Sunday, March 2, 2014

GSE-Gate, Better than the X-Files?




Scully: “Now Mulder, before we call this mess ‘GSE-Gate,’ let me see if I can understand?” 

Mulder: “Go for it Scully, you foxy redhead! Psst, when you’re not acting, do you really date men and wo….?” 

Scully: “Mulder! As I was saying...” 

It’s 2008, a conflicted Hank Paulson thinks he has to do something about F&F. With that in mind--but with the GOP lust for killing F&F sharing half his brain--he puts them into conservatorship, under rules and plans designed not to conserve them but beggar them, intending never let to their shareholders earn a penny, no matter what the companies’ financial fates produce.

Real bad move Hank, although it won’t hit you for about four years. 

Hank’s twisted path, possibly legal and possibly not, foists upon dumbfounded GSE managements and even dumber GSE board members, a byzantine legal quagmire which only gets realized, down the road, when hedge funds acquire F&F preferred and common stock, post facto, and seek to understand Paulson's statutory questionable machinations.



Flash forward a few years, a new Treasury Secretary, Jack Lew (Post facto blogger's correction: While Secy Lew is mentioned in the law suits, it was his predecessor Treasury Secretary Tim Geithner in office when the "sweep arrangement" was developed), looks at the Budget rules, gets some highly dubious revenue GSE projections--which erroneously suggest the companies are in financial trouble--and trumpets a change to the Paulson GSE payback scheme, just as F&F hit the revenue jackpot. 

Lew dispatches Paulson’s old plan, which for the first few years had Treasury borrowing money to pay itself, and then risks more legal mayhem when he decides to take, not just 10% of what the companies owe the Treasury (the original Paulson scheme), but scoops every revenue penny the companies generate. 

Scully: “How am I doing, Mulder?” 

Mulder: “Great, Scully, you vixen. Keep going girl.” 

Flat footed investors are dumbfounded and pissed, and are smart enough to see abrogation, self-dealing, “takings” and a host of other legal violations and hire some of the best lawyers in the nation (just ask them) to sue Uncle Sam to get back to the shareholders, the rightful owners of Fannie and Freddie, some of what should have been theirs when they bought stock in the two. 

A murder of law suits fly. 

Enter the dimmest crew of all, the Congress.

Blind to any of the mortgage finance facts of life, with many still guided by the “kill Fannie and Freddie GOP meme,” bills are introduced to abolish the two and set up either a Rube Goldberg apparatus to replace them or just give the nation’s mortgage finance system to the large commercial banks, market impact or fairness be damned. 

As all of this is going on, the nation’s media wake up and start asking about various federal documents and records, which pop up,  showing possible undue and punitive actions against F&F that were not employed against any of the other large financial institutions which took federal financial support in that era.

This begets more congressional confusion (almost a constant state on the Hill), including one US Senator bragging how he plans to throw 12,000 or so of his constituents out of their jobs, which stimulates internecine battles raging in the middle of other internecine battles. 

In the meantime, Fannie Mae and Freddie Mac, run (very inefficiently) by their government overseers, continue to persevere and support the national mortgage market daily, while shipping billions in profits each quarter to the US Treasury—which desperately needs cash to cover all of the other government red ink—making sure the nation’s would be home buyers (also called constituents) have access to fairly priced and designed mortgage products, every day of the week, in every community in the nation. 

Last week,  a federal judge rules against the government and allows plaintiffs’ lawyers “discovery,” permitting them to meticulously go over Treasury and OFHEO/FHFA documents and communications to further cement their case against Uncle Sam. 

Scully: “Mulder, it’s so sad that the comic genius, Harold Ramis died last week, since this would have been a wonderful story line for him to exploit into a fabulously funny motion picture. What do you say?” 

Mulder: “Scully, baby, I agree with everything and anything you say. Yowza.”

GSE Lawsuits


I’m not a lawyer, so I am sure that 50 lawyers reading this segment can find 100 problems with it. But, to me, the 19 or so lawsuits (will there be more?) pending against the Treasury and the FHFA seem pregnant with some fairly dynamic consequences, if the Court favors the plaintiffs. 

Let me establish that I’ve asked many lawyer friends for their opinion of what could be contained in a range of decisions—favoring the plaintiffs—available to the Judges and, possibly, ultimately the Supreme Court. 

I find no consistency in their answers, even when they just try and measure possible financial damage awards. 

The lawsuits question both the 2008 initial action-- putting Fannie and Freddie into conservatorship-- and then the subsequent action to change the rate at which the two should pay back federal government amounts they “borrowed” (a technical impossibility, but a fact which effectively has been achieved, with the final 2013 F&F earnings statements).

F&F started paying back at a 10% rate (twice what TARP-aided banks faced), but then in 2012 that “dividend payment” was changed from a simple percentage of debt outstanding to a sweep of every profitable penny the two generated, which is one of the reasons the two paid back Uncle Sam in just three years. 

With numbers like $50 billion being owed investors tosses around, the issue of carving up the two companies and giving them to the preferred investors seems one judicial option. One plaintiff, Fairholme’s Bruce Berkowitz already has offered to buy the two and operate them. 

How much of a possible award might cause a Judge to substitute that option before she forces Uncle Sam to payout $50 Billion or more to all investors? 

The stock prices on Fannie and Freddie preferred and common have slowly been going up over the past two years but have spiked up recently. 

Judge Margaret Sweeney granted “discovery” this week to the Berkowitz lawyers, an action which, ultimately, might cause the US government to sue for peace and seek a settlement with the plaintiffs, as it weighs what additional evidence Berkowitz might find in government files. 

When does Uncle Sam call for a settlement, which gives up its right to the companies, rather than pay out money it desperately wants to keep? 

And, what happens to the government 79.9% ownership of F&F (a number chosen because it keeps the entire transaction out of the US budget rules), could that be nullified? 

At what point does some green eye shade guy/woman, sitting in Treasury’s basement, decide that if F&F were allowed to operate as true shareholder owned companies, they could generate earnings that would allow Treasury to retire a big chunk of the national debt. But, could any of that arrangement be legal not just expedient? 

And what does the Congress do--given all of their harsh (mostly unfounded) F&F rhetoric--if a Court possibly breathes entrepreneurial life back into the mortgage giants? 

It could sit on its hands and do nothing but loudly complain, one click below what it’s been doing. 

None, some, or all of this seems possible giving the latitude the Court has in these suits. 

Of course, the courts rule against the shareholders and find for the government; but consider the alternative for a moment? 

Would one of you senior legal partners--who are blog readers--put a few of your associates to work and send to the blog what realistically could be an out most parameter in a finding for the plaintiffs, given the demands of the current 19 lawsuits? 

A lot of us would like to know.


Kent Colton 

I’ve known Dr. Kent Colton for more than 30 years, as an independent housing and mortgage finance consultant, as part of the Harvard Joint Housing Center, as one time head of the National Association of Home Builders, and as the competent “that guy” people reach out to when they want a solid review on a housing matter. 

Recently,  he collaborated with Michael Carliner, also from the Harvard JHC, on a study assessing the likely magnified mortgage cost increases for future home buyers, if any of the pending mortgage reform bills became law. (Make sure you see their estimate of C-W increased costs for borrowers.) 

Because I continue to be a “tech idiot” and can’t convert Kent’s paper into a link, he was decent enough to agree to provide a copy to anyone who contacts him at:

(Please note that this was an exclusive  Colton-Carliner paper done independently for a group of large high production  builders, called the Leading Builders of America. It is not a paper produced at the Joint Harvard Center.)


What Others Are Saying


--CNN’s Chris Isidore says F&F return more money to Treasury than any previous federal bailout.

--Politico’s Jake Sherman, Anna Palmer and Lauren French look at big bank responses to Ways and Means Chair’s tax plan.


--The AP’s Marcy Gordon details that bank earnings in 4Q 2013 were up 17%.


--Rick Newman writing for Yahoo repeats most of the stuff in my blog. (Mine was written first but his was published sooner.)

--Dan Freed’s piece in The Street hits the fact that FDIC—before it sold GSE preferred shares it acquired from failing depositories—may have known about the government’s plan to not allow F&F shareholders to benefits from any profits the two earned. 

--In Value Walk, Michael Ide discusses hits same theme, asks if FDIC was the beneficiary of insider trading when it sold F&F stock?


--Surprise, surprise, Bill Ackman sees big money coming in his bet on Fannie and Freddie in the WSJ story by Julie Chung and Nick Timiraos.

--Look at which crisis communications expert (smart, handsome, dude) is on Bloomberg talking about Target’s data breach?

Maloni, 3-2-2014



Anonymous said...

Hey Bill,

I see a lot of confusion out there questioning whether the government will exercise the 80% ownership of the common shares. Being one of those confused persons, I went back and researched other cases where the government did this to a large corporation. It didn't take long until I found the AIG model. Although this is a little different scenario, some of the parallels have striking similarities. With AIG, the government did exercise warrants and reverse split the stock in order to cash in on the amount it originally loaned plus interest. To me this appeared to be an avenue in controlling the repayment of money loaned by the taxpayer. It make sense in a strange way and the government and taxpayer came out alright. The shareholder got the shaft perhaps. So with Fannie and Freddie, I think a warrant exercise would be causing even more damage to the company and shareholder and an act that cannot be legally justified. I guess there is still that myth out there that the taxpayer have yet to be repaid by the GSEs however I'm confused with this line of thinking. What are your thoughts on this?

Bill Maloni said...

Confused, quiet frankly.

I'll repeat, not being a lawyer, I asked many about the suit and how a Judge could if she decided for the plaintiffs?

No consistency in the answers, which suggest the parameters may be expansive or worse, totally relative. ("Worse" in trying to decide how far she can go.)

You did what I hope others will do, provide some precedent or answers to the items I listed, because I just don't have a good measurement standard.

I know many lawyers involved in the lawsuits read the blog and I hope one or more will respond.

Bill Maloni said...

Damn, I wish I knew how to type.

That's "quite!"

Bryndon Fisher said...

Dear Bill:

As always, your blog is not only informative but completely entertaining. Using The X-Files for context was a hoot. With regard to the opinions proffered by your legal associates, I cannot see any scenario where the government could win on the merits of its arguments. As a consequence, the government is relying heavily on legal technicalities such as standing and subject-matter jurisdiction in order to dismiss the various complaints. But the violation of law against Fannie Mae, Freddie Mac, and their stakeholders, perpetrated by misguided government agencies is so clear, so evident, and so egregious that this period in our nation’s history will be taught in high school civics classes to demonstrate the abuse of power by government, and the specific relief from such.

However, setting aside the lawsuits (ours included) for a moment, a resolution to this conflict exists outside of the courts, and it rests in the hands of the Director of the FHFA. Director Mel Watt is, by operation of law, the most powerful individual in this entire political/economic drama. Per HERA legislation, the FHFA “when acting as conservator or receiver . . . shall not be subject to the direction or supervision of any other agency of the United States.” 12 U.S.C. § 4617(a)(7)

Thus, Mr. Watt could show real leadership and integrity, and direct his agency to take the “bold” step of actually behaving like a conservator and unilaterally 1) strike down the third amendment to the PSPA as contrary to the FHFA's mandate to put the entities in a sound and solvent condition, 2) withhold from the U.S. Treasury the currently scheduled “dividend” payment, and declare the senior preferred stock fully redeemed based on past payments, 3) extinguish the warrants issued to the U.S. Treasury as unnecessary for repayment, 4) permit the GSEs to relist their securities on the NYSE, 5) allow the entities to recapitalize through the issuance of additional common stock, and 6) release the entities from conservatorship, and back to their rightful shareholders - us.

And as for reforming America’s housing finance system, that is possible by simply employing regulators that are neither lackadaisical nor adversarial to their regulated entities, but effective in detecting detrimental deviations from set standards and, thus, preventing another financial crisis; and, by allowing Fannie Mae and Freddie Mac to do what they have done best for generations – purchasing and securitizing high-quality, conforming prime mortgages. And if further reform is necessary, Congress can alter or remove the GSEs’ charters as they did with Sallie Mae, whether the entities are in conservatorship or operating free of this now intrusive government overreach.

Thank you for everything you’re doing to set the record straight. And if you should communicate with Tim Howard, please let him know his book is a big hit in our family. Thank you, again.

Best regards,
Bryndon Fisher

Bill Maloni said...

Bryndon--I really like your thinking, but never say never, especially in Washington. One never knows who or what people think about parties in a lawsuit.

One man's "legal technicalities" is another's clear statement of legal fact.

Everyone should relax, we have some time before this marathon ends.

While you may be right as to Mr. Watt's, it's the rare political appointee who rolls the person who named him to his position.

As I've said and written to others, I see no reason for the Obama Admin to fess up to major mistakes and errors as suggested by the plaintiff's suits.

They still could win in the lower courts and the SCOTUS likely won't act until President Obama is gone from office.

Howard is due back in town this week for additional book meetings and some other significant confabs.

Wayne Olson said...

I am just a holder of non-cumulative preferred stocks, so I don't expect to get any "damages." Best case, I think, is that the injunctive relief requested by Perry (T. Olson) will overturn the 3rd Amendment sometime this summer and FnF will suddenly have cash flows that are sufficient to pay the preferreds a dividend going forward. They may even have sufficient cash flows to pay a small common dividend. At any rate, the non-cumulative preferreds should be golden sometime soon. Buying FnF commons would force me to start thinking more seriously about the "end game" issues, along the lines of Bryndon's post, which I have been hesitant to do. I bought preferreds when they were trading at a 15 premium to the commons, so it's all good.

Anonymous said...

Mr. Maloni, Have you heard anymore about the Johnson/Crapo bill such as when it will be introduced and what it contains? I'm wondering why there aren't any whispers only that it will be used as the Hail Mary pass for mortgage reform in 2014. Could this be a spoiler?

Bill Maloni said...

Wayne--Lots of people are in yoru shoes (or wish they were, darn it!).

When I worked for the Fed, I remember once describing managing US monetary policy as trying to balance a tennis ball on the top of seven shoe boxes, which never were aligned.

You get the picture.

There are lots of moving parts in these lawsuits and as I tried to suggest to Bryndon, you never can remove politics from any issue decided in Washington.

Someone whose work I really admire, Michael Kim a partner at CRT Capital, did a piece last fall where he tried to describe the possible parameters of a finding for plaintiffs.

I haven't seen anything more comprehensive or better since then. But, his work is going on 5 months old.

Bill Maloni said...

Anon--No new word beyond "working on principles" which I mentioned last week.

The sand may be running out of that hour glass and onto the floor, because of their inability to agree on enough to satisfy conservative R's and the "progressive" committee D's.

But, once again, you never say never.

I think most Senators and Members, both sides of the aisle, would like to see this issue flutter off into the sunset, which means some aggressive Admin action or an all encompassing court decision which isn't appealed.

(And Wayne, it's "your" not "yoru." Maybe I should try to sue more than two fingers?)

Bryndon Fisher said...

If politics needs to prevail at this time, President Obama can simply direct the FHFA and the U.S. Treasury to follow those steps I outlined earlier, and declare taxpayers repaid and the enterprises restored to a more sound and solvent condition. This isn't rocket science, just good policy. Cheers to doing the right and honorable thing.

1st Anon... JM said...

Bill, Thanks for this platform.

1. Yes GSE Gate is true. I'd like to see hearings on that Dec 2010 memo, who knew what when. For example who told Goldstein it was the "Administrations" goal. Such that he wrote it "back" to TG? I wasn't an original thought of his... so who knew and when...

2. I read BFishers' notes and have considered same. But what Fisher fails to consider is how "profitable" these two entities currently are. While sure they won't continue above normal earnings forever, but lets not be too hasty.

There is simply no pressing need to "5) allow the entities to recapitalize through the issuance of additional common stock" at the present time, as a current run rate of near $20B a year for Fannie and a little less for Freddie they will easily put $40-$50 B away each over the next 3 years. Prior to diluting the common stock they should accumulated Retained Earnings and allow their "Fair Values" to appreciate. Then in 2-4 years consider whether an S2 Offering is necessary at Market Adjusted Fair Value. There is no reason to raise $25B in Capital today by issuing 6Billion shares.

These entities don't need to be in conservatorship for congress to discuss "reforms". That's a misnomer.

3. The question here is why won't Watt release them. What or WHO is preventing him, and if so, is he or his predecessors ever truly been independent? Who is holding his chain?

1st Anon - JM

Bill Maloni said...

JM--First, thanks for reading and commenting.

You will see and hear more about the 2010 memo; it can't be hidden and too many people are writing about, see my links to just two stories last week.

In reverse order, chances are Mel Watt would have retired soon--since the D's are unlikely to capture the House--and gone back home to practice law or do something in obscurity (as most MoCs do).

He was saved all of that by the Obama Admin (and reportedly Valerie Jarrett, who acted as his "Rabbi" inside the WH supporting his nomination).

You just don't bite that hand which fed you.

Watt can do a lot on his own--and hopefully will--on affordability issues or even helping underwater borrowers, but to launch a campaign as big as what you describe, before the Admin who gave him his job gives him a green light, just isn't going to happen. And that's not a shot at Mr. Watt.

Your suggestions are logical and rational; those qualities don't come into play here, where everyone seeks some political advantage in the smallest of issues. Just think how many angles and clashing interests exist in something macro and mondo like resurrecting F&F?

That's why it will take a monster court decision or this WH exploring every bit of executive authority it can muster to go around the Congress--actions themselves which will be subject to Rightwing law suits by the ton.

Yes, F&F are very valuable, especially if they are run thoughtfully and with some entrepreneurial sense; generating revenue isn't a sin especially when so many consumers seem to benefit, as they did in the pre-2005 days.

Anonymous said...

Bryndon's thought for the current administration to do the right thing has a big glass of KoolAid to deal with first courtesy of Chief Economic Advisor Sperling,

"The Obama administration’s plan for comprehensive reform has several core principles, including putting private capital at the center of the housing finance market, winding down Fannie Mae and Freddie Mac, and providing and protecting widespread access to credit for worthy borrowers, ensuring a nation that is well-housed."

Anonymous said...

Sperling wants private capital at center and a nation well housed. LOL, I want a billion dollars and get it by doing nothing.

Bill Maloni said...

Anon and Anon--

This Administration doesn't have a huge amount of credibility these days, no matter what the subject.

Nothing it wants for mortgage finance can ever get support in the House.

And, nothing fast is happening in the Senate.

Right now, it sucks to be the Obama Administration.

Things could change, but not quickly. So much for that Koolaid!

BTW, Sperling's White House job ends this week; he'll be replaced by Jeffrey Zients.

Anonymous said...

Bill...great work (again). I see Berkowitz is at it again - this time, as I'm sure you've already seen, calling for some board governance. My take is that he's basically calling for these folks to do their job, or just do something for that matter. I'm sort of getting the impression that Fairholme is the equivalent of someone poking the bear at the zoo...except the door is unlocked and the 'bear' hasn't decided to launch out yet. Of course, the bear wants to maul these people, just not sure if he can get away with it is the rub. Any thoughts on the latest musings is always much appreciated.


Bill Maloni said...

I don't know either.

But, try this.

Maybe he's trying to show how little involved either "board" has been on matters of substance, underscoring part of his lawsuit's contention--with the recent board responses proving it?

Anonymous said...

So, the board(s) essentially responded with 'we're not in charge', what exactly is the purpose? Basically what Berkowitz is argueing I suppose...he makes good points not only about their compensation, but also the fact that they do indeed (publically traded after all) have a fiduciary duty. It's a mystery.


Anonymous said...

The board members of F&F have not fulfilled their fiduciary responsibilities. Now that they are "on notice" from investors, what will they do?
Continue their passive posture?
They may be personally liable for their inaction.
How many board members of savings institutions were found liable for not fulfilling their fiduciary responsibilities?

Bill Maloni said...

Anon 1 (GW)--I have written many times that F&F are singled out for disparate regulatory treatment and always have been.

We'll see if the courts agree.

Beyond that I have no explanation for the boards actions, save they
have no authority over anything.

Anon 2--See answer above. The board positions largely have been federal sinecures.

It will be fascinating if that arrangement comes back to bite any of them?

Qualified Observer said...

OT: Howard Vindicated

Bill Maloni said...

QO--Yes, my friend Fiderer is a big fan of Tim's and has communicated with him on matters relating to Fannie/OFHEO history.

I plan to use DF's article, which is in the current National Mortgage News, in my next blog.

BIG JAM said...

Hope you use this

Bill Maloni said...

Big Jam--It will appear in the next one; I remember seeing this, thinking it was fabulously hilarious, and passing it on to friends.

Not sure why it didn't land in the blog.


Wayne Olson said...

And thoughts on Judge Royce Lamberth? A quick google search found him to be a "colorful character," independent, willing to "rattle the cages of the powers that be," and so on. I'm not an expert or a lawyer, but I'm guessing that he will come out in favor of the rule of law, the 5th Amendment (takings clause and due process clause), and take a dim view of expropriation from investors without just compensation. That's just my best guess, so I'm interested in what you might have to say.

Bill Maloni said...

Wayne--Like you I am not a lawyer; Lambert is a colorful character and many of the lawyers I've talked to, plus others supporting the "referred investors," like him a great deal, given their objectives.

Qualified Observer said...

I'm trumpeting this one too:

While the article itself is interesting, the *real* meat is in the annotated Plaintiffs' Motion which is linked to at the bottom of the above article. It speaks to an unbelievable degree of disarray at the FHFA...

Bill Maloni said...

QO--Thanks. I saw this just after posting my latest, so I snuck it in the "Others Are Saying" segment, post facto.