Fannie Mae and Freddie Mac were
among the biggest disasters of the financial crisis. In September
2008, nine days before Lehman Brothers failed, the federal government took over
the mortgage companies; it eventually spent more than $187 billion bailing them
out. The U.S. Treasury has received billions in profit that investors are suing
for.
For decades, the companies had
provided an implicit government backstop to the U.S. mortgage market, buying
loans from private lenders and guaranteeing payments to investors. That helped
spur a steady rise in homeownership—until the subprime crisis hit and Fannie
and Freddie were on the hook for billions in losses.
Lawmakers vowed to overhaul the
companies and some planned to wind them down completely. But more than eight
years later, Fannie and Freddie still operate under government control—and
they’re now a bigger part of the system, guaranteeing payment on just under
half of all U.S. mortgages, up from 38 percent before the crisis.
There is one key difference: Any
profits the companies generate go to the government instead of investors. The
latest payment, a combined $9.9 billion to the U.S. Treasury at the end of
March, pushed the total amount of cash Fannie and Freddie have paid to
taxpayers to $266 billion, making their bailout one of the most profitable in
history.
There’s now a pitched battle over
who should get those profits. The companies’ pre-crisis common and preferred
stocks still trade over-the-counter, and investors who snapped up the shares,
such as hedge fund managers Bill Ackman and John Paulson, say Treasury is
breaking the law by taking the money. The fight goes back to a change the
Barack Obama administration made to the bailout terms in 2012.
When the government took them
over, Fannie and Freddie issued Treasury a new class of preferred stock that
paid a 10 percent dividend, along with warrants to acquire almost 80 percent of
the companies’ common stock. In 2012 the government changed the terms to say
that every quarter Fannie and Freddie would send Treasury all their profits
except for a certain amount of money kept in reserve. That reserve started at
$3 billion in 2013 and was scheduled to fall by $600 million every subsequent
year, until hitting zero in 2018.
The department said this would
hasten the wind down of the companies. In 2013, Fannie and Freddie became
profitable again. All those earnings went to taxpayers, infuriating investors
who hoped to share in the rebound. Ackman, along with mutual fund manager Bruce
Berkowitz, and Richard Perry, a prominent hedge fund manager, said the changes
were illegal and sued. In more than 20 lawsuits, investors have made claims
including that the dividend payment is an illegal confiscation of private
property, that the government lied about its reasoning, and that the structure
of the regulator in charge of Fannie and Freddie, the Federal Housing Finance
Agency (FHFA), is unconstitutional.
Judges who’ve ruled so far have
come down on the government’s side. Matthew McGill, an attorney with Gibson,
Dunn & Crutcher who represents Perry in one of the cases, says Perry plans
to keep pressing his case. “This is a case where the government’s conduct and
the damage it’s done to investors is simply immense,” McGill says. An FHFA spokeswoman
declined to comment. Treasury didn’t respond to a request for comment.
Investors want the government to
begin the process of selling its stake in Fannie and Freddie by stopping the
dividend, but they don’t want the companies to go away. Ackman favors a plan
that would strengthen the companies and keep their activities largely intact.
“There is simply no credible alternative to Fannie and Freddie,” he wrote in a
letter to investors in March.
The Obama administration left it
to Congress to pass legislation dealing with the problem, but nothing has
emerged. Texas Republican Jeb Hensarling, chairman of the House Financial
Services Committee, wants to wind down Fannie and Freddie completely, while
some Democrats think they should be strengthened rather than killed.
Some small lenders and advocates
for affordable housing would also like to see the dividend suspended to let the
mortgage companies build their reserves. They’re nervous that any alternative
Congress might put in place would make it harder for lower-income borrowers to
get mortgages. Investors had hoped Donald Trump’s administration would move to
sell the government’s stake, but so far the view from the White House is
unclear. Treasury Secretary Steven Mnuchin has said that ending government control
is a priority, but that he’s focused on regulatory relief and tax reform.
In the middle of the debate is
Mel Watt, the Obama appointee who heads the FHFA and essentially controls
Fannie and Freddie. Watt has the authority to order the companies’ boards of
directors to suspend the dividend payments. He came close to doing so at the
end of March, just before Fannie and Freddie’s last payment was due, according
to people familiar with the matter. A group of senators wrote Watt a letter
that week, warning him against stopping payment, and Watt decided to make it.
Stopping the payment would have
let Fannie and Freddie build their reserves, making it less likely they would
need more money from taxpayers in the event of a loss. Under terms of the
bailout, the companies could still borrow up to $259 billion in an emergency,
so insolvency is a long way off. Watt, a former North Carolina congressman, has
told people around him that he’d consider it a dereliction of duty if the
companies needed more money on his watch.
Investors would’ve been thrilled
if Watt had withheld the dividend in March. Building capital is a necessary
precursor to selling Fannie and Freddie back to the private market, where their
shares could be worth billions. Mnuchin put one of his counselors, Craig
Phillips, in charge of the situation. In meetings, Phillips has floated ideas
as wide-ranging as putting the companies into receivership, which could wipe
out investors, as well as legislation to replace or supplement them with a new
system, according to people familiar with the matter. Clarity on what the
administration wants to do could be a long way off.
The bottom line: Fannie
Mae and Freddie Mac have paid $266 billion to the U.S. Treasury. Investors say
it’s time for them to get paid.
Click here for the original
article from Bloomberg.