Congress Is Stealing Fannie and Freddie

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Politicians are running rough-shod over the rule of law as they seek to rob private citizens of their assets to achieve their own amorphous political objectives. If we were speaking of some banana republic, this would be par for the course - but this is unfolding in the United States today.

The Federal National Mortgage Association (commonly known as "Fannie Mae") and the Federal Home Loan Mortgage Corporation (Freddie Mac) remain two of the largest companies in the world, as measured by both asset value and revenue. The shares of these privately owned, for-profit mortgage finance companies trade on the New York Stock Exchange. They are known as "government sponsored entities" (GSEs) due to their federal charters, which charge each with providing stability and assistance to the secondary mortgage market and promoting access to mortgage credit.

As the mortgage crisis gained momentum in 2007, the federal government directed Fannie Mae and Freddie Mac to purchase subprime and other risky securities to bolster the economy and stabilize the industry. Unsurprisingly, this caused Fannie and Freddie to be hit particularly hard by the financial crisis of 2008. Even though the companies never became insolvent, Congress passed the Housing and Economic Recovery Act of 2008 (HERA) to take control over Fannie and Freddie, placing the companies under the FHFA.

As conservator, the FHFA entered into senior preferred stock arrangements whereby it would advance $100 billion to the companies in exchange for $1 billion in shares of senior preferred stock with a cumulative 10% dividend. In addition, the companies issued to the government rights to purchase 79.9% of the common stock for a mere $0.00001 per share. Once in control, the government forced Fannie and Freddie to delist their shares, suspend shareholder meetings, and purchase additional subprime assets.

In spite of such measures, the GSEs returned to profitability in 2012 and are currently generating cash - enough, in fact, to more than repay the $187.5 billion in emergency funding received from the government during the downturn. As the appointed conservator, the FHFA is charged with marshalling such assets for the benefit of the shareholders; instead, the government amended the stock agreement to forbid Fannie and Freddie from using excess income to return the companies to "a sound and solvent condition," requiring "a full income sweep of all future Fannie Mae and Freddie Mac earnings" to the government. This is a violation of the government's fiduciary obligations.

Proposed housing finance reform legislation in Congress would repeal the GSEs' charters and liquidate the two entities; destroying the last vestige of value for Fannie and Freddie's shareholders in the process. A Senate bill introduced by Banking Committee leadership Tim Johnson and Mike Crapo, and modeled after previously introduced legislation by Senators Mark Warner and Bob Corker, has so far failed to gain momentum but could be marked up by the Committee this week.

The Johnson-Crapo legislation threatens to codify the federal government's actions toward shareholders to date - constituting a complete federal taking of the shareholders' property. This is not only illegal, it is unconstitutional. As the Supreme Court has observed, the constitutional prohibition on the taking of property is in place to prevent the government from forcing "some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole."

Rather than ensuring these companies maintain their profitability, selling them to private parties, or discharging the debt via a traditional bankruptcy, the plans considered by Congress potentially burden taxpayers with Fannie Mae and Freddie Mac's enormous liabilities. Washington has always hedged on whether they would guarantee the mortgage giants' liabilities. Now, while opportunities to divest without assuming the liabilities exist, Congress is poised to pledge the full faith and credit of the United States behind both GSEs' debt.

With the mortgage giants' liabilities estimated at a whopping $5.2 trillion, such action threatens to imperil the nation's credit rating, curtail economic growth, spur inflation, threaten social programs, and diminish the nation's social, economic, and political power.

Under the proposed liquidations, virtually everyone loses. First, the GSEs' shareholders' property rights are violated. Second, the taxpayers face the potential burden of the GSEs' trillions in liabilities. Finally, the rule of law is subverted, thereby making lending and business in general a riskier proposition.

The United States was founded on a firm commitment to Americans' property rights. In fact, of the Declaration of Independence's charges against King George III, a majority are offenses against private property. The political winds of the moment make it popular to extract short term taxpayer advantage on the backs of Fannie and Freddie's shareholders. But we should not allow political expediency and crony capitalism to flout the rule of law. In the longer run, the governments' handling of Fannie Mae and Freddie Mac could subvert certainty and order - a key competitive advantage for the U.S. economy. 

Jonathan R. Macey is the Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale Law School.  Logan Beirne is Olin Scholar at Yale Law School, and author of Blood of Tyrants.  


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