law allowed the government wide latitude. That decision is on appeal and documents made public since have done more than raise eyebrows about the government’s actions and efforts to conceal those actions from Judge Lamberth’s court.