Fannie Mae-No Politics (FNMA)

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Judge Sweeney Should Let Discovery Continue On Fannie And Freddie Tuesday, November 4th, 2014

On October 28, 2014, the United States sought to follow up the major advantage that it received from the decision of Judge Royce Lamberth on September 30, 2014, which dismissed all the claims brought by the junior preferred shareholders of Fannie Mae and Freddie Mac to set aside the Third Amendment of August 2012 of the Senior Preferred Stock Purchase Agreements (SPSPA) of September 2008. As I have urged in previous posts, here, here and here, that I have made as a consultant to some institutional investors regarding this litigation, I think that Judge Margaret Sweeney should reject the government’s motion and allow the discovery to go forward in her court in accordance with her original order. The arguments here go both to matters of procedure and to substance.

Procedural Issues

On the procedural side, it is quite clear that the government strategy throughout this litigation is to keep all of its deliberations surrounding the Third Amendment out of the public eye. The government renews a claim, earlier rejected by Judge Sweeney, that the discovery of this sensitive information could compromise delicate deliberations over major financial matter. But by the same token, the release of this information to private parties in the course of litigation could shed the necessary light on the processes that were used to conclude the one-sided Third Amendment, where the Federal Housing and Finance Agency (FHFA) irrevocably released all future income streams for both junior preferred and common shareholders, only to receive precisely nothing in exchange. There are of course, the risks that some sensitive information could be inadvertently disclosed to the public at large, in violation of the terms of this protective order. But it would be most unwise to stop the collection of that information when ex post sanctions could be imposed upon the plaintiffs if they violate the order’s terms. In addition, Judge Sweeney could well conclude that much of the information turned over to the private plaintiffs does not warrant protection, at which point it could and should be made public.

Certainly, there is good reason to think that this is indeed the case, because it allows for the honest and full assessment of the government claim that the Third Amendment was needed to stop the supposedly vicious circle whereby initial funds would be lent to Fannie and Freddie to pay the dividends. On its face, that claim looks indefensible given that the government’s position ignores Fannie and Freddie’s option under the SPSPA to defer payment of the 10 percent dividends on the preferred in exchange for the right to pay 12 percent later.

Unfortunately, the decision in Perry Capital never once asks why it is that the conservator for Fannie and Freddie would give up this valuable option for nothing. Blocking discovery through a summary judgment in Perry Capital allows the government to win its case without ever having to answer the charges that the entire Third Amendment was a sham, intended to siphon off known profits to Treasury. The government has repeatedly made the solvency of Fannie and Freddie an issue before Judge Sweeney. The validity of that claim should be tested in her court. Indeed, if she chooses to make that information public, it could influence the outcome of any future appeal that takes place in the Court of Appeals for the District of Columbia, especially if it reveals that FHFA operated as an “arm” of the federal government and did not exercise its appropriate independent judgment.

Knowing that Judge Sweeney may be reluctant to undo a decision that she has already made, the government then adds that she should stop the case on the grounds that a judgment in the Court of Appeals could “preclude” further litigation between the same parties in this case, given the core of common facts. But at the very least there are other lawsuits with different parties who could benefit from the release of this information, and it strains credibility that this important information should remain under wraps in order to economize on litigation costs that are tiny in comparison with the principles and dollars at stake in this litigation.

The government also takes the position that the entire matter is not ripe for litigation because it turns out that FHFA is not in liquidation. “Simply stated, ‘liquidation preference claims are not fit for a judicial decision until liquidation occurs.’”

The government then further notes in the same vein that “[g]iven that the plaintiffs maintain no current right to a liquidation preference while the GSEs are in conservatorship, the plaintiffs are no worse off today than they were before the Third Amendment.” The first of these arguments means that if the government strips out all the money from Fannie and Freddie but never liquidates them, it can never be challenged in court. The second argument flies in the face that the Third Amendment purports to be a binding contract whose immediate effect was to send the market into a tailspin. The ripeness argument is also incorrect for a variety of technical reasons.

First, all of the facts that are needed to resolve the question of whether FHFA and Treasury exceeded their powers under the law are available right now. Nothing that is done in the future can either add to or detract from the strength of the takings claim that is now located in the Court of the Federal Claims (CFC). The postponement therefore does nothing whatsoever to sharpen the issue.

Second, there is no likelihood that the legal situation will change on the ground. Recall that the Third Amendment is an ostensible contract between FHFA and Treasury. There is at this point nothing that FHFA could do unilaterally to escape the consequences of the Third Amendment in the event that it should be found valid. The Treasury, which stands to receive future billions of dollars has no incentive whatsoever to back off that contract, even if FHFA abandoned its conservatorship and put the control of the operation back into the hands of a Board of Directors responsive to the interests of the private shareholders that FHFA was supposed to represent in the first place.

http://originatortimes.com/freddie-mac/judge-sweeney-should-let-discovery-continue-on-fannie-and-freddie-2/