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GSE Reform: Affordable Housing Goals and the “Duty” to Provide Mortgage Financing
By Norbert J. Michel, Ph.D. & John L. Ligon
November 12, 2013
http://www.heritage.org/research/reports/2013/11/affordable-housing-goals-and-the-duty-to-provide-mortgage-financing
As Congress considers legislation to eliminate the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, advocacy groups are pressuring financial institutions to adhere to a “duty to serve” their markets rather than to meet specific affordable housing goals.
The “duty to serve” is a nebulous concept that codifies the idea that the GSEs (and lenders) have a “duty” to provide mortgage financing to the entire market. Thus mortgage market participants would no longer have to make sure a certain percentage of their business serves a low-income segment, but they would have to fulfill their duty to serve that segment. A regulatory regime such as this one leaves so much discretion in the hands of regulators that it effectively replaces the market with a government directive. There is no doubt that less private capital will be available when financial institutions have to do whatever regulators determine on a case-by-case basis.
This approach is misguided and it presents a serious danger for taxpayers, potential homebuyers, and ultimately all consumers. All of these people will be harmed if lawmakers ignore the following facts:
The “duty to serve” regime will almost certainly be a regulatory framework with added confusion for lenders and an enhanced ability for regulators to use politics to pressure financial institutions into making imprudent lending decisions.
Market economies provide benefits to people when business owners earn profits, not when they have a specific “duty” to serve government mandates. Finally, affordable housing goals tend to encourage people with low wealth to get into an enormous amount of debt—a point that seems to be getting lost in this debate.
Brief Background on Affordable Housing Goals
Prior to the early 1990s, Fannie and Freddie were regulated by the Department of Housing and Urban Development (HUD). During this time, the HUD Secretary only had the authority to “encourage” Fannie and Freddie to purchase mortgages in low-income markets. In 1992, Congress required Fannie and Freddie to finance fixed percentages of mortgages from clearly specified low-income and underserved markets.[1]
These affordable housing goals remain at the center of the GSE reform debate because mortgage defaults and foreclosures among higher risk mortgages were a contributing factor to the recent financial crisis. At the very least, the affordable housing goals encouraged financial institutions to lend to high-risk borrowers because lenders knew the GSEs would purchase the loans.
Thus, newly proposed legislation in both the House and the Senate eliminates the housing goals. The legislation in the Senate, though, expands a new regulatory approach—one that began in 2008—that is much worse than the specific goals the bill eliminates.
Legislative Background on “Duty to Serve”
The Housing and Economic Recovery Act of 2008 introduced language that allowed for a shift away from affordable housing goals. It explicitly acknowledged a “duty to serve” role for the GSEs in the U.S. mortgage market and assigned the task of writing regulations to the GSEs’ new regulator, the Federal Housing Finance Agency (FHFA). In 2010, the FHFA completed rules that require the GSEs to “serve” various “underserved markets.” For example, the FHFA regulations charged the GSEs with a duty to provide
leadership to the market in developing loan products and flexible underwriting guidelines to facilitate a secondary market for mortgages on housing for very low-, low- and moderate-income families with respect to manufactured housing, affordable housing preservation and rural markets.[2]
Thus, the nebulous “duty to serve” language replaced the prior focus on “affordable housing goals” in the GSE regulations. This concept is now an integral component to legislation working through Congress.
Corker–Warner Extends Duty to Serve
In the Senate, S. 1217, co-authored by Senators Bob Corker (R–TN) and Mark Warner (D–VA), eliminates both the GSEs and the affordable housing goals. However, the bill replaces the GSEs with a new government agency called the Federal Mortgage Insurance Corporation (FMIC) and gives the FMIC a vague set of “duties” instead of explicit goals. Section 201 of the bill states that one of the principal duties of the FMIC shall be to “provide leadership to the housing finance market to help ensure that all geographic locations have access to mortgage credit.”
This language closely mirrors the wording of the recent FHFA regulations, but housing advocacy groups are criticizing the Corker–Warner bill for failing to “articulate a key public policy goal that any proposals to rebuild the home finance market must embody: Broad access to affordable mortgage credit for all credit-worthy borrowers.”[3] More specifically, these groups have called for legislation “to include an explicit duty to serve credit-worthy borrowers protected by civil rights laws.”[4]
This euphemistic language replaces “housing goals” with “duty to serve,” and it potentially does more harm to markets because regulators will have more leeway to craft rules without any specific reference points. Lenders, for example, will constantly operate under the threat of a regulatory agency accusing them of failing to live up to their “duty” regardless of how many loans they make in underserved markets. The end result will almost certainly be a regulatory framework with added confusion for lenders and an enhanced ability for regulators to use politics to pressure financial institutions into making imprudent lending decisions.
Simply put, regulating the housing market with “housing goals” is distinct from doing so with a “duty to serve,” but they are both bad policy, and the latter is much worse because of the added uncertainty and increased potential for political influence.
Recommendations
Neither “duties to serve” or “affordable housing goals” should be imposed by policymakers on the GSEs or any successor agencies.
New laws should not bias the market toward homeownership because a free market allows people to choose between renting and owning a home.
A Bad Euphemism
Proposed legislation focuses on mandating a duty to serve various markets so that borrowers in all types of communities will be guaranteed “access” to credit. However, when it comes to regulatory policy, the more vague “duty to serve” is much worse than specific goals. Duty to serve is simply a bad euphemism for “housing goals,” and it is bad economic policy.
—Norbert Michel, PhD, is Research Fellow in Financial Regulations in the Thomas A. Roe Institute for Economic Policy Studies and John L. Ligon is Senior Policy Analyst in the Center for Data Analysis at The Heritage Foundation.
!!!Please read the post that this is a reply to!!! Very important
!!!!!!!!!A Primer for Tomorrow's Proceedings!!!!!!!!!
(A long read but very important)
November 11, 2013
An Unconstitutional Bonanza
by Richard A. Epstein
http://www.hoover.org/publications/defining-ideas/article/161456
In a previous column, Grand Theft Treasury, I highlighted the recent lawsuits (now numbering seventeen) brought against the United States in connection with its controversial conservatorship of two government-sponsored enterprises, The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac).
The occasion for that story was the then-recent public announcement that about $59 billion had been paid to the United States Treasury as a “dividend” on the $188 billion in purchase money payments that Treasury had advanced to Fannie and Freddie pursuant to agreements that it had entered into with its conservator, the Federal Housing Finance Agency (FHFA). The two key agreements were the initial “Senior Preferred Stock Purchase Agreement” of September 26, 2008, and the Third Amendment to that agreement of August 17, 2012. (All the relevant documents can be found here).
This past week two events of note took place. First, the United States filed its much anticipated brief in Washington Federal v. United States, defending itself against charges that it had seized the wealth of the private shareholders of Fannie and Freddie. The second is that FHFA, on behalf of Fannie and Freddie, paid the Treasury another $39 billion in dividends on the original advances of about $188 billion. Combined with the earlier payments, the Treasury has now virtually recouped its huge original advance. The prospect of further and equally lucrative paydays promises to turn Treasury’s erstwhile “rescue operation” into an unparalleled bonanza for the government. The deal looks almost too good to be true. Indeed, a close examination of the government’s responsive brief reveals that it is.
The Original Deal
At root, the legal challenges to the government’s action rest on the one-sided terms of the original stock purchase agreement and especially the controversial Third Amendment. In September 2008, FHFA wrested control away from the Boards of Directors of Fannie and Freddie by installing itself as the conservator of both corporations, charged with managing all of their affairs. Armed with these extensive powers, FHFA promptly entered into a sweetheart deal with Treasury whereby Treasury purchased a new issue of senior preferred stock from Fannie and Freddie for about $188 billion, which carried with it a 10 percent dividend, and an option that allowed Treasury to acquire some 79.9 percent of the common stock for the nominal price of $0.00001 per share. That transaction drove down the prices of the common and (now junior) preferred. The 2012 Third Amendment replaced the previous 10 percent dividend with a “sweep” to Treasury of all the net profits of Fannie and Freddie, as of January 1, 2013.
The deal was made just as both companies were returning to profitability. As commonly expected, the revised agreement has proved wholly one-sided. Treasury has reaped over one hundred billion dollars and, through the profit sweep, has assured that Fannie and Freddie will never amass a single dime to enable the repurchase of the senior preferred stock. A conservatorship requires the conservator to act in the best interest of its beneficiaries—here the shareholders of Fannie and Freddie at the time the conservatorship was imposed. The original stock purchase agreement, and most emphatically the Third Amendment, which benefited only FHFA and Treasury, were signed in blatant violation of that basic duty. FHFA’s responsibility to the shareholders demands, at the very least, was that the Third Amendment be unraveled, and not exalted.
The Government’s Response
In speaking and writing about this issue (which I have done as a paid consultant for several hedge funds), I have often been asked how the government could defend itself in these dubious transactions that would be regarded as both intolerable and illegal if done by private parties. The government brief does not provide an acceptable answer to that question on either procedural or substantive grounds.
The Procedural Move.The government’s initial move is to refer to a key provision of the conservatorship law that it reads as making it impossible for the shareholders to have their day in court. Thus under 12 U.S.C. § 4617(b)(2)(A), FHFA shall “as conservator or receiver, and by operation of law, immediately succeed to—(i) all rights, titles, powers, and privileges of the regulated entity, and of any stockholder, officer, or director of such regulated entity with respect to the regulated entity and the assets of the regulated entity.” According to the government, this provision silences the shareholders because all their rights and powers have been transferred to FHFA.
That extravagant claim makes sense only so long as the interests of FHFA are aligned with those of its shareholders. The obvious distress of many financial institutions means that something has gone amiss. It is therefore a legitimate legislative judgment to grant the new government officials the power to pursue all claims that the corporations and their shareholders could bring against outsiders.
In support of its position, the government cites a 2012 Circuit Court decision, Kellmer v. Raines, which held that only FHFA was in a position to sue the former officers and directors of Fannie and Freddie for the breach of their duties to the corporation. That court insisted that, as a general proposition, its sole job was to “read the statute,” from which it concluded that “all rights, titles powers, and privileges” meant just that.
Therefore, on the basis of Washington Mutual, the government now insists that individual shareholders cannot sue FHFA and Treasury either as owners of shares or “derivatively” (that is, not in their own right but on behalf of the corporation). Thus the government concludes that persons who claim that billions of their dollars have made it into the treasury lack “standing” to challenge the FHFA and Treasury in court on, it appears, any and all legal grounds.
Two responses are appropriate. First, it is an absurd literalism to read the statute as though it contains no implied and necessary exception for those cases in which shareholders claim that FHFA has acted in violation of the duty of loyalty to them. The general legal maxim is that no person shall be a judge in his own cause, which is just what the government does with its wooden reading of the statute. The judicial injunction to read the statute means to read it as a whole, so as to make sense of all its moving parts, not just some.
Second, read as the government would have it, the statute is flatly unconstitutional because it denies individuals and their property the protections afforded against the government by the Fifth Amendment to the Constitution, which says “No person shall . . . be deprived of life, liberty, or property, without due process of law.” This, at a minimum, gives them the right to a hearing before a neutral and impartial judge in cases that involve major disputes over the nature and validity of substantial property claims.
The canon of constitutional avoidance holds that all statutes should be construed to avoid any serious clash with the Constitution “unless such construction is plainly contrary to the intent of Congress.” The government’s interpretation of the statute flouts that rule; if adopted, it should lead to the statute’s invalidation to the extent that it bars shareholders from the courtroom door.
The Substantive Move. The government’s second response is that even if they are allowed into Court, the shareholders of Fannie and Freddie really have nothing to complain about because their property has not been taken. At one point, the government makes the weird claim that this action should be barred because the plaintiffs do not allege that “the Government has the citizen’s money in its pocket.” The technical reason for that claim is that Washington Mutual did not allege that the government had taken the money, but only that it had suffered a reduction in its shares’ value as a result of the government’s action.
Yet that perceived defect in pleading is easily remedied. The explicit purchase agreement took stock from the corporations in exchange for the infusion of cash. The taking comes from the fact that the value given to Fannie and Freddie was less than the value taken from the corporations. Phrased in this way, there are 100 billion reasons why money that belonged to the two corporations ended up in the pockets of the United States after the last two major sweeps.
The argument that these transactions count as takings is no more complex than the simple claim that the government forcibly takes the house of A, worth $100,000, for a mere $25,000. The forced purchase on unequal terms is a taking of $75,000, which should be enjoined unless the government ponies up the remaining $75,000. The situation does not change if the government plunks down that $25,000 in cash in exchange for a mortgage upon the property for $75,000, which it then empowers itself to collect by renting out the premises, keeping all the rents net of expenses for itself.
The Third Amendment to the Stock Purchase Agreement represents just this kind of one-sided transaction. Yet the government seeks to avoid this obvious implication by three specious arguments. First, it claims that there really was a mutually beneficial bargain here. After all, the Third Amendment was needed “because of a concern that the Enterprises, although solvent with Treasury’s assistance, would fail to generate enough revenue to fund the 10 percent dividend obligation.” Fat chance. Indeed, the one way to magnify the miniscule risk of default is to strip Fannie and Freddie of liquidity by the unilateral “dividend” payment made to the government. As a conservator, FHFA is supposed to defend shareholders, not fork over their money to Treasury.
Next, the government offers two more threadbare arguments for its position. The first is that the time is not “ripe” for a complete accounting because the books have not closed on the transaction. But the goal in this case is to stop the bloodletting before the patient is dead, not to let the government go on with its rigged scheme until that future day when it will solemnly pronounce that it is just too late to unravel this complex transaction.
Finally, the government claims that the shareholders of Fannie and Freddie have assumed the risk that they will be looted. After all, an extensive body of law, much of which comes out of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), takes the highly contentious line that all banks know that they cannot challenge government regulations because they have willingly entered into a highly regulated area. Consequently, they do not have the requisite “investment-backed expectations” that they will be free of government regulation.
But this lawsuit is not a case where the government has acted pursuant to its general powers to regulate thrift institutions. Those cases are worlds apart from the present for two reasons. First, the source of the shareholders’ disaffection here is the purchase agreement of the senior preferred stock, and not any form of general government regulation of banks that have otherwise failed. Second, those cases do not contain the obvious element of self-dealing which pervades the Third Amendment.
Notwithstanding the government’s efforts to sugarcoat the obvious, this deal remains one of the most lopsided and unfair transactions in the annals of United States history—which says a lot about the sad state of public law and finance today.
!!!!!!!!!A Primer for Tomorrow's Proceedings!!!!!!!!!
(A long read but very important)
November 11, 2013
An Unconstitutional Bonanza
by Richard A. Epstein
http://www.hoover.org/publications/defining-ideas/article/161456
In a previous column, Grand Theft Treasury, I highlighted the recent lawsuits (now numbering seventeen) brought against the United States in connection with its controversial conservatorship of two government-sponsored enterprises, The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac).
The occasion for that story was the then-recent public announcement that about $59 billion had been paid to the United States Treasury as a “dividend” on the $188 billion in purchase money payments that Treasury had advanced to Fannie and Freddie pursuant to agreements that it had entered into with its conservator, the Federal Housing Finance Agency (FHFA). The two key agreements were the initial “Senior Preferred Stock Purchase Agreement” of September 26, 2008, and the Third Amendment to that agreement of August 17, 2012. (All the relevant documents can be found here).
This past week two events of note took place. First, the United States filed its much anticipated brief in Washington Federal v. United States, defending itself against charges that it had seized the wealth of the private shareholders of Fannie and Freddie. The second is that FHFA, on behalf of Fannie and Freddie, paid the Treasury another $39 billion in dividends on the original advances of about $188 billion. Combined with the earlier payments, the Treasury has now virtually recouped its huge original advance. The prospect of further and equally lucrative paydays promises to turn Treasury’s erstwhile “rescue operation” into an unparalleled bonanza for the government. The deal looks almost too good to be true. Indeed, a close examination of the government’s responsive brief reveals that it is.
The Original Deal
At root, the legal challenges to the government’s action rest on the one-sided terms of the original stock purchase agreement and especially the controversial Third Amendment. In September 2008, FHFA wrested control away from the Boards of Directors of Fannie and Freddie by installing itself as the conservator of both corporations, charged with managing all of their affairs. Armed with these extensive powers, FHFA promptly entered into a sweetheart deal with Treasury whereby Treasury purchased a new issue of senior preferred stock from Fannie and Freddie for about $188 billion, which carried with it a 10 percent dividend, and an option that allowed Treasury to acquire some 79.9 percent of the common stock for the nominal price of $0.00001 per share. That transaction drove down the prices of the common and (now junior) preferred. The 2012 Third Amendment replaced the previous 10 percent dividend with a “sweep” to Treasury of all the net profits of Fannie and Freddie, as of January 1, 2013.
The deal was made just as both companies were returning to profitability. As commonly expected, the revised agreement has proved wholly one-sided. Treasury has reaped over one hundred billion dollars and, through the profit sweep, has assured that Fannie and Freddie will never amass a single dime to enable the repurchase of the senior preferred stock. A conservatorship requires the conservator to act in the best interest of its beneficiaries—here the shareholders of Fannie and Freddie at the time the conservatorship was imposed. The original stock purchase agreement, and most emphatically the Third Amendment, which benefited only FHFA and Treasury, were signed in blatant violation of that basic duty. FHFA’s responsibility to the shareholders demands, at the very least, was that the Third Amendment be unraveled, and not exalted.
The Government’s Response
In speaking and writing about this issue (which I have done as a paid consultant for several hedge funds), I have often been asked how the government could defend itself in these dubious transactions that would be regarded as both intolerable and illegal if done by private parties. The government brief does not provide an acceptable answer to that question on either procedural or substantive grounds.
The Procedural Move.The government’s initial move is to refer to a key provision of the conservatorship law that it reads as making it impossible for the shareholders to have their day in court. Thus under 12 U.S.C. § 4617(b)(2)(A), FHFA shall “as conservator or receiver, and by operation of law, immediately succeed to—(i) all rights, titles, powers, and privileges of the regulated entity, and of any stockholder, officer, or director of such regulated entity with respect to the regulated entity and the assets of the regulated entity.” According to the government, this provision silences the shareholders because all their rights and powers have been transferred to FHFA.
That extravagant claim makes sense only so long as the interests of FHFA are aligned with those of its shareholders. The obvious distress of many financial institutions means that something has gone amiss. It is therefore a legitimate legislative judgment to grant the new government officials the power to pursue all claims that the corporations and their shareholders could bring against outsiders.
In support of its position, the government cites a 2012 Circuit Court decision, Kellmer v. Raines, which held that only FHFA was in a position to sue the former officers and directors of Fannie and Freddie for the breach of their duties to the corporation. That court insisted that, as a general proposition, its sole job was to “read the statute,” from which it concluded that “all rights, titles powers, and privileges” meant just that.
Therefore, on the basis of Washington Mutual, the government now insists that individual shareholders cannot sue FHFA and Treasury either as owners of shares or “derivatively” (that is, not in their own right but on behalf of the corporation). Thus the government concludes that persons who claim that billions of their dollars have made it into the treasury lack “standing” to challenge the FHFA and Treasury in court on, it appears, any and all legal grounds.
Two responses are appropriate. First, it is an absurd literalism to read the statute as though it contains no implied and necessary exception for those cases in which shareholders claim that FHFA has acted in violation of the duty of loyalty to them. The general legal maxim is that no person shall be a judge in his own cause, which is just what the government does with its wooden reading of the statute. The judicial injunction to read the statute means to read it as a whole, so as to make sense of all its moving parts, not just some.
Second, read as the government would have it, the statute is flatly unconstitutional because it denies individuals and their property the protections afforded against the government by the Fifth Amendment to the Constitution, which says “No person shall . . . be deprived of life, liberty, or property, without due process of law.” This, at a minimum, gives them the right to a hearing before a neutral and impartial judge in cases that involve major disputes over the nature and validity of substantial property claims.
The canon of constitutional avoidance holds that all statutes should be construed to avoid any serious clash with the Constitution “unless such construction is plainly contrary to the intent of Congress.” The government’s interpretation of the statute flouts that rule; if adopted, it should lead to the statute’s invalidation to the extent that it bars shareholders from the courtroom door.
The Substantive Move. The government’s second response is that even if they are allowed into Court, the shareholders of Fannie and Freddie really have nothing to complain about because their property has not been taken. At one point, the government makes the weird claim that this action should be barred because the plaintiffs do not allege that “the Government has the citizen’s money in its pocket.” The technical reason for that claim is that Washington Mutual did not allege that the government had taken the money, but only that it had suffered a reduction in its shares’ value as a result of the government’s action.
Yet that perceived defect in pleading is easily remedied. The explicit purchase agreement took stock from the corporations in exchange for the infusion of cash. The taking comes from the fact that the value given to Fannie and Freddie was less than the value taken from the corporations. Phrased in this way, there are 100 billion reasons why money that belonged to the two corporations ended up in the pockets of the United States after the last two major sweeps.
The argument that these transactions count as takings is no more complex than the simple claim that the government forcibly takes the house of A, worth $100,000, for a mere $25,000. The forced purchase on unequal terms is a taking of $75,000, which should be enjoined unless the government ponies up the remaining $75,000. The situation does not change if the government plunks down that $25,000 in cash in exchange for a mortgage upon the property for $75,000, which it then empowers itself to collect by renting out the premises, keeping all the rents net of expenses for itself.
The Third Amendment to the Stock Purchase Agreement represents just this kind of one-sided transaction. Yet the government seeks to avoid this obvious implication by three specious arguments. First, it claims that there really was a mutually beneficial bargain here. After all, the Third Amendment was needed “because of a concern that the Enterprises, although solvent with Treasury’s assistance, would fail to generate enough revenue to fund the 10 percent dividend obligation.” Fat chance. Indeed, the one way to magnify the miniscule risk of default is to strip Fannie and Freddie of liquidity by the unilateral “dividend” payment made to the government. As a conservator, FHFA is supposed to defend shareholders, not fork over their money to Treasury.
Next, the government offers two more threadbare arguments for its position. The first is that the time is not “ripe” for a complete accounting because the books have not closed on the transaction. But the goal in this case is to stop the bloodletting before the patient is dead, not to let the government go on with its rigged scheme until that future day when it will solemnly pronounce that it is just too late to unravel this complex transaction.
Finally, the government claims that the shareholders of Fannie and Freddie have assumed the risk that they will be looted. After all, an extensive body of law, much of which comes out of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), takes the highly contentious line that all banks know that they cannot challenge government regulations because they have willingly entered into a highly regulated area. Consequently, they do not have the requisite “investment-backed expectations” that they will be free of government regulation.
But this lawsuit is not a case where the government has acted pursuant to its general powers to regulate thrift institutions. Those cases are worlds apart from the present for two reasons. First, the source of the shareholders’ disaffection here is the purchase agreement of the senior preferred stock, and not any form of general government regulation of banks that have otherwise failed. Second, those cases do not contain the obvious element of self-dealing which pervades the Third Amendment.
Notwithstanding the government’s efforts to sugarcoat the obvious, this deal remains one of the most lopsided and unfair transactions in the annals of United States history—which says a lot about the sad state of public law and finance today.
!!!!!!!!!A Primer for Tomorrow's Proceedings!!!!!!!!!
(A long read but very important)
November 11, 2013
An Unconstitutional Bonanza
by Richard A. Epstein
http://www.hoover.org/publications/defining-ideas/article/161456
In a previous column, Grand Theft Treasury, I highlighted the recent lawsuits (now numbering seventeen) brought against the United States in connection with its controversial conservatorship of two government-sponsored enterprises, The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac).
The occasion for that story was the then-recent public announcement that about $59 billion had been paid to the United States Treasury as a “dividend” on the $188 billion in purchase money payments that Treasury had advanced to Fannie and Freddie pursuant to agreements that it had entered into with its conservator, the Federal Housing Finance Agency (FHFA). The two key agreements were the initial “Senior Preferred Stock Purchase Agreement” of September 26, 2008, and the Third Amendment to that agreement of August 17, 2012. (All the relevant documents can be found here).
This past week two events of note took place. First, the United States filed its much anticipated brief in Washington Federal v. United States, defending itself against charges that it had seized the wealth of the private shareholders of Fannie and Freddie. The second is that FHFA, on behalf of Fannie and Freddie, paid the Treasury another $39 billion in dividends on the original advances of about $188 billion. Combined with the earlier payments, the Treasury has now virtually recouped its huge original advance. The prospect of further and equally lucrative paydays promises to turn Treasury’s erstwhile “rescue operation” into an unparalleled bonanza for the government. The deal looks almost too good to be true. Indeed, a close examination of the government’s responsive brief reveals that it is.
The Original Deal
At root, the legal challenges to the government’s action rest on the one-sided terms of the original stock purchase agreement and especially the controversial Third Amendment. In September 2008, FHFA wrested control away from the Boards of Directors of Fannie and Freddie by installing itself as the conservator of both corporations, charged with managing all of their affairs. Armed with these extensive powers, FHFA promptly entered into a sweetheart deal with Treasury whereby Treasury purchased a new issue of senior preferred stock from Fannie and Freddie for about $188 billion, which carried with it a 10 percent dividend, and an option that allowed Treasury to acquire some 79.9 percent of the common stock for the nominal price of $0.00001 per share. That transaction drove down the prices of the common and (now junior) preferred. The 2012 Third Amendment replaced the previous 10 percent dividend with a “sweep” to Treasury of all the net profits of Fannie and Freddie, as of January 1, 2013.
The deal was made just as both companies were returning to profitability. As commonly expected, the revised agreement has proved wholly one-sided. Treasury has reaped over one hundred billion dollars and, through the profit sweep, has assured that Fannie and Freddie will never amass a single dime to enable the repurchase of the senior preferred stock. A conservatorship requires the conservator to act in the best interest of its beneficiaries—here the shareholders of Fannie and Freddie at the time the conservatorship was imposed. The original stock purchase agreement, and most emphatically the Third Amendment, which benefited only FHFA and Treasury, were signed in blatant violation of that basic duty. FHFA’s responsibility to the shareholders demands, at the very least, was that the Third Amendment be unraveled, and not exalted.
The Government’s Response
In speaking and writing about this issue (which I have done as a paid consultant for several hedge funds), I have often been asked how the government could defend itself in these dubious transactions that would be regarded as both intolerable and illegal if done by private parties. The government brief does not provide an acceptable answer to that question on either procedural or substantive grounds.
The Procedural Move.The government’s initial move is to refer to a key provision of the conservatorship law that it reads as making it impossible for the shareholders to have their day in court. Thus under 12 U.S.C. § 4617(b)(2)(A), FHFA shall “as conservator or receiver, and by operation of law, immediately succeed to—(i) all rights, titles, powers, and privileges of the regulated entity, and of any stockholder, officer, or director of such regulated entity with respect to the regulated entity and the assets of the regulated entity.” According to the government, this provision silences the shareholders because all their rights and powers have been transferred to FHFA.
That extravagant claim makes sense only so long as the interests of FHFA are aligned with those of its shareholders. The obvious distress of many financial institutions means that something has gone amiss. It is therefore a legitimate legislative judgment to grant the new government officials the power to pursue all claims that the corporations and their shareholders could bring against outsiders.
In support of its position, the government cites a 2012 Circuit Court decision, Kellmer v. Raines, which held that only FHFA was in a position to sue the former officers and directors of Fannie and Freddie for the breach of their duties to the corporation. That court insisted that, as a general proposition, its sole job was to “read the statute,” from which it concluded that “all rights, titles powers, and privileges” meant just that.
Therefore, on the basis of Washington Mutual, the government now insists that individual shareholders cannot sue FHFA and Treasury either as owners of shares or “derivatively” (that is, not in their own right but on behalf of the corporation). Thus the government concludes that persons who claim that billions of their dollars have made it into the treasury lack “standing” to challenge the FHFA and Treasury in court on, it appears, any and all legal grounds.
Two responses are appropriate. First, it is an absurd literalism to read the statute as though it contains no implied and necessary exception for those cases in which shareholders claim that FHFA has acted in violation of the duty of loyalty to them. The general legal maxim is that no person shall be a judge in his own cause, which is just what the government does with its wooden reading of the statute. The judicial injunction to read the statute means to read it as a whole, so as to make sense of all its moving parts, not just some.
Second, read as the government would have it, the statute is flatly unconstitutional because it denies individuals and their property the protections afforded against the government by the Fifth Amendment to the Constitution, which says “No person shall . . . be deprived of life, liberty, or property, without due process of law.” This, at a minimum, gives them the right to a hearing before a neutral and impartial judge in cases that involve major disputes over the nature and validity of substantial property claims.
The canon of constitutional avoidance holds that all statutes should be construed to avoid any serious clash with the Constitution “unless such construction is plainly contrary to the intent of Congress.” The government’s interpretation of the statute flouts that rule; if adopted, it should lead to the statute’s invalidation to the extent that it bars shareholders from the courtroom door.
The Substantive Move. The government’s second response is that even if they are allowed into Court, the shareholders of Fannie and Freddie really have nothing to complain about because their property has not been taken. At one point, the government makes the weird claim that this action should be barred because the plaintiffs do not allege that “the Government has the citizen’s money in its pocket.” The technical reason for that claim is that Washington Mutual did not allege that the government had taken the money, but only that it had suffered a reduction in its shares’ value as a result of the government’s action.
Yet that perceived defect in pleading is easily remedied. The explicit purchase agreement took stock from the corporations in exchange for the infusion of cash. The taking comes from the fact that the value given to Fannie and Freddie was less than the value taken from the corporations. Phrased in this way, there are 100 billion reasons why money that belonged to the two corporations ended up in the pockets of the United States after the last two major sweeps.
The argument that these transactions count as takings is no more complex than the simple claim that the government forcibly takes the house of A, worth $100,000, for a mere $25,000. The forced purchase on unequal terms is a taking of $75,000, which should be enjoined unless the government ponies up the remaining $75,000. The situation does not change if the government plunks down that $25,000 in cash in exchange for a mortgage upon the property for $75,000, which it then empowers itself to collect by renting out the premises, keeping all the rents net of expenses for itself.
The Third Amendment to the Stock Purchase Agreement represents just this kind of one-sided transaction. Yet the government seeks to avoid this obvious implication by three specious arguments. First, it claims that there really was a mutually beneficial bargain here. After all, the Third Amendment was needed “because of a concern that the Enterprises, although solvent with Treasury’s assistance, would fail to generate enough revenue to fund the 10 percent dividend obligation.” Fat chance. Indeed, the one way to magnify the miniscule risk of default is to strip Fannie and Freddie of liquidity by the unilateral “dividend” payment made to the government. As a conservator, FHFA is supposed to defend shareholders, not fork over their money to Treasury.
Next, the government offers two more threadbare arguments for its position. The first is that the time is not “ripe” for a complete accounting because the books have not closed on the transaction. But the goal in this case is to stop the bloodletting before the patient is dead, not to let the government go on with its rigged scheme until that future day when it will solemnly pronounce that it is just too late to unravel this complex transaction.
Finally, the government claims that the shareholders of Fannie and Freddie have assumed the risk that they will be looted. After all, an extensive body of law, much of which comes out of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), takes the highly contentious line that all banks know that they cannot challenge government regulations because they have willingly entered into a highly regulated area. Consequently, they do not have the requisite “investment-backed expectations” that they will be free of government regulation.
But this lawsuit is not a case where the government has acted pursuant to its general powers to regulate thrift institutions. Those cases are worlds apart from the present for two reasons. First, the source of the shareholders’ disaffection here is the purchase agreement of the senior preferred stock, and not any form of general government regulation of banks that have otherwise failed. Second, those cases do not contain the obvious element of self-dealing which pervades the Third Amendment.
Notwithstanding the government’s efforts to sugarcoat the obvious, this deal remains one of the most lopsided and unfair transactions in the annals of United States history—which says a lot about the sad state of public law and finance today.
The information your looking for is in the 3rd and 4th paragraph.
Link 1: http://online.wsj.com/news/articles/SB10001424052702303309504579183831541669864
Link 2: http://www.marketwatch.com/story/otc-markets-glitch-halts-trade-of-unlisted-shares-2013-11-07
Trading in thousands of unlisted shares, including those of Fannie Mae FNMA -3.32% and Freddie Mac, FMCC -1.76% was frozen for more than five hours Thursday after a network failure knocked out stock quotes at OTC Markets Group Inc. OTCM -0.64%
The outage prevented trading on OTC Markets' platform from opening until 3 p.m. EST, sidelining brokers and traders and keeping investors in the dark as buy and sell orders piled up.
The New York company's president and chief executive, R. Cromwell Coulson, said trading would open on time Friday following what he called the company's longest-ever outage. The marketplace contemplated switching over to its disaster-recovery site in Philadelphia but opted to wait until its network came back up, Mr. Coulson said.
"The industry wanted us to be careful, that trading was orderly," he said on a media conference call.
Thursday's glitch follows a series of malfunctions that have roiled financial markets in recent years. Outages such as the May 2010 "flash crash," in which the Dow Jones Industrial Average tumbled more than 700 points in a few minutes, and a three-hour August freeze in Nasdaq Stock Market NDAQ +2.31% -listed securities have drawn scrutiny from regulators and raised questions among investors over the resilience of U.S. market systems.
"All it does is undermine the public's confidence," said Peter Sidoti, founder of small-cap equity research firm Sidoti & Co. "It's one thing after another."
Mr. Coulson said the problems originated with an outage at Lightower Fiber Networks and Sidera Networks, which maintain some of OTC Markets' systems. Representatives for Lightower, which merged with Sidera earlier this year, didn't immediately respond to requests for comment.
Thursday's shutdown took place in a century-old marketplace that operates largely outside the purview of regulators, comprising scores of little-known, thinly traded companies whose shares trade for fractions of a penny. Investors flock to the market to deal in the securities of firms that in many cases are too small, lightly traded or troubled to make it on a big stock exchange.
Along with government-backed mortgage companies Fannie Mae and Freddie Mac, the list of household-name companies whose shares trade outside the major exchanges includes AMR Corp. AAMRQ +4.23% , the American Airlines parent that is operating in bankruptcy proceedings, and some U.S. securities issued by global giants such as Nestlé SA and Adidas AG ADS.XE +0.28% . OTC Markets provides a marketplace for about 10,000 companies.
"It was definitely a huge issue for us and our clients," said Jacob Rappaport, head of Americas trading at INTL FCStone Securities, which trades American shares of foreign companies over the counter. "Orders piled up, and it was a real question if they don't open. It was really fortunate that they got open."
OTC Markets staff noticed technology problems around 6 a.m. Thursday and opted not to begin trading when the U.S. stock market opened at 9:30 a.m., Mr. Coulson said.
The Financial Industry Regulatory Authority later halted trading in all OTC equity securities because of the "lack of current quotation information." Finra sounded the all-clear Thursday afternoon. A spokeswoman for Finra, the Wall Street-funded regulator for the securities industry, directed questions to OTC Markets.
Though OTC Markets' systems were down, brokers were still able to trade some unlisted securities directly with one another and match up trades internally.
The glitch left traders in Fannie and Freddie, which were among the most frequently traded over-the-counter stocks last month by dollar volume, unable to access the main venue for trading unlisted securities on a day when the companies reported their latest quarterly profit.
"We were truly in the dark all day," said Richard Sgueglia, a trader at Guggenheim Securities LLC, which normally handles thousands of trades daily.
Since their shares were delisted from the New York Stock Exchange NYX +1.54% in 2010, Fannie and Freddie have become enormously profitable, buoyed by a federal backstop, an improving housing market and little competition from private investors. The profits have sparked heavy trading in the companies' common and preferred shares.
For much of Thursday, Fannie Mae was listed as up 10 cents at $2.40 on volume of 391,880 shares, according to the OTC Markets website. After trading reopened Thursday afternoon, the stock inched up a penny to close at $2.41 a share on volume of 12.1 million shares.
Average daily volume in Fannie Mae over the past three months was 19.4 million shares, according to the OTC Markets website.
Market-wide trading volume on OTC Markets on Thursday was $488 million, the company's website said. That compares with a daily average of $26 billion on the New York Stock Exchange, according to data from BATS Global Markets Inc.
Before a corporate makeover in the past decade, OTC Markets was long known as the "pink sheets," a venue that had a reputation as a Wild West of stock trading. The marketplace got its name because of the pink-colored sheets of paper once used to maintain prices for stocks in unlisted companies. Most trades were done over the phone.
Mr. Coulson, a former stock trader who sometimes dealt in pink-sheets companies, took over the company in 1997 and overhauled it, developing electronic-trading functions and pitching the platform as a steppingstone for companies aspiring to list on a major stock exchange.
Trading on the platform is generally the domain of big brokerages and trading houses, such as KCG Holdings Inc., KCG -0.40% Canaccord Genuity Group Inc. CF.T -1.13% and Jane Street Markets LLC.
OTC Markets doesn't have listing requirements like Nasdaq or the New York Stock Exchange, which require quarterly filings with regulators or the maintenance of certain minimum share prices or trading volumes. But the company encourages companies that trade on its platform to divulge financial and governance information. OTC Markets now segments its companies into different tiers.
The top tier, OTCQX, includes companies that make regular disclosures and are sponsored by a third-party adviser, while the OTCPink tier features "all types of companies that are there by reasons of default, distress or design."
—Alexandra Scaggs contributed to this article.
Write to Jacob Bunge at jacob.bunge@wsj.com
Sounds good!
NEW VIDEO!
NEW VIDEO!
AND ANOTHER!!
NEW VIDEO!
Thanks for the update.
You have a link for that?
Tweet from Freddie Mac CEO
Freddie Mac CEO Layton: "We are here, stronger than before, competing for your business, and we plan to be here for a pretty long time." #MBA100Annual
Love the videos! Thx!
Yea, Just made it available on YouTube.
Great find! Just posted it to our website: Restorefanniemae.us
Thanks!
Fannie Mae CEO welcomes new employees
All the videos from the daylong conference “The Future of Fannie and Freddie,” co-sponsored by the Classical Liberal Institute and the NYU Journal of Law & Business are up.
This is the link to all four: http://www.nyujlb.org/academicevents/fallpanels/2013fallconference/
I posted a video of "Panel 3: Conservatorship and the Takings Clause" a week or so back. Have not had a chance to watch the last one "Panel 4: The Future of Fannie and Freddie" but the one below provided interesting.
All the videos from the daylong conference “The Future of Fannie and Freddie,” co-sponsored by the Classical Liberal Institute and the NYU Journal of Law & Business are up.
This is the link to all four: http://www.nyujlb.org/academicevents/fallpanels/2013fallconference/
I posted a video of "Panel 3: Conservatorship and the Takings Clause" a week or so back. Have not had a chance to watch the last one "Panel 4: The Future of Fannie and Freddie" but the one below provided interesting.
All the videos from the daylong conference “The Future of Fannie and Freddie,” co-sponsored by the Classical Liberal Institute and the NYU Journal of Law & Business are up.
This is the link to all four: http://www.nyujlb.org/academicevents/fallpanels/2013fallconference/
I posted a video of "Panel 3: Conservatorship and the Takings Clause" a week or so back. Have not had a chance to watch the last one "Panel 4: The Future of Fannie and Freddie" but the one below provided interesting.
Hope all is well. Glad your back!
Nice find
Europeans Import U.S. Mortgage Models
October 7, 2013
http://online.wsj.com/article/SB10001424052702304176904579110941131532048.html?ru=yahoo&mod=yahoo_hs
U.S. taxpayers had to rescue mortgage giants Fannie Mae FNMA +2.68% and Freddie Mac, FMCC +3.55% but that isn't stopping some European governments from adopting similar programs and institutions.
The Dutch government recently announced it will seek to develop its own version of Fannie and Freddie to take some pressure off its banks' balance sheets and help revitalize the local housing market. Meanwhile, U.K. and Italian officials are implementing policies aimed at helping more people buy homes by getting the state to partly guarantee certain types of home loans—a project that resembles the mandate of the U.S. Federal Housing Administration.
The shift toward explicit government subsidies in these European mortgage markets is raising eyebrows. The plans reflect mounting concern among policy makers that a dearth of bank lending is stymying fragile economic recoveries. But some experts question whether these policies will instead stoke housing bubbles or lead to a system where banks increasingly lean on governments to back their lending to riskier borrowers.
"It's deeply irresponsible," said Philip Booth, professor of insurance and risk management at Cass Business School in London. "It reduces incentives for banks to monitor loans [and] it distorts the credit market by ensuring they don't take on the full risk of the loans they make."
Fannie and Freddie don't make loans but instead buy them from lenders and package them into bonds. In 2008, they were rescued by the U.S. government, a move that ultimately required more than $150 billion in taxpayer aid. Meanwhile, the Federal Housing Administration, a U.S. government agency that guarantees mortgages for certain borrowers, said last month that it needed a cash injection from the U.S. Treasury as losses on legacy loans mount. In the wake of the taxpayer rescues, several U.S. lawmakers pointed to Europe's mortgage model as an example of a free-market alternative.
There was some securitization of European mortgages before the crisis but nothing like in the U.S. A major difference is that European mortgages are mainly funded by savings deposits or covered bonds.
As banks cut their risk appetites as they seek to bolster their capital ratios in the face of stiffer regulation, some European governments feel they have no choice but to intervene to get credit flowing.
The U.K. Treasury on Tuesday will present the details of its latest "Help To Buy" policy, in which the government will guarantee a portion of certain mortgages.
Under the plan, a home buyer will need to put down a 5% deposit on any property valued at up to £600,000 ($960,066). In return for a small fee from a bank, the government will then guarantee nearly 15% of the property's value. The program is set to run for three years.
The project's proponents say it will get people who don't have large savings onto the housing ladder while encouraging property developers to build more homes. Similar policies have worked in Canada and Australia, analysts say.
U.K. housing starts have increased in recent months but still are 40% below their peak in 2007, according to recent government data.
"You have to go back to the 1980s to see as few houses being built in the U.K.," said Huw Van Steenis, a banking analyst at Morgan Stanley. "It's not that house builders don't want to build, but regulation has changed what banks can finance." But there are fears that the £12 billion the U.K. government has committed to the guarantee program could stoke a housing bubble. Recent Bank of England data showed that the number of mortgages approved in the U.K. rose in August to the highest monthly total since February 2008. "This scheme is not needed and is not a risk worth taking," said Rob Wood, chief U.K. economist at Germany's Berenberg Bank.
In the Netherlands, authorities are going a step further and setting up a state-sponsored mortgage vehicle with strong parallels to Freddie Mac and Fannie Mae. The Dutch government, which has offered mortgage guarantees since 1995, last month announced a deal with banks and pension funds to develop a national mortgage institute, known as the Nederlandse Hypotheekinstelling, or NHI, which it hopes will be up and running next year.
Dutch banks will be able to transfer some mortgage portfolios to the NHI, which will package them into bonds and sell them to large investors like pension funds and insurers. The Dutch state will guarantee so-called national mortgage bonds, enabling the banks to borrow at more favorable rates as they benefit from the Dutch government's triple-A credit rating.
Banks can only transfer low-risk loans that are covered by the government's existing mortgage-guarantee plan. Lenders will remain liable for any default risk and will have to pay the Dutch state a fee if they want to use the facility.
The NHI aims to issue at least €50 billion ($67.79 billion) worth of bonds within five years. That would represent roughly 8% of the total mortgage debt in the Netherlands.
In Italy, where homeownership is high and only a small minority of households have mortgages, the government in August approved a measure ordering Cassa Depositi e Prestiti, a state-owned financial institution, to supply local banks with more than €2 billion in funds for new mortgages to be used for those buying their first home.
It is the first such measure in Italy, where mortgage lending fell by half last year to €26 billion.
Banks say that some details remain unclear, but it may be a first step toward a larger program. Roberto Nicastro, general manager at UniCredit SpA, Italy's largest bank by assets, this summer explicitly cited Fannie Mae and Freddie Mac programs while appealing to a parliamentary finance committee to approve a guarantee program whereby the CDP would guarantee €70 billion in new mortgages over the next three years.
A public guarantee is "the only way to restore confidence," Mr. Nicastro said.
Washington Policy:
Flash Note, Housing Policy Conference Takeaways
October 2, 2013
"Our sense is that the conversation in D.C. appears to be shifting slightly toward support of simply rebranding the GSEs as we know them. There is a meaningful concern among some policymakers that liquidating the GSEs may create an unsustainable vacuum without a clear and capable replacement in place (i.e. PMI, banks, PLS investors)."
https://compasspoint.bluematrix.com/sellside/EmailDocViewer?encrypt=b63899a0-4016-420c-be3a-b26e32ea593b&mime=pdf&co=Compasspoint&id=iboltansky@compasspointllc.com&source=mail&distribution=library
Washington Policy:
Flash Note, Housing Policy Conference Takeaways
October 2, 2013
"Our sense is that the conversation in D.C. appears to be shifting slightly toward support of simply rebranding the GSEs as we know them. There is a meaningful concern among some policymakers that liquidating the GSEs may create an unsustainable vacuum without a clear and capable replacement in place (i.e. PMI, banks, PLS investors)."
https://compasspoint.bluematrix.com/sellside/EmailDocViewer?encrypt=b63899a0-4016-420c-be3a-b26e32ea593b&mime=pdf&co=Compasspoint&id=iboltansky@compasspointllc.com&source=mail&distribution=library
Washington Policy:
Flash Note, Housing Policy Conference Takeaways
October 2, 2013
"Our sense is that the conversation in D.C. appears to be shifting slightly toward support of simply rebranding the GSEs as we know them. There is a meaningful concern among some policymakers that liquidating the GSEs may create an unsustainable vacuum without a clear and capable replacement in place (i.e. PMI, banks, PLS investors)."
https://compasspoint.bluematrix.com/sellside/EmailDocViewer?encrypt=b63899a0-4016-420c-be3a-b26e32ea593b&mime=pdf&co=Compasspoint&id=iboltansky@compasspointllc.com&source=mail&distribution=library
The Future of Fannie and Freddie: Friday, September 20, 2013
Jointly sponsored by: The Classical Liberal Institute & NYU Journal of Law & Business
The Future of Fannie and Freddie: Friday, September 20, 2013
Jointly sponsored by: The Classical Liberal Institute & NYU Journal of Law & Business
The Future of Fannie and Freddie: Friday, September 20, 2013
Jointly sponsored by: The Classical Liberal Institute & NYU Journal of Law & Business
Nice:)
Lol, its all good;)
Nice find!