Tuesday, February 11, 2014
Fannie Mae & Freddie Mac Shareholder Suits Challenge U.S.'s Profit-Taking Structure
How is the shareholder action described below affected by the fact that The Fed is sending at least $40 billion per month to Fannie and Freddie in the form of mortgage backed securities purchases?
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 wasn't 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. About 20 lawsuits have been filed will take "a long time" to play out.
Litigants believe the Treasury "has effectively nationalized the companies and ensured that they will never return to private ownership" using steps that are "plainly unlawful. The government has argued that the plaintiffs don't have standing to challenge its decisions because the rescue legislation barred shareholder claims and that the cases don't have merit. According to the government, "Treasury committed and provided hundreds of billions of dollars to rescue the entities. 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 Fannie's and Freddie's 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.
Some observers argue that the government's 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.
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 wasn't 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 weren't lawful, it isn't 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 haven't shown much support for privatization proposals advanced by some investors. If investors are going to get any money out of this, it's going to come out of the courts, and it's going to take years. (WSJ, 2/10/2014)