3. None of the Criteria Under HERA for Appointing a Conservator Was Properly Satisfied 91. In total, HERA provided for 12 circumstances in which the FHFA could place the Companies into receivership or conservatorship:
A. if a Company’s assets were insufficient to meet its obligations;
B. if a Company’s assets or earnings were substantially dissipated due to unlawful conduct or unsafe or unsound practices;
C. if a Company was in an unsafe or unsound condition to transact business;
D. if a Company willfully violated a cease and desist order;
E. if a Company concealed books and records from the FHFA Director;
F. if a Company became unlikely to be able to pay its obligations or meet the demands of its creditors in the normal course of business;
G. if a Company incurred, or became likely to incur, losses that would deplete substantially all of its capital with no reasonable prospect of becoming adequately capitalized;
H. if a Company violated the law;
I. if a Company’s board of directors or shareholders passed a resolution consenting to a conservatorship or receivership;
J. if a Company became undercapitalized or significantly undercapitalized, as defined by the governing statute, and could not or would not take corrective measures;
K. if a Company became critically undercapitalized, as defined by the governing statute; or
L. if a Company engaged in money laundering.
See 12 U.S.C. § 4617(a)(3)(A)-(L).
92. As explained below, none of these statutory grounds existed with respect to either company. Therefore, there was no legal basis for the Government to place the Companies into receivership or conservatorship.
a. The Companies’ assets were significantly greater than their liabilities. 93. Title 12, section 4617(a)(3)(A) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he assets of the regulated entity are less than the obligations of the regulated entity to its creditors and others.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
94. As of June 30, 2008, the date of the most recently reported financial results for the last quarter immediately preceding Fannie Mae’s conservatorship, which were not filed with the SEC until August 8, 2008, Fannie Mae had assets of $885.9 billion and liabilities of $844.5 billion. Thus, Fannie Mae’s assets exceeded its liabilities by more than $41 billion just shortly before the conservatorship was imposed.
95. Indeed, at the time the conservatorship was imposed, Fannie Mae’s assets had exceeded its liabilities by approximately $40 billion for each of the past three calendar years. Specifically, Fannie Mae’s assets exceeded its liabilities by about $40 billion, $41 billion, and $44 billion at the end of 2005, 2006, and 2007, respectively.
96. Similarly, as of June 30, 2008, the date of the most recently reported financial results for the last quarter immediately preceding Freddie Mac’s conservatorship, which were not filed with the SEC until August 6, 2008, Freddie Mac had assets of $879.0 billion and liabilities of $866.0 billion. Thus, Freddie Mac’s assets exceeded its liabilities by more than $23.0 billion just shortly before the conservatorship was imposed.
97. At the time the conservatorship was imposed, Freddie Mac’s assets had exceeded its liabilities by more than $26 billion for each of the past three calendar years. Specifically, Freddie Mac’s assets exceeded its liabilities by $28.1 billion, $28.8 billion, and $26.9 billion at the end of 2005, 2006, and 2007, respectively.
98. Thus, no factual basis existed for asserting that the Companies’ assets were less than their obligations and, therefore, the statutory ground for appointing a conservator set forth in section 4617(a)(3)(A) was not satisfied.
b. The Companies had not suffered a substantial dissipation of assets or earnings due to a violation of law or unsafe and unsound practices. 99. Title 12, section 4617(a)(3)(B) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when the entity experiences a “[s]ubstantial dissipation of assets or earnings due to: i) any violation of any provision of Federal or State law; or ii) any unsafe or unsound practice.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
100. From December 31, 2005, to June 30, 2008, Fannie Mae’s assets grew from $834.1 billion to $896.6 billion. Thus, the company’s assets were increasing. Nor was there a substantial dissipation of Fannie Mae’s earnings. Although Fannie Mae’s earnings decreased from 2005 to 2007, they increased in the first half of 2008 over earnings in the second half of 2007.
101. Further, Fannie Mae’s decline in earnings in 2007 was not attributable to either a violation of law or to any unsafe and unsound practice. Rather, this decline was largely attributable to the following circumstances: a narrowing of the interest spread earned by Fannie Mae resulting from higher borrowing costs during a period of turmoil in the financial markets; the need to increase reserves to offset expected future credit losses stemming from the general decline in the housing market which was negatively impacting all financial institutions at the time; and discrete one-time losses on derivatives contracts with corresponding offsetting gains that were not simultaneously recognized. None of these circumstances reflected either a violation of law or an unsafe and unsound practice on the part of Fannie Mae.
102. With regard to Freddie Mac, from December 31, 2005, to June 30, 2008, although the company’s earnings declined, its assets grew from $798.6 billion to $879.0 billion. Thus, Freddie Mac’s assets were increasing, not dissipating.
103. The decline in Freddie Mac’s earnings was not attributable to either a violation of law or to any unsafe and unsound practice. Rather, this decline was largely attributable to the following circumstances: a narrowing of the interest spread earned by Freddie Mac, resulting from higher borrowing costs during a period of turmoil in the financial markets; the need to increase reserves to offset anticipated expected future credit losses stemming from the general decline in the housing market which was negatively impacting all financial institutions at the time; and other factors arising from a general period of decline and higher risk in the market. None of these circumstances reflected either a violation of law or an unsafe and unsound practice on the part of Freddie Mac.
104. There has never been any allegation that the Companies engaged in a violation of any law resulting in the substantial dissipation of assets or earnings. Neither company was engaging in any unsafe and unsound practice. Indeed, in his September 7, 2008 public announcement of the appointment of the conservator, Director Lockhart strongly emphasized that the management and directors of the Companies had done nothing wrong, noting that any difficulties they were facing were the result of extenuating circumstances. And in his September 7, 2008 public statement, Secretary Paulson stated that, “I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. [Fannie Mae’s and Freddie Mac’s] management and their Boards are responsible for neither.”
105. Accordingly, neither Fannie Mae nor Freddie Mac had experienced a substantial dissipation of assets and earnings caused by either a violation of law or an unsafe and unsound practice and, therefore, the ground for appointing a conservator set forth in section 4617(a)(3)(B) was not satisfied.
c. Neither company was in an unsafe or unsound condition. 106. Title 12, section 4617(a)(3)(C) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when the entity is operating in “[a]n unsafe or unsound condition to transact business.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
107. Neither Fannie Mae nor Freddie Mac was engaged in any unsafe or unsound practice or was in danger of incurring losses that would cause their capital to fall below regulatory capital requirements. Moreover, the Companies had capital substantially in excess of their regulatory capital requirements. Accordingly, the Companies were not operating in an unsafe or unsound condition.
108. The Companies were subject to capital requirements contained in HERA which, by definition, were engineered to ensure that the Companies remained in a safe and sound condition. To that end, HERA specifically provides that the risk-based capital requirement shall “ensure that the enterprises operate in a safe and sound manner, maintaining sufficient capital and reserves to support the risks that arise in the operations and management of [each] enterprise.” As discussed in ¶¶ 109-12 and 141-45, infra, both of the Companies substantially exceeded the applicable risk-based requirements, and this had always been the case. Thus, by definition, the Companies were in a safe and sound condition.
109. Further, one of the capital requirements applicable to the Companies was the requirement that they have “total capital” in excess of their “statutory risk-based capital level.” “Total capital” is defined in a published regulation, as is “statutory risk-based capital level”; the latter is specifically crafted to ensure that the Companies remain in a safe and sound condition. Indeed, the 1992 Act imposing the risk-based capital level required OFHEO to identify a level of total capital by developing an extreme “stress test.” This stress test, often referred to as the “100-year storm” test, required that the Companies’ total capital was sufficient to withstand a 10-year period of extreme economic instability and adverse market conditions.
110. As of June 30, 2008, Fannie Mae’s core capital exceeded both the FHFA-directed and statutory minimum capital requirement and its total capital exceeded its required risk-based capital. As of June 30, 2008, Fannie Mae’s core capital exceeded its statutory minimum capital requirement by $14.3 billion, or 43.9%, and its total capital exceeded its statutory risk-based capital requirement by $19.3 billion, or 53.1%. Likewise, as of March 30, 2008, the statutory risk-based capital level was $23 billion, and the company had total capital of $47.6 billion – more than twice the amount required to withstand the 100-year storm test. Similarly, over the quarters immediately preceding the appointment of the conservator, Fannie Mae’s total capital increased from $48.7 billion as of December 31, 2007, to $55.6 billion as of June 30, 2008.
111. Freddie Mac’s total capital has always substantially exceeded the extreme stress test imposed by the statutory risk-based capital requirement. For example, as of March 30, 2008, the statutory risk-based capital level was $26.1 billion, and the company had total capital of $42.2 billion – exceeding the requirement by $16.1 billion. And, over the quarters immediately preceding the appointment of the conservator, Freddie Mac’s total capital increased from $40.9 billion as of December 31, 2007 (a surplus of $6.6 billion), to $46.6 billion as of June 30, 2008 (a surplus of $5.1 billion). While HERA called for the FHFA to devise new risk-based capital requirements, the FHFA had not yet done so when the conservatorships were imposed on the Companies. Regardless, the Companies would have passed any reasonable risk-based capital stress test that could have been applied at that time.
112. Accordingly, the Companies were not operating in an unsafe or unsound condition and, therefore, the statutory ground for appointing a conservator set forth in section 4617(a)(3)(C) was not satisfied.
d. Neither company was in violation of any cease and desist order. 113. Title 12, section 4617(a)(3)(D) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when there is “[a]ny willful violation of a cease and desist order [by a GSE] that has become final.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
114. Although a Consent Order was issued against Fannie Mae by OFHEO on May 23, 2006, Fannie Mae fully complied with it. The Consent Order was lifted on May 6, 2008. Freddie Mac was not subject to any such Consent Order.
115. Neither Fannie Mae nor Freddie Mac had been subject to any other cease and desist orders and, therefore, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(D) was not satisfied with respect to the Companies.
e. Neither company concealed or refused to submit any books or records. 116. Title 12, section 4617(a)(3)(E) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when there is “[a]ny concealment of the books, papers, records, or assets of the regulated entity, or any refusal to submit the books, papers, records, or affairs of the regulated entity, for the inspection to any examiner or to any lawful agent of the Director.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
117. Neither Fannie Mae nor Freddie Mac at any time concealed their books and records or refused to make their books and records available for inspection.
118. Thus, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(E) was not satisfied with respect to the Companies.
f. The Companies were able to pay their obligations and meet the demands of their creditors. 119. Title 12, section 4617(a)(3)(F) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he regulated entity is likely to be unable to pay its obligations or meet the demands of its creditors in the normal course of business.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
120. As of June 30, 2008, Fannie Mae had $344.8 billion of short-term assets, comprised chiefly of cash, cash equivalents, and investments in publicly traded securities. This far exceeded the company’s $247.0 billion in short-term liabilities. Fannie Mae’s holdings of investment securities were carried on the company’s balance sheet on a fair value basis, and thus represented a market valuation for those assets.
121. For the six months ending June 30, 2008, Fannie Mae generated net cash from its operating activities of $29.9 billion and had a net increase in cash and cash equivalents from all sources of $3.7 billion.
122. As of June 30, 2008, Freddie Mac had $745.4 billion of short-term assets consisting of cash, cash equivalents, resale agreements or investments in securities, which greatly exceeded its $356.4 billion in short-term debt.
123. Fannie Mae and Freddie Mac both had sufficient assets to meet their obligations and any demands of their creditors in the normal course of business.
124. Thus, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(F) was not satisfied with respect to the Companies.
g. Neither company incurred or was likely to incur losses that would deplete all or substantially all of its capital. 125. Title 12, section 4617(a)(3)(G) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he regulated entity has incurred or is likely to incur losses that will deplete all or substantially all of its capital, and there is no reasonable prospect for the regulated entity to become adequately capitalized.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
126. During the period leading up to the imposition of the conservatorship, neither Fannie Mae nor Freddie Mac incurred losses that substantially depleted their capital, let alone all of their capital.
127. From December 31, 2007, to June 30, 2008, Fannie Mae’s total capital increased from $48.7 billion to $55.6 billion, and its core capital increased from $45.4 billion to $47.0 billion. Thus, Fannie Mae’s capital had not been depleted.
128. Likewise, Freddie Mac’s capital had not been depleted. From June 30, 2007, to June 30, 2008, Freddie Mac’s core capital decreased only slightly from $37.9 billion to $37.1 billion. Thus, Freddie Mac’s capital had not been depleted.
129. The net losses recorded on Fannie Mae’s income statement during the four quarters between June 30, 2007, and June 30, 2008 did not deplete the company’s capital. Those losses primarily reflected the company’s recording of substantial reserves for potential future credit losses. These losses are not actually realized until future periods (if they are ever realized at all), and they can be offset by correlating deferred tax assets that have a reasonable expectation of being realized in the future (based partly on a lengthy history of largely positive financial performance). Thus, they are added back into the calculation of total capital and do not actually impact total capital.
130. Moreover, Fannie Mae had access to substantial capital in the public equity markets. From October 2007 through the imposition of the conservatorship, Fannie Mae raised more than $12 billion through issuances of its preferred stock. In December 2007, the company raised approximately $7 billion through an issuance of Series S preferred stock; in May 2008, Fannie Mae raised almost $2.1 billion through issuing Series 2008-1 preferred stock; and, also in May 2008, Fannie Mae raised an additional $2.25 billion by issuing Series T preferred stock. Fannie Mae also raised an additional $2.59 billion by issuing 94.3 million shares of common stock at a price of $27.5 per share in May 2008. The original 82 million-share offering was oversubscribed, and an additional 12.3 million shares were allocated to the underwriters.
131. Freddie Mac was likewise able to obtain capital from the public equity markets. Specifically, Freddie Mac raised $500 million from an offering of Series Y preferred stock in September 2007, and $6.0 billion from an offering of Series Z preferred stock in December 2007.
132. Thus, to the extent that either company had incurred net losses, those losses did not deplete either company’s capital.
133. Accordingly, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(G) was not satisfied with respect to the Companies.
h. Neither company violated any law or regulation, or engaged in any unsafe or unsound practice or condition that would likely cause insolvency, a substantial dissipation of assets or earnings, or a weakening of its condition. 134. Title 12, section 4617(a)(3)(H) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[a]ny violation of any law or regulation, or any unsafe or unsound practice or condition [] is likely to: i) cause insolvency or substantial dissipation of assets or earnings; or ii) weaken the condition of the regulated entity.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
135. Neither Fannie Mae nor Freddie Mac violated any law or regulation; nor did they engage in any unsafe or unsound practice or condition. When the conservatorships were imposed, neither company was in any danger of becoming insolvent or incurring a substantial dissipation of assets or earnings, or falling into a weakened condition as the result of any violation of law or regulation or unsafe or unsound practice or condition.
136. Accordingly, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(H) was not satisfied with respect to the Companies.
i. The Companies did not consent to the appointment of a conservator. 137. Title 12, section 4617(a)(3)(I) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he regulated entity, by resolution of its board of directors or its shareholders or members, consents to the appointment.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
138. Neither company’s shareholders resolved to consent to a conservatorship.
139. As discussed in Section V(E)(2), supra, any consent purportedly obtained by the Companies’ boards of directors was coerced and/or otherwise improperly obtained, rendering any such consent invalid.
140. Accordingly, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(I) was not satisfied with respect to the Companies.
j. Neither company was undercapitalized. 141. Title 12, section 4617(a)(3)(J) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he regulated entity is undercapitalized or significantly undercapitalized, and: (i) has no reasonable prospect of becoming adequately capitalized; (ii) fails to become adequately capitalized, as required by: (I) section 4615(a)(1) of this title with respect to a regulated entity; or (II) section 4616(a)(1) of this title with respect to a significantly undercapitalized entity; (iii) fails to submit a capital restoration plan acceptable to the Agency within the time prescribed under section 4622 of this title; or (iv) materially fails to implement a capital restoration plan submitted and accepted under section 4622 of this title.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
142. At all relevant times prior to and including the time the FHFA was appointed as conservator, the Companies were “adequately capitalized.” To qualify as “adequately capitalized,” a company is required to have:
a. “Total Capital” (as defined at 12 C.F.R. § 1750.11(n)) equal to or in excess of its “Risk-Based Capital” (as defined at 12 U.S.C. § 4611(a)(1)); and
b. “Core Capital” (as defined at 12 C.F.R. § 1750.2) equal to or in excess of its “Minimum Capital” (as defined at 12 C.F.R. § 1750.4).
143. At the time the conservatorships were imposed, not only were the Companies adequately capitalized, as they met both of these requirements, but each company’s capital was substantially in excess of its capital requirements. Moreover, each company’s ability to raise capital from the public equity and private capital markets was more than sufficient to allow it to absorb any potential future losses, particularly if the Companies had been allowed to offer terms to potential investors as favorable as those demanded by the Government in exchange for the extremely costly capital it provided upon taking control of the Companies. And the Companies always had more than sufficient assets and capital to satisfy all obligations to their creditors:
144. Because Fannie Mae and Freddie Mac were more than adequately capitalized, as defined under law, they were not undercapitalized or significantly undercapitalized. Therefore, the FHFA Director lacked any justification or legal authority to appoint a conservator for the Companies.
145. In addition to the statutory capitalization requirements, Fannie Mae was, during parts of 2007 and 2008, subject to a consent order from OFHEO under which it was required to keep core capital at a level 30% higher than the minimum capital requirement. This 30% requirement was lowered to 20% for the first quarter of 2008, and lowered again to 15% for the second quarter of 2008 in accordance with the provisions of the consent order. Fannie Mae had sufficient surplus capital such that it was always in compliance with this additional capitalization requirement.
146. As noted in ¶¶ 62-66, supra, in the months leading up to the decision to appoint the FHFA as conservator for Fannie Mae and Freddie Mac, the Companies’ regulators repeatedly emphasized that the Companies were adequately capitalized.
147. Moreover, even if one of the Companies was undercapitalized, Director Lockhart would have been required to provide the undercapitalized company an opportunity to submit and comply with a capital restoration plan, and to demonstrate that it could have raised private capital if and as needed. Specifically, under 12 U.S.C. § 4615(a) (entitled “Mandatory actions”), as amended by HERA, “[t]he Director [of the FHFA] shall” impose on an undercapitalized regulated entity a capital restoration plan. Had such a plan been required of either company, both Fannie Mae and Freddie Mac would have been capable of meeting such a requirement and, further, would have been able to raise additional capital from the private markets if and as needed.
148. Accordingly, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(J) was not satisfied with respect to the Companies.
k. Neither company was critically undercapitalized. 149. Title 12, section 4617(a)(3)(K) provides that the FHFA should be appointed conservator of Fannie Mae or Freddie Mac when “[t]he regulated entity is critically undercapitalized.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
150. As alleged above, at all relevant times, both Fannie Mae and Freddie Mac had total capital and core capital in excess of all applicable regulatory requirements. Therefore, at all relevant times, neither Fannie Mae nor Freddie Mac was critically undercapitalized.
151. As such, the ground for appointing the FHFA as conservator set forth in section 4617(a)(3)(K) was not satisfied with respect to the Companies.
l. Neither company was found guilty of money laundering. 152. Title 12, section 4617(a)(3)(L) provides that the FHFA may be appointed conservator of Fannie Mae or Freddie Mac when “[t]he Attorney General notifies the Director in writing that the regulated entity has been found guilty of a criminal offense under section 1965 or 1957 of Title 18 or section 5322 or 5324 of Title 31.” Neither of the Companies fell within the purview of this subsection at the time they were placed in conservatorship.
153. Neither Fannie Mae nor Freddie Mac was ever found guilty of any criminal offense and, therefore, the statutory ground for appointing a conservator set forth in section 4617(a)(3)(L) was not satisfied with respect to the Companies.
AI
