New(ish) Study: Government’s Violation of Corporate, Fiduciary, Legal and Democratic Duties in Handling of Fannie Mae and Freddie Mac

New(ish) Study: Government’s Violation of Corporate, Fiduciary, Legal and Democratic Duties in Handling of Fannie Mae and Freddie Mac

This week Michael Ide, reporter for ValueWalk, addressed a recent legal paper by Steven Davidoff Solomon and David Zaring titled, “After the Deal: Fannie, Freddie and the Financial Crisis Aftermath.”  Davidoff, a Professor of Law at the University of California, Berkeley and New York Times Deal Book columnist and Zaring, a Professor of Legal Studies and Business Ethics at the Wharton School, University of Pennsylvania make the argument that the government’s action to sweep 100 percent of Fannie Mae and Freddie Mac’s profits “failed to observe a laundry list of basic principles of corporate and administrative law.”[1] Outlining the government’s missteps throughout the analysis, Davidoff and Zaring make clear that the government violated its duties in the several roles they play within American society.  

Including Ralph Nader in a list of shareholders rightfully angered with the Treasury’s decision, Davidoff and Zaring claim, “This later action [Third Amendment Sweep] was problematic not just because corporate law ordinarily would not permit this sort of action by the controlling shareholder, but precisely because of this problem, ran afoul of both constitutional and administrative law on the matter.”[2]

Investors Unite has long made a variation of this argument: The government failed to follow the law when enacting the Third Amendment Sweep by disregarding shareholder rights. Davidoff and Zaring’s paper is yet another piece of support as they make their assessment based on an evaluation of the government from a corporate and administrative legal perspective.

When discussing the Third Amendment Sweep, Davidoff and Zaring make the legal case that the Treasury violated federal securities laws by enacting the Third Amendment because the transaction cannot be determined as “entirely fair.”[3] They also point to Treasury’s knowledge of the GSEs future profitability:

At the time of the Third Amendment Fannie and Freddie had both experienced profitable quarters. There was also an argument that the housing market was in recovery. Even though prior to the Third Amendment the GSEs would have to pay back $5 billion before either preferred or common shareholders received anything, there was residual value by their mere existence beyond any profit potential.[4]

Once again, it has become clear that the Treasury was knowledgeable about the recovery of Fannie and Freddie, and their profit-making ability, before the enactment of the sweep. By violating their fiduciary role as majority shareholder and conservator, the government fails to uphold the rule law and disadvantages minority shareholders by shutting them out.

The authors of the study affirm that by the time the Third Amendment net worth sweep was instated in 2012, the housing markets had stabilized, and Fannie and Freddie became profitable, “leaving plenty of profits that under the initial stock purchase agreements could have been paid to Fannie and Freddie shareholders who had retained their stakes in the seized firms.”[5]  

As we know, despite Fannie and Freddie returning to health, which are the right conditions under which to end the conservatorship, the Administration has not made a move to allow them to retain their capital. Davidoff and Zaring explain that the government, acting as conservator, should be subject to corporate laws citing:

Beyond simple rule of law issues, we see no reason why the ordinary rules for corporations should not apply given the government’s seeming pre-commitment to abide by these rules, rules which have solid economic foundation.[6]

Davidoff and Zaring rightfully point out that the government had the opportunity to liquidate or nationalize the GSEs but chose not to, making its bed of conservatorship, it should not be allowed “outside a crisis situation to simply abrogate its pre-commitment.”[7]

Perhaps most insightful, Davidoff and Zaring explain that even looking beyond the government’s role as a corporate entity in these dealings, it has the primary authority to protect the taxpayer and provide stability to the marketplace and their decision to enact the Third Amendment violates their duties as a government corporation:

The broad authority to protect taxpayers and provide stability to the financial markets cannot be said to reasonably include the pursuit of corporate shenanigans that never would be accepted in […] courts of equity at the federal level. Government corporations, for example, are often thought to have fiduciary obligations.[8]

The notion that a person can buy shares of an entity and have confidence that the corporation will be accountable to the agreement has long been rooted in our government’s economic and democratic principles, and has been an argument Investors Unite often cites as a reason Congress and FHFA should end the conservatorship and restore what’s owed to shareholders:

The economic basis of these fiduciary duties is rooted in classic governmental principles of trust and integrity. Shareholders provide funds to corporate entities knowing that corporate rules will prevent fiduciaries from taking undue advantage of their trust. This is the bedrock principle of corporate law and is designed to engender more optimal economic outcomes and provide avenues for acceptable capital raising. […] in the government setting the rule of law serves similar republican purposes. More specifically, here the government has raised capital from private investors.[9]

Davidoff and Zaring highlight an op-ed by David Skeel as the reason for shareholder repayment “arguing that there must be some redress for shareholders who lost in a deal where ‘the regulator sat on one side of the bargaining table and Treasury on the other—one arm of the government negotiating with the other.’”

While we at Investors Unite agree with much of the argumentation in this new study, the conclusion is perplexing, claiming that certain shareholders receive portion of the profits and putting the pressure on the courts to make the decision as to the exact amount that the others should be compensated. The study is hardly the last word in reforming Fannie and Freddie, but it serves as a basis for continued discussion among thought leaders, elected officials and stakeholders.



[1] Steven Davidoff Solomon & David Zaring, “After The Deal: Fannie, Freddie And The Financial CrisisAftermath,” Social Science Research Network, 8/20/14, Pg 1

[2]Ibid. Pg 5

[3]Ibid. Pg. 18

[4]Ibid. Pg. 19

[5]Ibid. Pg 13

[6] Ibid, Pg. 35

[7] Ibid. Pg 35

[8]Ibid. Pg 34-35

[9] Ibid. Pg 35