The Conservatorships of Fannie Mae and Freddie Mac: Actions Violate HERA and Established Insolvency Principles
By Michael Krimminger1 and Mark Calabria2
I. Executive Summary
When the Federal Housing Finance Agency (“FHFA”) was appointed conservator for Fannie Mae and Freddie Mac3, it was the first use of the conservatorship authority under the Housing and Economic Recovery Act of 2008 (“HERA”), but it was not without precedent. For decades, the Federal Deposit Insurance Corporation (“FDIC”) has successfully and fairly resolved more than a thousand failing banks and thrifts using the virtually identical sections of the Federal Deposit Insurance Act (“FDIA”).
While the FDIC most often uses its receivership authority to resolve failing banks and thrifts, it rehabilitated dozens of weak financial institutions through open bank assistance and conservatorships by returning the banks and thrifts to full compliance with regulatory capital and other requirements, recouping the FDIC's investments in the institution, if possible, and treating stakeholders fairly. If the bank or thrift could not meet regulatory requirements, it was resolved through the FDIC's well-established receivership powers with statutory protections for all stakeholders.
This approach has been recognized by the courts, Congress, and the public as providing invaluable predictability, fairness, and stability. The success of the FDIC's approach to rehabilitating or resolving failing banks and thrifts has led it to become the principal international model used by the Financial Stability Board and national regulators.
1 Partner, Cleary Gottlieb Steen & Hamilton LLP.
2 Director, Financial Regulation Studies, Cato Institute.
3 The Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") will be collectively referred to in this paper as the "Companies"
The predictability, fairness, and acceptance of this model led Congress to adopt it as the basis for authorizing the FHFA with conservatorship powers over Fannie Mae and Freddie Mac in HERA.
Instead of following this precedent, however, FHFA and Treasury have radically departed from HERA and the principles underlying all other U.S. insolvency frameworks and sound international standards through a 2012 re-negotiation of the original conservatorship agreement. Known as the “net worth sweep” or “Third Amendment,” this decision ignored HERA and decades of established practice, undermined public trust in the government role in insolvencies, and undercut the vital role that fair treatment in insolvencies plays in a market economy.
