Legal Sidebari

UPDATE: Fannie & Freddie Investors Turn to
Congress After S. Ct. Declines to Resurrect
Their Legal Claims
Updated July 25, 2018
UPDATE: On July 16, 2018, the U.S. Court of Appeals for the Fifth Circuit, in Collins v. Mnuchin,
became the fourth U.S. Court of Appeals to dismiss statutory claims asserted by Fannie Mae and Freddie
Mac shareholders challenging the terms of the mortgage companies’ financial assistance agreements with
the Department of the Treasury and the Federal Housing Finance Agency (FHFA). In a 2-1 decision, the
Fifth Circuit rejected the shareholders’ statutory challenges to the agreements’ so-called “net worth
sweep,” utilizing essentially the same legal reasoning applied by U.S. Courts of Appeals for the Sixth and
Seventh Circuits, as well as the U.S. Court of Appeals for the District of Columbia, which was the subject
of the original post below.
In contrast to its sister courts, however, the Fifth Circuit also addressed a constitutional issue, holding
that the FHFA’s structure violated the separation of powers and Article II of the U.S. Constitution
because “Congress encased the FHFA in so many layers of insulation—by limiting the President’s power
to remove and replace the FHFA’s leadership, exempting the Agency’s funding from the normal
appropriations process, and establishing no formal mechanism for the Executive Branch to control the
Agency’s activities.” To rectify these constitutional infirmities, the court severed the FHFA Director’s for-
cause removal protections, thus making him removable by the President at will and essentially
transforming the FHFA from an independent agency to an executive branch agency subject to
Presidential supervision and control. The Fifth Circuit majority’s constitutional reasoning is similar to
that of a dissenting opinion, penned by Supreme Court nominee Brett Kavanaugh, in a case contesting the
constitutionality of the Consumer Financial Protection Bureau’s similar structure. The constitutional
issues at play in the CFPB case are analyzed in Legal Sidebars here and here.
The original post from March 16, 2018, is below.
On February 20, 2018, the U.S. Supreme Court declined to review Perry Capital LLC v. Mnuchin, a
United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) decision that dismissed
almost all of the legal claims asserted against the federal government by a consolidated group of Fannie
Mae and Freddie Mac shareholders. The lawsuits focused on the 2012 amendments to the Treasury
Department’s 2008 agreement with the Federal Housing Finance Agency (FHFA), which governs how
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Fannie and Freddie (together, the companies, Government Sponsored Enterprises, or GSEs) will
compensate the Treasury for providing them billions of dollars in financial assistance during the U.S.
housing crisis. The 2012 amendments require the companies to transfer their entire net worth, other than
small capital reserves, to the Treasury, thereby largely precluding other GSE shareholders from
benefitting from any future profits of Fannie and Freddie. Although a few of the Perry Capital plaintiffs’
judicial claims remain alive and other litigation is pending, the Supreme Court’s denial of certiorari in
Perry Capital was a major setback for the GSE shareholders’ efforts to challenge the 2012 amendments
through litigation. With the available routes to legal victory in the courts dwindling, some shareholders
are seeking to secure similar relief legislatively, as a component of the comprehensive housing finance
reform proposals currently being considered in the 115th Congress.
Origins of the Litigation. Fannie Mae and Freddie Mac are congressionally chartered, shareholder-
owned companies that support the U.S. housing market by buying mortgages, issuing securities backed by
those mortgages, and guaranteeing against default on close to $5 trillion in mortgage debt. In July 2008,
with the housing market roiling and Fannie and Freddie struggling financially, Congress passed the
Housing and Economic Recovery Act of 2008 (HERA). HERA established the FHFA as the GSEs’ new
regulator and temporarily authorized the Treasury to make unlimited financial investments in the GSEs in
order to “prevent disruptions in the availability of mortgage finance.” With Fannie and Freddie on the
brink of default, the FHFA, exercising HERA authorities, appointed itself conservator of the GSEs in
September 2008.
In one of its first acts as conservator, the FHFA signed the Senior Preferred Stock Purchase Agreements
(PSPAs) that are the subject of the Fannie and Freddie shareholder lawsuits. Under the original terms of
the PSPAs, the Treasury offered each GSE up to $100 billion in financial support (referred to as the
funding commitment) in exchange for several forms of consideration, including: the acquisition of senior
preferred shares in both Fannie and Freddie that are prioritized above all other stock classes; rights to
quarterly dividend payments; and warrants to purchase up to 79.9% of each GSE’s common stock. The
original PSPAs were amended twice, chiefly to increase the funding commitments. In late 2012, the
parties made a third amendment to the PSPAs, which modified how the Treasury’s dividend payment
would be calculated. The third PSPA amendment converted a fixed 10% dividend into a “net worth
sweep,” which “requires Fannie Mae and Freddie Mac to pay a quarterly dividend to Treasury equal to the
entire net worth of each [GSE],” except for a $3 billion capital buffer for each company. Thus, the net
worth sweep largely precludes the GSEs’ common and non-senior preferred shareholders from benefitting
from any future profits of Fannie and Freddie. By the end of 2017, Fannie had made a total of $122.8
billion in draws from the funding commitment with the Treasury, while paying the Treasury $166.4
billion in dividends, while Freddie had drawn $74.6 billion and paid $112.4 billion in dividends.
Beginning in 2013, groups of Fannie and Freddie shareholders filed a series of lawsuits against the FHFA
and the Treasury challenging the legality of the net worth sweep. Many of these suits were consolidated in
Perry Capital. The Perry Capital shareholders alleged, among other things, that the net worth sweep
constituted a taking without just compensation in violation of the Fifth Amendment of the U.S.
Constitution; exceeded the FHFA’s statutory authority under HERA; was arbitrary and capricious in
violation of the Administrative Procedure Act (APA); breached various provisions of the plaintiffs’ stock
certificate contracts; and constituted breaches of implied covenants of good faith and fair dealing under
common law.
Court Decisions in Perry Capital. The U.S. District Court for the District of Columbia (D.C. District
Court) dismissed all of the Perry Capital plaintiffs’ claims. The court generally held that (i) the plaintiffs
“fail[ed] to plead a cognizable property interest” for the purpose of the Takings Clause; (ii) the
shareholders’ statutory claims and common law tort claims were barred by a provision of HERA, 12
U.S.C. §4617(f), which establishes that “no court may take any action to restrain or affect the exercise of
powers or functions of the Agency as a conservator;” (iii) claims brought derivatively (i.e., by

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shareholders on behalf of the GSEs) were barred by HERA’s “succession clause,” which provides that the
FHFA, as conservator, assumes “all rights, titles, powers, and privileges” of the GSEs’ shareholders; and
(iv) some of the plaintiffs’ breach of contract and implied covenant of good faith and fair dealing claims
were not yet ripe for review because they were based upon an event that might never occur—the
liquidation of Fannie or Freddie.
On appeal, the D.C. Circuit affirmed the lower court’s dismissal of almost all of the plaintiffs’ claims.
(The Perry Capital plaintiffs did not appeal the D.C. District Court’s constitutional holding, but a separate
case raising almost identical Takings Clause claims is currently pending in the discovery phase at the U.S.
Court of Federal Claims.) However, the D.C. Circuit remanded a few of the shareholders’ common law
claims to the D.C. District Court for reconsideration on the grounds that the lower court had applied the
wrong legal standard to some of the claims and that other claims were ripe for review.
Although plaintiffs likely will continue to pursue the claims that survived dismissal, the Supreme Court’s
order denying review precludes the bulk of the shareholders’ claims.
Housing Finance Reform & Legacy GSE Shareholders. Some shareholders are attempting to get
Congress to provide the financial relief they, at least thus far, have failed to secure through litigation.
Since 2009, Congress has considered a number of GSE-reform bills without a consensus proposal
emerging, but there are signs of progress in the 115th Congress. It is possible that any broad GSE reform
package that becomes law would address the rights of legacy shareholders in Fannie and Freddie, and
Congress appears to have a number of potential options to address this issue. For example, a GSE reform
bill could terminate the FHFA-run conservatorships and the PSPAs, along with all of the Treasury’s rights
under the agreements (e.g., dividends, senior preferred shares, warrants to purchase common stock) and
allow Fannie and Freddie to resume operations as private, shareholder-owned companies. In such a
scenario, legacy shareholders might share the GSEs’ profits and losses, as the companies’ shareholders
did prior to the conservatorships. On the other side of the spectrum, a GSE reform bill could eliminate
Fannie and Freddie, force them to liquefy their assets, and compensate legacy shareholders and other
claimants (e.g., the Treasury) in accordance with a statutorily established priority scheme. In such a
scenario, legacy common and non-senior preferred shareholders might be paid pennies on the dollar or
possibly nothing at all depending on the funds the asset sales generate and the priority position of other
claimants. Congress also might choose to eliminate Fannie and Freddie, transfer their assets to new,
congressionally chartered entities, and compensate legacy shareholders with some form of ownership
stake in the new replacements.
Considerations for Congress. A number of issues might be relevant to congressional consideration of
these and other legislative options. For instance, policymakers might consider whether or not the federal
government, and by extension American taxpayers, has been sufficiently compensated for the financial
assistance it provided the GSEs, and what rights the Treasury should be allowed to exercise in
conjunction with a housing finance reform package. While both GSEs have paid more in dividends than
either borrowed, those payments have not reduced either firm’s “liquidation preference,” (the amount
contemplated by the PSPAs to compensate the Treasury as each GSE’s senior preferred stock holder if
either company was liquidated), which totaled $193.1 billion at the end of 2017. The Treasury also has
not exercised its authority to purchase 79.9% of each GSE’s common stock.
Another question Congress might consider is whether reform should treat GSE shareholders, who
invested before the FHFA took over as conservator and entered into the PSPAs with the Treasury, the
same as those who invested after. The stock prices of both GSEs plummeted from around $30 per share in
early 2008 to below $1.00 per share after the conservatorships. Many of the hedge funds that are behind
some of the lawsuits challenging the net worth sweep invested in the GSEs after the FHFA became the
companies’ conservator but before the third amendment to the PSPA. From a legal perspective, the D.C.
Circuit suggested that, on remand, plaintiffs who purchased their shares after the GSEs were placed into
conservatorships might have weaker legal claims than plaintiffs who bought their shares before the

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conservatorships. From a GSE reform perspective, policymakers might consider whether these two
groups of shareholders should be treated differently, as well as how that treatment might impact the future
behavior of participants in the housing finance system that develops after legislative reforms are
implemented.



Author Information

David H. Carpenter

Legislative Attorney





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