As plaintiffs move forward towards having their day in court, what’s the next potential barrier Defendants are going to use and when did the actual Taking occurred?
Based on Defendants’ strategy in the AIG case, I expect they are going to present the argument of Regulatory vs Physical Taking while Plaintiffs including Washington Federal obtain more evidence of when the Taking actually occurred.
Let’s get an understanding the difference between Physical and Regulatory Taking.
Modern takings law is in vast disarray; unfortunately, because the Supreme Court deals incorrectly with divided interests under the Takings Clause of the Fifth Amendment, which reads: “nor shall private property be taken for public use, without just compensation.” The Supreme Court’s regnant distinction in this area is between physical and regulatory takings. In a physical taking, the government, or some private party authorized by the government, occupies private land in whole or in part. In the case of a per se physical taking, the government must pay the landowner full compensation for the value of the land occupied. Regulatory takings, in contrast, leave landowners in possession, but subject them to restrictions on the ability to use, develop, or dispose of the land. Under current law, regulatory takings are only compensable when the government cannot show some social justification, broadly conceived, for its imposition.
Thus, under current takings law, a physical occupation with trivial economic consequences gets full compensation. In contrast, major regulatory initiatives rarely require a penny in compensation for millions of dollars in economic losses. The distinction has been defended on the ground that the Court’s cases have consistently offered higher protection to physical takings given the historical importance of protection against occupation. It is also, as Justice Thurgood Marshall wrote, that a physical taking “is perhaps the most serious form of invasion of an owner’s property interests. To borrow a metaphor, the government does not simply take a single ‘strand’ from the ‘bundle’ of property rights: it chops through the bundle, taking a slice of every strand.”
Next, let’s review the key sequence of events in detail starting from September 6, 2008 and a follow up with a quote from Tim Howard, former CFO of Fannie Mae.
On September 6, 2008, at the request of Treasury, Federal Reserve and FHFA, the Director of FHFA appointed FHFA, itself as the regulated entities’ conservator in accordance with HERA. The conservatorship is a statutory process designed to preserve and conserve assets and property, and put the regulated entities in a sound and solvent condition. The conservatorship has no specified termination date.
On September 7, 2008, Henry M. Paulson, Jr., Treasury Secretary and James B. Lockhart III, Director of FHFA announced several actions taken by Treasury and FHFA regarding the regulated entities. At the same time, FHFA indicated that the Director of FHFA will issue an order terminating the conservatorship upon the Director’s determination that the conservator’s plan to restore the regulated entities to a safe and solvent condition has been completed successfully.
Mr. Lockhart stated that they took these actions “to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed directly to the instability in the current market.” These actions included the following placing regulated entities in conservatorship; the execution of a senior preferred stock purchase agreement by FHFA, the conservator, on behalf of the regulated entities, and Treasury, pursuant to which the regulated entities issued to Treasury both senior preferred stock and a warrant to purchase common stock; and the agreement to establish a temporary secured lending credit facility that is available to both of the regulated entities.<<<<<<<<<<<<<when is loan not a loan?
Upon FHFA’s appointment, the conservator immediately succeeded to all rights, titles, powers, and privileges of the regulated entities, and of any stockholder, officer, or director of such regulated entities with respect to the regulated entities and the assets of the regulated entities; and title to the books, records, and assets of any other legal custodian of such regulated entities. The conservator has the power to take over the regulated entities assets and operate the regulated entities with all the powers of the regulated entities’ stockholders, directors and officers, and to conduct all business of the company. As a result, ten members of the board of directors resigned effective immediately. Thus, sounds like Physical Taking.<<<<<<<<<<<<<<<<<<<<<< See what Thomas Wheeler said about AIG.
The conservator announced at that time that it would eliminate the payment of dividends on common and preferred stock during the conservatorship. However, under the terms of the senior preferred stock, Treasury is entitled to a quarterly dividend of 10% per year (which increases to 12% per year if not paid timely and in cash) on the aggregate liquidation preference of the senior preferred stock. To the extent the regulated entities are required to draw on Treasury’s funding commitment, the liquidation preference of the senior preferred stock will be increased by the amount of any funds the regulated entities receive. The amounts payable for the senior preferred stock dividend could be substantial and have an adverse impact on the regulated entities financial position and net worth. The senior preferred stock is senior in liquidation preference to the regulated entities’ common stock and all other series of preferred stock. In addition, beginning on March 31, 2010, the regulated entities are required to pay a quarterly commitment fee to Treasury, which fee will accrue from January 1, 2010. The regulated entities are required to pay this fee each quarter for as long as the senior preferred stock purchase agreement is in effect, even if the regulated entities do not request funds from Treasury under the agreement. The amount of this fee has not been determined at the time. The senior preferred stock purchase agreement includes significant restrictions on the regulated entities ability to manage their business.
The senior preferred stock purchase agreement has an indefinite term and can terminate only by Treasury at will or NEVER at the discretion of Treasury, which do not include the end of the conservatorship. The agreement therefore could continue after the conservatorship ends. Treasury has the right to exercise the warrant, in whole or in part, at any time on or before September 7, 2028. The point is Treasury included an indefinite and/or perpetual term meaning never-ending, timeless, eternal, and unending in the agreement. If for any reason the courts disallow the indefinite term within the agreement, Treasury also has in place an option to take 79% ownership through warrant. Again, it sounds like Physical Taking since HERA didn’t authorize the perpetual term.
That legislation strengthened the existing safety and soundness oversight of the GSEs and provided FHFA with new safety and soundness authority that is comparable to and in some respects broader than that of the federal bank agencies. That legislation gave FHFA enhanced powers that, even if the regulated entities had not been placed into conservatorship, gave FHFA the authority to raise capital levels above statutory minimum levels, regulate the size and content of their portfolio, and approve new mortgage products. That legislation also gave FHFA the authority to place the GSEs into conservatorship or receivership under conditions set forth in the statute.
The conservatorship and senior preferred stock purchase agreement have materially limited the rights of the regulated entities’ common and preferred stockholders (other than Treasury as holder of the senior preferred stock).
The conservatorship has had the following adverse effects on the regulated entities common and preferred stockholders:
• the powers of the stockholders are suspended during the conservatorship. Accordingly, the regulated entities common stockholders do not have the ability to elect directors or to vote on other matters during the conservatorship unless the conservator delegates this authority to them;
• the conservator has eliminated common and preferred stock dividends (other than dividends on the senior preferred stock) during the conservatorship; and
• according to a statement made by the Treasury Secretary on September 7, 2008, because the regulated entities are in conservatorship, the regulated entities “will no longer be managed with a strategy to maximize common shareholder returns.”
The senior preferred stock purchase agreement and the senior preferred stock and warrant issued to Treasury pursuant to the agreement have had the following adverse effects on the regulated entities common and preferred stockholders:
• the senior preferred stock ranks senior to the common stock and all other series of preferred stock as to both dividends and distributions upon dissolution, liquidation or winding up of the company;
• the senior preferred stock purchase agreement prohibits the payment of dividends on common or preferred stock (other than the senior preferred stock) without the prior written consent of Treasury; and
• the warrant provides Treasury with the right to purchase shares of our common stock equal to up to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise for a nominal price, thereby substantially diluting the ownership in the regulated entities common stockholders at the time of exercise. Until Treasury exercises its rights under the warrant or its right to exercise the warrant expires on September 7, 2028 without having been exercised, the holders of the regulated entities common stock continue to have the risk that, as a group, they will own no more than 20.1% of the total voting power of the company. Under the regulated entities’ Charter, bylaws and applicable law, 20.1% is insufficient to control the outcome of any vote that is presented to the common shareholders. Accordingly, existing common shareholders have no assurance that, as a group, they will be able to control the election of their directors or the outcome of any other vote after the time, if any, that the conservatorship ends.
The fact is FHFA as Regulator have the authority to raise capital levels above statutory minimum levels to a point where the regulated entities are unable to meet the capital level requirement at any given time including weeks or days before September 7, 2008. Thus, allowing FHFA to legally appoint itself as Conservator under HERA to take physical possession of the bundle of rights from the regulated entities. This distinction between Regulatory and Physical Taking is important as this case moves forward. It is near certainty defendants will argue the taking was a Regulatory Taking but proving it might be difficult.
And finally rewind back to mid January, 2015, Tim Howard briefly discussed three important issues that are widely misunderstood or mischaracterized in the reform debate:
• Treasury’s actions to place Fannie Mae and Freddie Mac into conservatorship were fundamentally different from Treasury and Federal Reserve interventions in support of commercial and investment banks during the financial crisis. Intervention in support of banks was done in response to sudden and uncontrollable liquidity crises that required immediate government assistance to keep the companies from failing, and involved actions and tools intended to achieve that result (not always successfully). The act of placing Fannie Mae and Freddie Mac into conservatorship was not a response to any imminent threat of failure but rather a policy decision initiated at a time of Treasury’s choosing, and involved actions and tools intended to make and keep the companies insolvent.
• Convincing evidence exists that the conservatorships of Fannie Mae and Freddie Mac were planned well in advance, and that they were intended to remove the companies permanently from private ownership. There also is clear prior history of OFHEO and its successor agency FHFA following the dictates of Treasury in its dealings with Fannie Mae and Freddie Mac.
• The motive behind the third amendment to the Treasury-FHFA senior preferred stock agreement was made evident by its timing, coming as it did just ten days after Fannie Mae announced sufficient second quarter 2012 earnings not only to pay its $2.9 billion quarterly senior preferred stock dividend but also to add $2.5 billion to its capital. Coupled with strong and growing revenues, rising home prices in the first half of 2012 meant that the pessimistic assumptions that had driven earlier decisions to write down assets, add huge amounts to the loss reserve, and establish a valuation reserve for deferred taxes no longer were supportable. Treasury and FHFA entered into to the third amendment to ensure that when many of these write-downs were reversed it would be the government, and not Fannie Mae’s shareholders, that would benefit.
Reference links to publicly available information:
GSEs Quarterly 10Q and Annually 10K filings at: