Fannie-Freddie Fate Rests in Courts Shareholder Suits Challenge U.S.s Profit-Taking Structure By NICK TIMIRAOS Updated Feb. 11, 2014 9:24 a.m. ET Legal wrangling over who should keep the hundreds of billions of dollars in profits generated by Fannie Mae FNMA -0.66% and Freddie Mac FMCC -1.69% is heating up, and investors increasingly are betting the government will end up the loser. Since last summer, the Treasury Department has faced a host of shareholder lawsuits over changes it made in 2012 to the terms of the bailout agreements with the mortgage-finance giants in 2008, when the government seized the firms as they neared collapse. The plaintiffs say that the Treasury wasnt authorized to make the changes—which required Fannie and Freddie to send all of their profits to the Treasury—and that the move amounted to unlawful seizure of private property. The Treasury has effectively nationalized the companies and ensured that they will never return to private ownership using steps that are plainly unlawful, said Theodore Olson of Gibson, Dunn & Crutcher LLP, at a conference last week. Mr. Olson, who served as solicitor general through 2004, is representing Perry Capital LLC, a hedge-fund firm that filed suit last July. The government has argued that the plaintiffs dont have standing to challenge its decisions because the rescue legislation barred shareholder claims and that the cases dont have merit. Treasury committed and provided hundreds of billions of dollars to rescue the entities, the government said in its response last month. Having gained that benefit, the shareholders cannot credibly claim that the [Constitution] demands that Treasury compensate them further for their investment. Tens of billions of dollars are potentially at stake because Fannie and Freddie sent more than $130 billion to the U.S. Treasury last year, nearly seven times what would have been owed before the terms were changed. Plaintiffs in the lawsuits argue that those proceeds belong to the companies, not the U.S. Investors, meanwhile, are betting on the side of the plaintiffs. Some classes of Fannies and Freddies preferred stock, a form of senior equity, have doubled over the past six months. While shares are still trading at deep discounts from where they stood before the companies were bailed out, many hedge funds and other speculators began amassing the shares when they traded at even deeper discounts over the past five years. Developments in the court cases have been net positive for this trade because court filings have raised red flags over the bailout changes, said Michael Kim, managing director of CRT Capital Group LLC, a Stamford, Conn.-based broker dealer. About 20 suits have been filed, including two by Bruce Berkowitzs Fairholme Capital Management LLC, a mutual-fund firm. Many of the cases have been consolidated before U.S. District Judge Royce C. Lamberth in Washington, D.C. Investors are also suing the Federal Housing Finance Agency, which entered into the Treasury agreement on behalf of the companies; the FHFA declined to comment. Mr. Olson said last week that the lawsuits will take a long time to play out. But I believe we are clearly right here, and we will be successful, he said. Investors and attorneys watching the cases say the governments initial motions to dismiss, filed in January, look vulnerable. Some observers argue that the governments actions are at odds with the goals of conservatorship, the legal process by which the U.S. seized Fannie and Freddie. Unlike receivership, a form of liquidation that carries court oversight, conservatorship charged the U.S. with preserving the firms assets so that they can one day be returned to private ownership. But the bailout changes in 2012 made it impossible for Fannie and Freddie to rebuild capital, which according to some shareholders, means the U.S. effectively began liquidating the companies even though it never put the firms into receivership. Theyre trying a novel approach to conservatorship, said David Felt, a lawyer in private practice who headed litigation for the FHFA until 2010. Theres a risk that the court might not buy that approach. Im not predicting the shareholders will win by any means, but theyve got a shot. Mr. Felt informally has advised some shareholders but isnt involved in the litigation. In the initial bailout agreement in 2008, the U.S. agreed to inject nearly unlimited sums of aid—ultimately around $188 billion—and received in exchange a new class of senior preferred shares that initially paid a 10% dividend. It also received warrants to acquire nearly 80% of the firms common stock. Because the common and preferred stock wasnt ever wiped out, investors continued to trade them. Some concluded—accurately, it turned out—that Fannie and Freddie had reserved more money for loan losses than they would need, and that they would one day return to profitability. The Treasury revamped the bailout terms in August 2012. It eliminated the 10% dividend, requiring no payments during periods where the companies reported losses and collecting all of their profits as dividends in profitable quarters. In court filings, the Treasury has said the revamp was needed because of concerns that Fannie might eventually exhaust the aid pledged by the government simply to fund the 10% dividend. If shareholders successfully argue the dividend changes werent lawful, it isnt clear whether they will receive damages. One possibility would be that the government reduces the amount that Fannie and Freddie owe, a step that could make it easier for shareholders to eventually be paid when the firms are liquidated or restructured through legislation. The Obama administration and Congress havent shown much support for privatization proposals advanced by some investors. The upshot, according to Mr. Felt, is that if investors are going to get any money out of this, its going to come out of the courts, and its going to take years.
Posted on: Tue, 11 Feb 2014 19:30:57 +0000
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