Summary of Oral Argument in Perry v. Lew before the Appeals Court
April 27, 2016
Listen to a full replay of yesterday’s teleconference on the Investors Unite website.
The three federal judges who recently heard oral arguments in the Fairholme Funds suit stemming from the Net Worth Sweep of the profits and Fannie Mae and Freddie Mac offered no hint that they were about to rubber stamp U.S. District Judge Royce Lamberth’s 2014 dismissal of the case.
The fact that they gave attorneys three full hours, rather than the one hour allotted, to present arguments and respond to a number of probing questions demonstrates that they recognize the significance of the case and want to take a careful look at all the issues involved, in the view of Hamish Hume, a partner at Boies Schiller & Flexner, who argued before the three-judge panel on behalf of investors on April 15.
“I view that as a very positive sign for the shareholders,” he said during a call with media and shareholders hosted Investors Unite Executive Director Tim Pagliara today. “The more time they spend looking at this case, the better for us. The more they look at it, the more I hope they will see that something really unjust happened.”
While there are many legal arguments against the legality of the Sweep, Hume focused on three claims: That it was a breach of contractual rights of shareholders, a breach of fiduciary duties owed by Treasury and the Federal Housing Finance Agency to both the companies and their shareholders, and a taking of private property, which gives rise to a claim for just compensation under the Constitution.
Under the contractual terms of the conservatorship established for Fannie and Freddie in 2008, the U.S. Treasury Department had a right to a 10% dividend payment on its senior preferred stock. To secure payments above that dividend, Treasury could have exercised the warrants it held for 79.9% of the companies’ common stock. Instead, Treasury implemented the Sweep. By doing so, it violated the contractual terms and maneuvered out of obligations to shareholders’ rights, which the Housing and Economic Recovery Act specifically aimed to protect.
“Under a breach of contract claim, especially when you have a breached covenant claim, a court needs to look at the economic substance of what happened,” Hume said. “Substance should matter over form. That is a really central concept here.”
Pagliara raised questions about “what the government knew and when it knew it” with regard to the timing of Sweep, and asserted that revelations in newly unsealed documents in Perry Capital’s suit point to a “premeditated attempt to destroy the companies.”
Hume acknowledged the unsealed documents were helpful to both claims. They show Treasury officials, in the months leading up to the Sweep, expected the companies to bring in profits exceeding dividend payments.
Hume noted that two of the three judges voiced a number of comments and questions about the importance of this information. Therefore, it will be critical going forward, even if it does not have a direct bearing on the violation of contractual and fiduciary responsibilities he raised before the judges
“There is a lot of ammunition there,” he said.
At this stage in this long process, what matters is that with each step in the litigation and as more facts come to light, federal judges are willing to reconsider whether the government did the right thing by investors under the law.
To find more Investors Unite blogs click here.
Capital Continues to Matter
April 21st, 2016
“Capital matters a lot,” Fannie Mae CEO Tim Mayopoulos was quoted by Politico as saying at a luncheon hosted by the Exchequer Club in Washington Wednesday.
The fact that it was newsworthy that the CEO of one of the nation’s largest financial services firms thinks a capital buffer is useful is just another act in the surreal drama that continues to surround the conservatorship of Fannie Mae and Freddie Mac.
The capital levels at the GSEs are scheduled to decline to zero by the end of next year as the Treasury Department’s sweep of their profits continues. This strikes many policy experts as absurd. Investors Unite Executive Director Tim Pagliara argued over a year ago that setting standards similar to those of Systemically Important Financial Institutions, or SIFIs, would make sense. Around that time we noted more and more experts and stakeholders had come to our conclusion that capital matters.
Unfortunately, not much has changed, leaving shareholders, taxpayers and homebuyers in the same dubious position.
“I’m not going to offer an answer on exactly what the right number is, but I do know that we do not have sufficient capital today,” Mayopoulos said. “At the same time, we would note that it’s essential to have sufficient capital, but we also know that higher capital requirements mean higher costs to borrowers.”
Interestingly, his comments come amid reports that Mel Watt, director of the Federal Housing Finance Agency (Fannie and Freddie’s government conservator), is so concerned about their capital levels he might consider raising g-fees, which lending institutions pay Fannie and Freddie to minimize losses from possible individual loan defaults. This too would mean more expensive borrowing costs for perspective homebuyers. Two months ago Watt turned up the volume on the alarm about the perils of dwindling capital levels.
Thus far, Administration officials seem to think there is nothing to worry about. They have said the GSEs still have a credit line of over $200 billion. Revenues from the mortgage companies can pay off those credit lines rather than building up capital buffers. In essence, the government has seen to it that Fannie and Freddie are putting all the money aside they will be forced to borrow as a result of having their capital depleted by Treasury. Think about that construct for a moment.
Thus, everything seems to be going according to the plan hatched at Treasury with the advice and consent of mortgage bankers years ago: With the vilified Fannie and Freddie captive in a conservatorship, Treasury makes their exit all the more impossible with loans the GSEs neither needed nor requested. Then it confiscates their capital to use for whatever the government sees fit. By raising the bar for recapitalizing and releasing Fannie and Freddie, support would grow for simply dismantling them.
The only problem for Treasury’s plans is that shareholders are gaining ground as they press ahead in lawsuits that are exposing the folly, irresponsibility, secrecy and sheer dishonesty at work in the conservatorship.
At some point, a Fannie Mae CEO might make news for explaining to shareholders how capital buffers are sufficient to protect them and taxpayers alike for even a worst-case economic scenario. One day, FHFA’s director might announce new initiatives to make affordable homeownership more accessible instead of thinking about squeezing more money from g-fees to keep Fannie and Freddie solvent.
But we’re not there yet.
- The Perry appeal oral argument was conducted on April 15, 2016. After hundreds of pages of written briefs and almost 3 hours of oral argument, the case is submitted.
- This article cautiously assesses the oral argument in the context of the major legal issues presented in the Perry appeal, and the likelihood of their outcome.
- In my view, I believe that the appeals court will either reverse (“bull case”) or vacate and remand for a full trial (“base case”). I do not expect affirmance.
- GSE shareholders are in the position to reap significant gains if I am right.
- On April 15, judges Brown, Millett and Ginsburg listened to oral arguments for Perry Capital LLC v. Jacob Lew.
- A plaintiff victory may lead to higher equity stock valuations in the event that the third amendment net worth sweep is stopped and the GSEs can retain their capital.
- In the oral arguments, the judges seem to side with plaintiffs, which bodes well for shareholders. Inside this article, you will find links to key audio snippets of oral arguments.
- By listening to the nature of the line of questioning, one can discern whether or not a judge has a bias one way or another on this case.
- The GSEs are essentially public utilities. The FHFA’s duties as a regulator of the GSEs are essentially the same as those of a public utility regulator.
- As argued by FHFA’s attorney before the U.S. Court of Appeals, the FHFA as regulator has extraordinary authority, with no judicial oversight of its actions. This is regulation on steroids.
- That is not how public utility regulation ordinarily works. Public utility regulators should be subject to oversight by the executive branch, the judiciary, and the courts.
- It is hard to imagine that a court would think that government actions to expropriate assets from investors and de facto nationalization cannot be overseen by the courts.
- This case is very important for GSE common and preferred investors. Investors should do their own due diligence.