By William M. Isaac
It’s time for the Federal government to make a decision about Fannie and Freddie — to let them die a gradual death or to help them resurrect.
The government’s disingenuous measures that have kept the lending institutions afloat have been unlawful and dangerous for taxpayers and for the organizations’ investors. Congress should insist that Fannie and Freddie be wound down through receivership or be allowed to recapitalize and resume operations.
The ongoing litigation brought by private shareholders against the government for its alleged looting of Fannie Mae and Freddie Mac has finally started receiving media attention. Respected financial journalists have highlighted the contradiction between the Federal Housing Finance Agency’s (FHFA) decision to give the U.S. Treasury all of Fannie’s and Freddie’s profits in perpetuity with Congress’s mandate under theHousing and Economic Recovery Act of 2008 (HERA) that the FHFA act as conservator to restore the companies to sound condition.
In exchange for providing the companies $187 billion in capital, the Treasury received preferred stock paying a quarterly dividend of 10% of the companies’ profits, and 79% of the common stock in the form of warrants. This arrangement was a great deal for Treasury and was totally appropriate.
Taxpayers deserved to be compensated for the risks taken.
In 2012, around the time that Fannie and Freddie returned to profitability, the FHFA unilaterally changed the terms of the conservatorship to give the Treasury all of the companies’ profits in perpetuity-now over $240 billion and climbing, although HERA explicitly stated that the FHFA’s job as conservator was to restore the companies and preserve their assets.
This action by the Administration created the worst of all worlds. Instead of trying to restore the companies to health, as HERA requires, the government’s actions stripped Fannie and Freddie of all their capital. The result: They again pose a substantial risk to taxpayers.
When faced with litigation and demands from the public to know why it took this action, the government initially told the courts that the profit giveaway was intended to save the companies and avoid an upcoming “death spiral.” But documents released in litigation have proven that assertion to be false. The truth, it seems, is that the profit giveaway was intended to facilitate the companies’ demise while providing windfall profits for the Treasury. As former Treasury Secretary Geithner colorfully testified, the government actually wanted to dismember the companies.
Even to a layperson, dismemberment does not heed the mandate of a conservator to restore the companies to sound condition and preserve their assets. Faced with litigation, the government is floating a new rationale — that its actions would protect taxpayers. Certainly, alleged taxpayer protection will test better in focus groups. However, it is even more fundamentally at odds with the government’s role as conservator.
The idea of conservatorship has been around for thousands of years. The ancient Greeks, Romans and English all understood that a conservator had fiduciary duties to protect the property of its ward. English law precedent from 700 years ago forms the basis of U.S. conservatorship law. Distilled, no conservator may take assets for its benefit, or to the detriment of the conservatee.
Notably, the conservatorship standard in the case of Fannie and Freddie comes verbatim from the Federal Deposit Insurance Act, which courts have interpreted as placing the FDIC in a fiduciary relationship with a bank under conservatorship. Since the FDIC was created in 1933, bank regulators have understood conservatorship to mandate a fiduciary duty to the entity in conservatorship. The conservator must act in the best interests of that entity.
By the FHFA’s own admission and the government’s newly concocted litigation rationale, the government’s goal in stripping the companies of future profits was to fill the government’s coffers while ushering in the demise of Fannie and Freddie. But despite its supposed intent to wind the companies down, the government is keeping them alive and stripping them of all of their capital. This is incompatible with both current law and millennia of conservatorship history.
While taxpayer protection may sound good, it does not relieve the FHFA of its legal obligations to place the companies in sound condition, preserve their assets, and restore them to normal operations. The FHFA itself argued in a 2013 lawsuit that stripping capital has left the GSEs “effectively balance-sheet insolvent, a textbook illustration of financial instability.” As a result, taxpayers must continually support these entities. What should be immensely valuable warrants held by Treasury are rendered valueless.
The only lawful recourse at this point is to return to conservatorship law as it has existed traditionally.
William M. Isaac was the Chairman of the Federal Deposit Insurance Corporation (FDIC) from 1981 to 1985.