Fannie, Freddie Investors Lose Suits Over Lost Dividends

By Margaret Cronin Fisk, Jody Shenn and Clea Benson

Fannie Mae and Freddie Mac investors lost their legal challenges to a change to the mortgage giants’ 2008 bailouts that sent their profits to the U.S. Treasury.
The lawsuits, among the first of almost 20 related cases to be decided, were filed by investors including Bruce Berkowitz, the head of Fairholme Capital Management LLC, who was named Morningstar Inc. (MORN)’s domestic stock manager of the decade for the 2000s, and billionaire hedge-fund manager Richard Perry’s Perry Capital LLC.
The investors sued for breach of contract over allegedly promised dividends and liquidation preferences, and what they called an illegal “taking” under the U.S. Constitution. U.S. District Judge Royce Lamberth rejected their claims yesterday, finding that the government is allowed under a 2012 amendment to the companies’ bailout
agreements to sweep “nearly all” profits from Fannie Mae (FNMA) and Freddie Mac to the U.S. Treasury.
The government is defending its $182 billion bailout of American International Group Inc. at a federal trial in Washington in a case brought by Maurice “Hank” Greenberg’s Starr International Co., which was AIG’s biggest shareholder when the financial crisis struck. Starr claims the the assumption of 80 percent of AIG stock by the U.S. in September 2008 in exchange for an $85 billion loan amounted to an unconstitutional taking of private property.
The U.S. is facing almost 20 federal actions brought by investors claiming they’ve been barred from participating in post-bailout profits earned by Fannie Mae and Freddie Mac. At least $33 billion -- the face value of potentially worthless preferred shares in the companies -- is at stake in the cases, as well as investors’ efforts to win congressional support for the idea of reviving Fannie Mae and Freddie Mac.

Bill Ackman

Hedge-fund manager Bill Ackman’s Pershing Square Capital Management LP filed a separate suit in August in the U.S. Court of Federal Claims in Washington, claiming the government’s diversion of profits violates the Constitution’s Fifth Amendment, which prohibits the taking of private property for public use without just compensation. Fairholme also has a case in that court that is now in pretrial exchange of information.
Along with big investors, shareholder advocates such as one-time presidential candidate Ralph Nader and CapWealth Advisors Chief Executive Officer Tim Pagliara, who started a group called Investors Unite with 1,000 members, have argued the U.S. has been unfairly and illegally taking the companies’ profits. They contend the country would be better served by returning them fully to private shareholders.
Tony Fratto, a spokesman for Perry Capital, at Hamilton Place Strategies LLC, declined to immediately comment on the decision. Daniel Schmerin, director of investment research at Fairholme, didn’t immediately respond to a call seeking comment on it.
Lamberth’s decision, if upheld, is “troubling,” Marcel Kahan, law professor at New York University said in a phone interview.

Terms Changed

“Should the government be able to change the terms of the deal after the fact?” he asked. “They unilaterally changed the deal to make it better for the government.”
Fannie Mae and Freddie Mac shareholder-advocacy group Investors Unite “doubts that Congress ever intended for the conservatorships to lead to nationalization of” the companies “with no compensation for shareholders,” Pagliara said yesterday in an e-mailed statement. “We disagree with Judge Lamberth’s decision.”
The investors challenged the arrangement in which the U.S. Treasury takes all of Fannie Mae and Freddie Mac’s quarterly profits. The practice, known as the Third Amendment, began in 2012, replacing an earlier arrangement in which the two companies paid a quarterly dividend as a return on the U.S. bailout.
Fannie Mae and Freddie Mac, which were seized by regulators in 2008 as they neared bankruptcy, package mortgages into guaranteed bonds. They required $187.5 billion in taxpayer funds to stay afloat before they returned to profitability when the housing market rebounded.

Treasury Purchases

Treasury was authorized to “purchase any obligations and other securities issued by” Fannie Mae and Freddie Mac, a provision which also allowed it to “exercise any rights received in connection with such purchases,” Lamberth wrote yesterday.
The related amendment “requires Fannie Mae and Freddie Mac (FMCC) to pay a quarterly dividend to Treasury equal to the entire net worth of each” entity, minus a small reserve that shrinks to zero over time, Lamberth said.
The Third Amendment may “raise eyebrows, or even engender a feeling of discomfort,” Lamberth wrote in his decision. “But any sense of unease over the defendants’ conduct is not enough to overcome the plain meaning” of the text of the law under which the rescues were permitted, he said.
“Here, the plaintiffs’ true gripe is with the language of a statute that enabled FHFA and, consequently, Treasury, to take unprecedented steps to salvage the largest players in the mortgage finance industry before their looming collapse triggered a systemic panic,” Lamberth wrote, referring to the Federal Housing Finance Agency.
“Indeed, the plaintiffs’ grievance is really with Congress itself,” the judge said. “It was Congress, after all, that parted the legal seas so that FHFA and Treasury could effectively do whatever they thought was needed to stabilize and, if necessary, liquidate,” Fannie Mae and Freddie Mac.
The companies’ shares have been on a roller coaster ride as investors speculate that they could be saved by the courts or lawmakers. Fannie Mae has soared more than 950 percent since the end of 2012, though it fell 31 percent in September to wipe out gains this year and closeD at $2.69 yesterday.
The case is In Re Fannie Mae/Freddie Mac Senior Preferred Stock Purchase Agreement Class Action Litigations, 13-01288, U.S. District Court, District of Columbia (Washington).