GSE-Gate, Better than the X-Files?

 

 

GSE-Gate??

 

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.)

kcoltonllc@gmail.com,

 

What Others Are Saying

 

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

http://money.cnn.com/2014/02/21/news/economy/fannie-profit-bailout/index.html?source=yahoo_quote

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

http://www.politico.com/story/2014/02/wall-street-republicans-dave-camp-bank-tax-reform-104065.html

 

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

http://www.startribune.com/business/247256861.html

 

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

http://finance.yahoo.com/blogs/the-exchange/a-surprising-new-way-to-cut-america-s-debt-174529518.html 

--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. 

http://www.thestreet.com/story/12460420/1/fannie-and-freddie-plaintiffs-eye-fdic-share-sales.html

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

http://www.valuewalk.com/2014/02/fdic-accused-of-insider-trading/

 

--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.

http://blogs.wsj.com/moneybeat/2014/02/23/ackman-sees-big-upside-to-fannie-freddie-bet/

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

http://www.bloomberg.com/video/has-business-learned-from-target-s-data-breach-CbGN~V0oSkO63pFWmrTpsg.html

Maloni, 3-2-2014