Fannie and Freddie Boards did not consent…because they never met…!

Fannie Mae and Freddie Mac’s Boards of Directors did not consent to conservatorship. Claims of Board meetings where they consented to conservatorship never happened. 

The Government made several claims regarding why they initiated the conservatorships of Fannie Mae and Freddie Mac in September 2008. In Henry Paulson’s book, On the Brink, Paulson asserts that the companies were undercapitalized and operating in an unsafe and unsound manner. However, if you carefully read Paulson’s book it is clear these charges were trumped-up or fabricated.

In fact, this passage in the book debunks the “unsafe and unsound” claim:

Complicating matters, FHFA had recently given the two companies clean bills of health based on their compliance with those weak statutory capital requirements. Lockhart was concerned — and Bob Hoyt, Treasury’s general counsel, agreed — that it would be suicide if we attempted to take control of Fannie and Freddie and they went to court only to have it emerge that the FHFA had said, in effect, that there were no problems.

Paulson knew that the claim of undercapitalization was weak. Indeed, a recent forensic accounting review proves that Fannie Mae was not undercapitalized. I am unaware if a similar review was conducted on Freddie Mac’s capitalization level in 2008.

The point is that Paulson knew his case for conservatorship could not be substantiated. The only way he could justify placing the companies into a government-controlled conservatorship was if the companies consented to this action. In order for the companies to consent, the boards of directors would have had to meet and vote on the action.

The boards of directors never met. I’ll repeat this point – THE BOARDS NEVER MET!

Hopefully, this revelation is as shocking to you as it was to me when I realized it. It would be impossible for Fannie Mae and Freddie Mac to consent to conservatorship if their boards of directors never met to vote on the action.

James Lockhart made this statement during his September 7, 2008 announcement:

The Boards of both companies consented yesterday to the conservatorship. I appreciate the cooperation we have received from the boards and the management of both Enterprises. These individuals did not create the inherent conflict and flawed business model embedded in the Enterprises’ structure. I thank the CEOs for their service in these difficult times. 

And here is what Paulson said on September 7 in his official announcement:

Throughout this process we have been in close communication with the GSEs themselves… I appreciate the productive cooperation we have received from the boards and the management of both GSEs. I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither.

These statements are false. The boards did not consent…they never met.  Plus, there was no cooperation between the government and the companies.

The facts proving the boards of directors did not meet will be presented in a moment, but first review what Paulson wrote in his book that proves the statement in the announcement was a lie. Here is how Paulson describes the process:

“(speaking with President Bush)…‘we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.’

I’m a straightforward person. I like to be direct with people. But I knew that we had to ambush Fannie and Freddie. We could give them no room to maneuver. We couldn’t very well go to Daniel Mudd at Fannie Mae or Richard Syron at Freddie Mac and say: ‘Here’s our idea for how to save you. Why don’t we just take you over and throw you out of your jobs, and do it in a way that protects the taxpayer to the disadvantage of your shareholders’

The news would leak, and they’d fight…”

Paulson admits in his book that there was no cooperation – on the part of the government!

Why did Paulson feel the need to lie about Fannie Mae and Freddie Mac’s boards of directors consenting to conservatorship? Perhaps he realized that no other condition was met under the law – the Housing and Economic Recovery Act of 2008 (HERA). Paulson was aware of this law because he pushed it through congress (and some people assert he lied during that process, as well).

Under HERA, the Federal Housing Finance Agency (FHFA) was authorized discretionary authority to place Fannie and Freddie into conservatorship if one of the following conditions existed:













None of the above conditions existed when the US Treasury Department conspired with the Federal Reserve and FHFA to illegally takeover Fannie and Freddie. Paulson was aware none of these conditions existed so he resorted to lying to get what he wanted.

To prove that the boards of directors never met to vote on conservatorship a comparison of what Paulson wrote in On the Brink needs to be made with the official record of Paulson’s activities.

The Treasury Department maintains detailed records of the Treasury Secretaries’ meetings and phone calls. Paulson’s September 2008 record is available here:

Paulson claims in his book that he met with a small group of Fannie and Freddie executives on Friday, September 5 in advance of full boards of directors meetings on Saturday, September 6. However, the official record shows no meetings occurred on September 5, rather only the two meetings on September 6. And these meetings on Saturday were not with the boards of directors as Paulson states in his book, but rather meetings with a few company representatives. Again, this is very important, as the only way to have consent is to have an official board of directors meeting where they would vote for or against conservatorship.

The following description of events is from Paulson in On the Brink:

Thursday, September 4, 2008

From On the Brink:

“Thursday evening, Jim put in calls to the CEOs of Fannie and Freddie, summoning them to a meeting Friday afternoon that Ben and I would attend at FHFA’s headquarters on G Street. (Jim didn’t speak directly to Mudd until Friday morning.) We arranged for the first meeting to start just before 4:00 p.m. so that the market would be closed by the time it ended. We decided to lead with Fannie Mae, figuring they were more likely to be contentious.”

Friday. September 5, 2008

From On the Brink:

Our first meeting was with Fannie in a conference room adjacent to Jim’s office. We’d asked both CEOs to bring their lead directors. Fannie chairman Stephen Ashley and general counsel Beth Wilkinson accompanied Mudd. He also brought the company’s outside counsel, H. Rodgin Cohen, chairman of Sullivan & Cromwell and a noted bank lawyer, who’d flown down hastily from New York.

We ran through the same script with Freddie, and the difference was clear: Where Mudd had been seething, Syron was relaxed, seemingly relieved. He had appeared frustrated and exhausted as he managed the company, and he looked like he’d been hoping for this to happen. He was ready to do his duty—like the man handed a revolver and told, “Go ahead and do it for the regiment.” 

He and his people mostly had procedural issues to raise. Would it be all right for directors to phone in or would they have to come in person? How would the news be communicated to their employees?

Saturday September 6, 2008

From On the Brink:

From that call I went into a noon meeting that lasted perhaps an hour with the board of directors of Freddie Mac. In the afternoon, around 3:00 p.m., it was Fannie Mae’s turn. To avoid publicity, we switched from FHFA headquarters to a ground-floor conference room at the Federal Housing Finance Board offices, a few blocks from Lafayette Square.

Sunday September 7, 2008

Press conference – announcement of conservatorship

Here is further proof that Paulson claims meetings occurred over two consecutive days with Fannie and Freddie:

Just like the initial meetings the day before, the session with the Freddie board went much easier than the one with its sister institution.

Fannie’s directors, like its management, wanted to differentiate their company from Freddie, but we made clear we could do no such thing.

The official record of his events refutes Paulson’s fabricated version from On the Brink.

From the official account, one can find the relevant Fannie and Freddie references – phone calls and meetings:

Friday, September 5, 2008:

It is apparent that every event for Paulson on this day related to Fannie and Freddie, however the following meetings are of note:

8:55 – 9:00 am   Paulson call with Dan Mudd

9:00 – 10:15 am   GSE meeting (internal Treasury staff)

3:00 – 4:30 pm   Paulson meets with Jim Lockhart, Jim Wilkinson, Dan Jester, Kevin Fromer and Bob Hoyt (internal Treasury meeting)

6:40 – 7:10 pm   GSE update (internal Treasury staff)

Saturday September 6, 2008

Again, all of the meetings and phone calls on this day appear Fannie/Freddie related.

7:30 – 8:20 am   GSE management meeting (internal Treasury staff)

12:00 – 1:00 pm   GSE meeting (with a few Fannie Mae executives – Mudd, Ashley, B. Wilkinson and Cohen as described in the book)

3:00 – 4:00 pm   GSE meeting (with a few Freddie Mac executives – Richard Syron and a few others similar to the Fannie Mae small meeting)

Sunday September 7, 2008

11:00 – 11:45 am   Press conference – announcement of conservatorship

The record clearly indicates that meetings with Fannie and Freddie executives and board members did not occur over the course of two days. Though the official record purposely lacks detail on the attendees of the September 6 meetings, it is clear that these meetings are the ones that Paulson went into detail describing in his book – the smaller meetings…not with the full board of directors.

I believe the official record was intentionally vague as to the attendees at the Saturday meetings as if it provided full detail it would show that the meetings were with a small contingency of executives that lacked the authority to provide full board consent.

What is unmistakable is that meetings with Fannie and Freddie did not occur on both Friday and Saturday. It’s a complete fabrication to fit Paulson’s narrative and to justify the illegal government takeover of two private companies.

If the Government seizure was illegal, then everything that followed literally compounds a felony.

Obviously, the assessment of events is my own opinion.  But, you do have to question why Paulson claims to have had meetings on both Friday and Saturday, when the official record proves meetings only occurred on Saturday. 

The full expert from On the Brink can be found here:

Fannie and Freddie are more complicated than that

By Ralph Nader
February 21, 2014

This article was written in response to “How Ralph Nader learned to love Fannie and Freddie” (February 18) by Bethany McLean.

Bethany McLean’s article deserves a number of clarifying responses.

McLean injects an air of complexity and confusion with regard to my positions on a number of separate issues in what seems to be an attempt to imply a more interesting narrative for her article than exists in reality. Some clarifications are in order:

In the 1990s and early 2000s I opposed corruption in the government-sponsored enterprises (GSEs). I was clear about my admonition of the government subsidies they received in the form of an implicit government guarantee without meeting their obligations to advance affordable housing. I was clear that their drive for profits could tempt them deeper into murky legal waters. My opposition to their management compensation packages and questionable accounting practices were made plain.

Now I am advocating for the GSEs’ shareholders’ rights. This is an issue separate from the previous transgressions and corruption.

In its conservatorship of the GSEs, the federal government has used and abused GSE shareholders. It has unfairly treated the GSEs differently than other bailed-out corporations that were equally — or more — at fault for the financial crisis.

For example, AIG and Citigroup shareholders were given a chance to share in their companies’ recovery. In the Treasury Department’s unilateral amendment of the preferred stock purchase agreements in 2012, the federal government unlawfully changed the terms of its initial investment to its own benefit.

I have long been an advocate for shareholder rights. This is not an issue of supporting Fannie Mae and Freddie Mac in their previous incarnations, but an issue of the rule of law.

There exists a more nuanced position than one of the two extremes of proposing that we either completely eliminate the GSEs or that we maintain them without any reform, warts and all.

How Ralph Nader learned to love Fannie and Freddie

By Bethany McLean
February 18, 2014

“It is time for [government-sponsored enterprises] to give up ties to the federal government that have made them poster children for corporate welfare. Most of all, Congress needs to look more to the protection of the taxpayers and less to the hyperbole of the GSE lobbyists. –Ralph Nader, testimony before the House Committee on Banking and Financial Services, June 15, 2000

“Fannie Mae and Freddie Mac should be relisted on the NYSE and their conservatorships should, over time, be terminated. –Ralph Nader, letter to Treasury Secretary Jacob Lew, May 23, 2013

People certainly do change.

Right now, one of Ralph Nader’s key projects, Shareholder Respect, is supporting a group called Restore Fannie Mae. They are fighting for “an end to the unconstitutional conservatorship of Fannie Mae and Freddie Mac by the U.S. government.”  To that end, Nader has written an op-ed in the Wall Street Journal, “The Great Fannie and Freddie Rip-Off” and sent the above letter to Treasury Secretary Jack Lew, as well as one to the newFederal Housing Finance Authority director, Mel Watt. Nader also held a roundtable to drum up support for the cause, which largely seems to be about making sure shareholders get paid–but which seems an argument for a return to the status quo.

For most of their existence, Fannie and Freddie have been controversial.  Critics argued that their gains during good years would go to shareholders and executives, while taxpayers would be saddled with any losses, thanks to an implicit government guarantee. That’s indeed what happened during the 2008 economic crisis.

Critics soon began to assert that the government-sponsored enterprises were largely responsible for the financial calamity. The more extreme critics, like Representative Jeb Hensarling (R-Tex.), now want the GSEs wiped out and the government completely out of the housing market. Even former Representative Barney Frank, once one of the GSEs’ strongest defenders, nowsays they should be abolished. In polite society, you do not dare say that the GSEs should be restored to their old selves.

The funny thing is, as his 2000 testimony shows, Nader was once among these GSE critics. You have to go back to the late 1990s, when what became an underground war against the GSEs had barely gotten started. Louisiana Representative Richard Baker was, at that point, one of the few people willing to get bruised trying to rein in the then very powerful housing giants. Baker tried to pass a bill that would tighten regulation of GSEs.

Nader’s congressional testimony was in support of Baker’s bill. He was vehement, warning that the GSEs would cause a taxpayer bailout similar to the late 1980s savings and loan crisis if the rules weren’t changed. (“Ralph Nader Predicted Wall Street Meltdown 8 Years Ago” read the headline on a Nader press release during his 2008 presidential campaign.)

“We are obviously not talking about GSEs interested only in providing the American dream of home ownership,” Nader said.  “They have a big appetite that grows bigger as they saturate the mortgage market. They will reach out for more to maintain their high level of profits and shareholder dividends.”

It’s unclear how Nader got involved in the anti-GSE crusade. One longtime GSE watcher says that a guy named Jake Lewis, who worked as Nader’s spokesman around that time, previously had been a spokesman for the old House Banking Committee (now known as the House Committee on Financial Services). Armando Falcon, who became the head of Fannie and Freddie’s regulator and a huge opponent of the GSEs, was counsel to the House Banking Committee around that time. The longtime GSE watcher speculates that Falcon sparked Lewis’s interest, and maybe Lewis, in turn, sparked Nader’s.

Whatever the case, Tim Howard, Fannie Mae’s former chief financial officer,  recalls in his new book, The Mortgage Wars: Inside Fannie Mae, Big-Money Politics, and the Collapse of the American Dream, that Nader helped to organize a 1999 conference where anti-GSE types could complain.  (Ironically enough, Restore Fannie Mae calls The Mortgage Wars a“fantastic read,” which it is.)

It wasn’t long after this that the war got started in earnest. The big lenders and mortgage insurers started an organization called FM Watch, with the goal of curtailing Fannie and Freddie’s power. Then, in the wake of Enron, the George W. Bush White House, terrified of another scandal on its watch, decided to take on the GSEs. Both Fannie and Freddie had to do multibillion-dollar accounting restatements, and the chief executive officers and other top execs at both firms resigned. (At one point, I was sure that Fannie and Freddie were the bad guys. I’m less sure today. There are certainly two sides to the story, and if you want to understand the other one, read Howard’s book.)

Even after the denouement, Nader stayed involved. In 2006, he wrote a letter to then Securities and Exchange Commission Chairman Christopher Cox. “As you continue to investigate the Fannie Mae accounting debacle,” Nader wrote, “we are writing to urge you to seek civil sanctions, including disgorgement, from senior executives who profited directly from the misconduct at Fannie Mae, and that you urge the Department of Justice to give careful consideration to criminal prosecution of these individuals.”

Perhaps the most surprising thing is that despite his prescient warnings and his dislike of the GSE business model, somewhere along the way Nader bought stock in Fannie and Freddie.

As it turned out, the mid-2000s victory over the GSEs was small in comparison to what came later. When Fannie and Freddie were put into conservatorship in September 2008, the Treasury took 79.9 percent of their common stock and $1 billion in preferred stock. Which meant the Treasury had to be paid in full before any other shareholders realized anything.  The Treasury also charged the GSEs a 10 percent interest rate on funds advanced to cover their capital shortfalls, double the rate the big banks had to pay on the money they took. Then, in 2012, Treasury replaced the 10 percent dividend with a “net worth sweep,” which in essence meant that Treasury would take every dollar of profit the GSEs made. In other words, it was now impossible for Fannie and Freddie ever to pay back the government.

In Nader’s Wall Street Journal op-ed, he wrote that even after the conservatorship, “some faithful shareholders, including me, held on, believing that they might have a chance to recover something–as did their counterparts in Citigroup, AIG and the rest of the rescued.” He also writes that the “mistreatment of the Fannie Mae and Freddie Mac shareholders, including me, is uniquely reprehensible.” He wants shareholders (and taxpayers) to recoup some of the benefits of profitable GSEs.

Nader is right. At one point, you could have argued that the disparate treatment of the GSEs and the big banks was warranted because the GSEs required a lot more money. At the peak of the crisis they required $188 billion in total from the government, versus the $10 billion to $25 billion that the big banks each took as part of the 2008 Troubled Asset Relief Program.

Then again, there are lots of other ways in which the government financially supported the banks. At one point there was also an argument that the GSEs, unlike the banks, would always be a black hole, draining money from taxpayers. But that hasn’t turned out to be true either: The GSEs will soon have sent more to the Treasury than they took.

In addition to Nader’s past opposition to the GSEs, there’s another irony here. Restore Fannie Mae describes itself as a “group of concerned taxpayers, students, families, shareholders and citizens who are dedicated to establishing fairness in America’s housing market.” But it is also aligned with the interest of powerful financial firms–not Nader’s usual pals!–including hedge fund Perry Capital and mutual fund Fairholme Capital.

Both Perry and Fairholme have sued the government, arguing that the 2012 restructuring of the conservatorship was illegal. Theodore Olson, the former U.S. solicitor general turned Gibson & Dunn lawyer who is representing Perry Capital, spoke at Nader’s Feb. 5 roundtable, discussing the impact of conservatorship on the GSEs.

Maybe it’s fitting that the topic of housing makes for interesting bedfellows. This past weekend, New York Times columnist and long-time GSE critic Gretchen Morgenson also wrote a piece sympathetic to the shareholder point of view.

Apart from getting his money back, it isn’t clear what Nader’s goal is.  What he doesn’t want is to see the housing market handed to the banks, which would be the result of most of the GSE reform bills now circulating around Congress. Restore Fannie Mae makes a point of saying that “responsible lending standards” should be enshrined in the GSEs’ charters. But if Nader wants a fundamental change in their structure from the pre-2008 days, I can’t find a clear overview of what that is.

Messages seeking comment sent to Nader’s organization and Restore Fannie Mae through their websites received no response from Nader. Nader was not contacted directly.

Is it just a story of pure hypocrisy, the way we can all change our minds when our own money is at stake? Or did the 2008 fiscal crisis, along with the right’s highly politicized efforts to blame it on the GSEs, make Nader realize that the alternative of the big banks might be worse?

Has Nader come to believe, in a twist on Winston Churchill’s famous saying about democracy, that the GSEs might be the worst possible way to finance housing–except for all the others?

Three New Animated Videos

1st from @westernmassvote and @timhoward717

Fannie Mae and Freddie Mac’s critical role in protecting Black America


Next two from @HousingPimp

The Fannie Grabbers – Con Job – Season 1, Episode 1

The Fannie Grabbers – Eaton Pork – Season 1, Episode 2

How the Fannie and Freddie Conservatorship Has Undermined the Resolution Process

By William Isaac & Senator Bob Kerrey | April 2015


Seven years after the crisis that rocked the global financial system, we are still rebuilding and redesigning its structure and rules – and probably will be for years to come. As policymakers engage in this process, laws enacted to address the crisis must be faithfully executed or formally amended.

Otherwise, the government would introduce uncertainty into a marketplace that can ill afford it. Regrettably, uncertainty is precisely what is occurring with regard to the mortgage banking giants commonly known as Fannie Mae and Freddie Mac.

In the summer of 2008, the world’s largest secondary financial market was unraveling. Given the size and systemic significance of Fannie Mae and Freddie Mac in the mortgage finance market, the Treasury Department intervened, based on authority granted to it by Congress in its passage of the Housing and Economic Recovery Act (HERA). Treasury invested $187 billion in senior preferred stock in Fannie Mae and Freddie Mac, carrying a ten percent dividend. As part of the deal, the government also effectively acquired ownership of 79 percent of the GSEs’ common stock. As structured, these terms avoided a complete government takeover of the GSEs and protected taxpayers from future bailouts. The government was right to insist on tough terms given its indispensable role in restoring stability into the marketplace.

However, given its critical role, the government has a uniquely important obligation to abide by the terms of deals that it makes. That is why the government’s actions in recent years are troubling. As this paper will detail, beginning in 2012 the government unilaterally changed the terms of HERA and began to sweep all of the GSE’s profits into the general fund. Rather than “conserving and preserving” the GSEs’ assets for their eventual restoration to a “safe and solvent” condition, as the HERA stipulates, the ongoing confiscation of 100% of the GSEs’ profits does just the opposite.

This misapplication of the law has created several problems. First, it ignores the rights of shareholders. Second, it leaves the GSEs’ vulnerable to the need for the infusion of taxpayer dollars should another market disruption occur.

Congress and the Administration will eventually decide what to do about Fannie and Freddie, and whether or not these institutions should have any role in the future of housing finance. Until that time, the government must follow the law, and not undercut its ability to act decisively in times of crisis.

Executive Summary

The conservatorship established for Fannie Mae and Freddie Mac in the midst of the severe financial crisis of 2008-2009 initially helped stabilize housing finance, but in the years since has thwarted the clear direction provided by Congress to the Federal Housing Finance Agency (FHFA) under the Housing and Economic Recovery Act (“HERA”). The conservatorships were accompanied by an investment by the government of $187 billion in senior preferred stock in Fannie and Freddie carrying a 10% dividend. The government also obtained warrants, convertible at nominal cost, into 79% of Fannie Mae’s and Freddie Mac’s common stock.

Under HERA, one of FHFA’s primary duties as conservator is to “preserve and protect the assets and property” of the enterprises as well as to take actions necessary to putting Fannie and Freddie in a “safe and solvent” condition. In 2012, four years after FHFA established the conservatorships, the federal government unilaterally amended the agreements to sweep 100% of Fannie’s and Freddie’s profits to the U.S. Treasury. This action, and the resulting draining of the GSEs’ profits and capital each quarter, actually reduces the effectiveness of future resolution efforts by the government in times of crisis. Resolution of financial institutions by federal agencies often requires participation of the private sector. In turn, established rules and law surrounding the priority of claims in such arrangements depends on the consistent and clear application of these rules. By placing public claims ahead of private stakeholders in the Third Amendment to the preferred stock purchase agreements, the federal government has adversely affected future resolutions of financial institutions by changing the rules of the game by putting one group of legal stakeholders ahead of others ex post.

In the meantime, the conservatorships endure. With no hope of recapitalizing without extraordinary intervention, the secondary mortgage market remains in a state of suspended animation, lacking private capital, exposing taxpayers to future losses, and raising the cost of mortgage credit and reducing its availability to creditworthy borrowers.

Historic Context and Policy Perspectives

On September 6, 2008, the U.S. mortgage market – the world’s largest secondary financial market – avoided an unprecedented and catastrophic unraveling when both Fannie Mae and Freddie Mac were placed by their regulator into conservatorship. Conservatorship is a legal process taken by an entity at the time financial insolvency occurs to oversee its activities in an effort to return the company to solvency. Conservatorship is distinct from receivership, which is aimed

more at an orderly liquidation of an enterprise that cannot be saved. The federal government, leading up to conservatorship, had few policy tools available to it to step in and provide stability to the GSEs. That changed when Congress enacted the Housing and Economic Recovery Act of 2008 (HERA) that created the Federal Housing Finance Agency (FHFA) and gave FHFA the authority to establish the conservatorships and manage both enterprises with a great deal of policy latitude. HERA granted FHFA authority and direction to “preserve and conserve the assets and property” of Fannie Mae and Freddie Mac along with the power to take actions to put the enterprises in a “safe and solvent condition.” Four years later, in direct contradiction to these mandates, the federal government embarked on an unprecedented sweep of 100% of the enterprises’ profits, thus denying both companies any chance of escaping from conservatorship and frustrating the point of conservatorship itself – i.e., returning the undercapitalized financial institutions to health.

Conservatorship was not intended to be a long-term solution to the GSEs, but six years later the companies continue in a state of limbo. The management of these conservatorships has jeopardized future resolution processes by effectively changing the rules of the game between private and public stakeholders. By elevating the priority of public claimants over private interests, FHFA’s actions regarding the conservatorships set a precedent with potentially negative long-term consequences. This could significantly impair private participation in future resolution processes while potentially raising the costs of housing and limiting credit availability across the markets.

FHFA has purposefully avoided engaging directly in any strategy that would end the conservatorships or place them into liquidation via receivership. In this political vacuum, the conservatorships have failed in meeting many of their objectives. FHFA’s interpretation of its discretionary authority under HERA, coupled with unprecedented unilateral changes to the preferred stock agreements between the government and the enterprises, forestalls any chance for Fannie and Freddie to recapitalize without some intervention on their behalf. It also undermines the effectiveness of future resolution activities of financial companies during times of crisis by subverting well-established rules and laws relating to insolvency.

This report provides a review of the policy and strategy surrounding the conservatorships. The intent is to provide an objective and fact-based assessment of how the conservatorship has worked against stated objectives, how actions taken by FHFA and the U.S. Treasury have affected the enterprises, taxpayers, markets and homeowners, and what insights can be gained from these events that may be used in shaping a policy solutions for final resolution of the conservatorships.

Looking back, few policymakers would have expected the conservatorships to still be in place after more than six years. With investment in residential housing and associated housing services accounting for nearly one fifth of U.S. GDP on average over time, addressing the conservatorships of the two agencies directly responsible for financing the vast majority of this nation’s mortgages is one of this nation’s major policy imperatives. This is especially true as housing continues to recover at stubbornly slow pace, on average, in comparison with the economy as a whole.

Stabilizing Fannie and Freddie During the Financial Crisis

The charters granted to Fannie Mae and Freddie Mac were a uniquely American financial innovation originally designed out of necessity from the Great Depression to help get the nation’s housing market on its feet. An urgent need to establish a deep liquid market for mortgages was clear when Fannie Mae was chartered in 1938. Both enterprises (Freddie Mac following much later in 1970) provided guarantees for credit risk embedded in mortgages that were bundled and used as collateral underlying mortgage-backed securities (MBS) sold by the enterprises to investors. These guarantees were not made explicit obligations of the federal government – to the contrary, all the legal documentation of the MBS and debt issued by the enterprises stated otherwise. However, markets interpreted the linkages outlined in their charters, including a line of credit from the U.S. Treasury, as implying some form of guarantee. This so-called “implicit” guarantee helped lower the cost of the enterprise’s debt, which in turn helped reduce the rates on Fannie- and Freddie-backed “conforming” mortgages relative to privately financed mortgages.

From a credit perspective, neither enterprise encountered a period leading up to 2008 that posed an insolvency risk due to credit losses. This is a critical fact that made the housing boom preceding the 2008 conservatorships an exceptional period in its own right and central to the discussion of the effectiveness and purpose of the conservatorships.

A combination of low capital requirements, poor oversight relating to GSE risk- taking, and a strategy to grow the retained portfolios and expand the credit risk envelope put the enterprises in a precarious position when the mortgage crisis broke, eventually sealing the fates of the GSEs in 2008. Both enterprises incurred combined losses of $108.8B in 2008, more than the total losses experienced by Fannie and Freddie in the 37 years leading up to 2008. At the time, the Office of Federal Housing Enterprise Oversight (OFHEO), which oversaw the GSEs, had limited authority to address what was fast becoming a systemic risk issue for the U.S. housing market as both enterprises’ financial conditions became increasingly dire as the financial crisis unfolded.

In response to the accelerating decline in the enterprises’ capital positions, increased borrowing costs, and potential liquidity crisis Congress passed HERA on July 30, 2008. HERA, among other things, created FHFA as the successor agency to OFHEO and granted it the authority to place the GSEs into conservatorship upon determining that the firms were undercapitalized or otherwise unable to meet their financial obligations. After a comprehensive review by the Treasury Department, Federal Reserve, the Office of the Comptroller of the Currency and FHFA, the FHFA director on September 6th, 2008 designated FHFA as conservator for both Fannie and Freddie, based on the results of that analysis indicating inadequate capital levels and an inability for the enterprises to raise a sufficient level of capital to maintain their solvency during this extraordinary period. According to statements from then Secretary of the Treasury Henry Paulson, the conservatorship was to maintain market stability and access to mortgage credit and to protect the U.S. taxpayer. Importantly, Secretary Paulson also indicated that conservatorship was intended to be a short-term solution to the enterprises’ financial problems. In fulfilling its role as conservator, FHFA took over the assets of both firms, assumed the powers of the board and executive management and replaced the CEOs of both companies. Under HERA, FHFA suspended, but did not eliminate, shareholder rights in accordance with HERA until such time as the enterprises could be placed into a safe and solvent condition.

Senior Preferred Stock Purchase Agreements

Following enactment of HERA, the U.S. Treasury along with FHFA entered into the senior Preferred Stock Purchase Agreements (PSPAs). The PSPAs provided the mechanism for financial support (in the form of preferred stock purchases) to each enterprise, in return for $1 billion in preferred shares of that enterprise ($2 billion between them) and warrants that when exercised gave the Treasury 79.9% of the common shares of each company. By ensuring that the enterprises remained solvent, the holders of debt and mortgage-backed securities issued by the GSEs were protected from loss and stability of the secondary market was maintained. Initially, the preferred stock held by the Treasury had a dividend of 10% if paid in cash and 12% if paid in preferred stock, payable quarterly. Over time the PSPAs have been amended including a major change in 2012 – the Third Amendment to the PSPAs – requiring the companies to transfer 100% of all of their profits to Treasury without any credit for such amounts as pay-down of principal, and thereby preventing any possibility of the enterprises’ eventual recapitalization and exit from conservatorship. This was “the profit sweep,” leading shareholders in Fannie and Freddie to sue FHFA and Treasury for violating HERA.

The effect of this Third Amendment can be seen in Figure 1. Through 2012, Fannie and Freddie drew down on Treasury’s financial support as they worked through their problems, and FHFA directed the GSEs to make cash dividend payments even though they were undercapitalized and had the option of making those payments in the form of stock. In 2013, the companies turned profitable, requiring no further draws on Treasury’s financial support, and under the profit sweep they made enormous payments back to Treasury. As of the date of this paper, of the most recent fiscal quarter, Fannie Mae has paid $136.4 billion, after receiving $116.1 billion from Treasury. Freddie Mac has paid $91.8 billion, after receiving $71.3 billion from Treasury.


At the end of 2012, Treasury changed the PSPA to increase Treasury’s dividend from 10% to 100% on a quarterly basis, effectively stripping the GSEs of their ability to ever rebuild capital again. This change coincided with a change in the financial fortunes of the enterprises. Beginning in 2012, both companies began turning a profit again as credit losses moderated in the years after the crisis. In the absence of any profit sweep, these profits could have gone directly to building capital that would be essential to maintaining the safety and solvency of the enterprises as required by FHFA under HERA. Conceptually, the change in the PSPAs in 2012 meant all profits made by the enterprises would be paid to Treasury going forward.

In 2008, in light of the fragility of the enterprises’ capital and their systemic importance to the mortgage market and the financial system generally, establishing a backstop framework was essential to ensuring the stability and integrity of the mortgage secondary market, particularly in light of the evaporation of private-label securitization from the market. The government had every right to demand the terms it took in 2008. But whatever financial terms the executive branch of government took, it should have to live by those terms. It cannot change those financial terms in 2012. Having chosen conservatorship rather than receivership, FHFA has to follow its statutory mandate to “conserve and preserve assets” and “restore [then enterprises] to safe and solvent condition”, it cannot wait for Congress to give it a legal mandate that it wants to follow more than the one that it has. If FHFA doesn’t want to let Fannie and Freddie recapitalize, it has to make the requisite factual findings under the statute to send them into receivership.

The current Administration is following a course of action which has no clear resolution and has committed the U.S. housing market, homeowners, market participants, and taxpayers to perpetual conservatorships. The profit sweep was an unprecedented and unilateral change in the terms of the PSPAs that contradicted the clear intent of HERA to ensure FHFA would take actions to ensure the safety and soundness of the enterprises. By diverting all profits away from the GSEs, FHFA effectively precluded any ability of the companies to boost their capital levels and over time “earn” their way out of conservatorship. Moreover, the profit sweep contradicts FHFA’s mandate to “preserve and protect” enterprise assets and property. Thus far, Treasury has made cumulative payments to the GSEs of $189.4 billion and received cumulative draws from the GSEs of $228.2 billion. Even giving pay-down credit to payments over the original 10% dividend level, the current value of the remaining preferred stock plus unexercised warrants, according to some experts, gives taxpayers $100 billion more. These numbers undermine FHFA and Treasury’s claims that the sweep is needed to ensure that “the taxpayer gets paid back”.

How the Net Worth Sweep Weakens Future Resolution Process

Importantly, the profit sweep from the GSEs has substantially weakened future resolution processes. During financial crises, the federal government time and time again relies on private capital to support resolutions of troubled financial institutions wherever possible, so that taxpayers do not have to step in unless there is truly no other option. Such public-private partnerships at times of crisis require consistency in the federal government’s respect for, and protection of, private property rights. No private party will put capital at risk if they think the government can take it away from them in conservatorship or bankruptcy, however noble the underlying policy goals or inspiring the associated political rhetoric.

In the case of Fannie and Freddie, the government had the right to impose harsh terms on private sector investors when it intervened to save the GSEs from failure. It did that by taking 79.9% of the company from the private stockholders and taking a senior preferred stock with a 10% dividend. No problem so far. But for the government to come back four years later and unilaterally change the terms to a sweep of all profits is unconscionable and will cause significant problems in getting private sector investors to help out in future crises. There is a considerable body of insolvency case law that clearly describes how and in what priority creditors are paid out on the residual value of the firm. Contrary to these rules of the financial markets, the profit sweep had Treasury “jump the line” of legal priority ahead of Fannie and Freddie shareholders, in direct contravention of FHFA’s legal obligation to respect those stakeholders. These actions establish a precedent now that is likely to have a chilling effect on future resolutions, as they undermine the integrity of the resolution process while introducing significant uncertainty into the process in terms of creditor administration.


The financial crisis precipitated an unprecedented policy response to the decline of Fannie and Freddie that led to their conservatorship. In taking this step, the U.S. Treasury, and Congress through its enactment of HERA, wanted to stabilize a housing market on the edge of collapse and reassure nervous global investors in mortgage securities, ensure liquidity and access to mortgage credit, and protect the US taxpayer.

But the conservatorships have left the enterprises in a state of suspended animation; neither private nor public entity and yet their business must continue. The government’s decision to violate HERA in 2012 by invoking the so-called “profit sweep” has deprived the GSEs of their ability to rebuild capital and has put taxpayers at greater risk. It also undermines the government’s role in times of future crisis. If private capital can’t count on the rule of law, it won’t participate in the future and taxpayers will have to pick up the pieces of what’s left of the financial system.