Non-Severability

The following section is a part of the SENIOR PREFERRED STOCK PURCHASE AGREEMENT (SPSPA) between the US Treasury and Fannie Mae/Freddie Mac.

The clause states that if any part of the agreement is determined to be illegal or unenforceable, then the whole agreement should be rescinded. In other words, if the Third Amendment (which is obviously a integral part of the whole) is determined to be illegal, then the Warrants are also illegal.

6.12. Non-Severability. Each of the provisions of this Agreement is integrated with and integral to the whole and shall not be severable from the remainder of the Agreement. In the event that any provision of this Agreement, the Senior Preferred Stock or the Warrant is determined to be illegal or unenforceable, then Purchaser may, in its sole discretion, by written notice to Conservator and Seller, declare this Agreement null and void, whereupon all transfers hereunder (including the issuance of the Senior Preferred Stock and the Warrant and any funding of the Commitment) shall be rescinded and unwound and all obligations of the parties (other than to effectuate such rescission and unwind) shall immediately and automatically terminate.

The following section is also contained in the SPSPA:

6.7. Effect of Order; Injunction; Decree. If any order, injunction or decree is issued by any court of competent jurisdiction that vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of Conservator as conservator of Seller or otherwise curtails Conservator’s powers as such conservator (except in each case any order converting the conservatorship to a receivership under Section 1367(a) of the FHE Act), Purchaser may by written notice to Conservator and Seller declare this Agreement null and void, whereupon all transfers hereunder (including the issuance of the Senior Preferred Stock and the Warrant and any funding of the Commitment) shall be rescinded and unwound and all obligations of the parties (other than to effectuate such rescission and unwind) shall immediately and automatically terminate.

If a court rules that the Third Amendment is illegal, it will effectively be submitting an order that “curtails the Conservator’s powers.” This court order could lead to “declaring the entire Agreement null and void.”

Another section in the SPSPA describes its foundational authority:

4.3. Authorization and Enforceability. All corporate or other action on the part of Seller or Conservator necessary for the authorization, execution, delivery and performance of this Agreement by Seller and for the authorization, issuance and delivery of the Senior Preferred Stock and the Warrant being purchased under this Agreement, has been taken…The Agency is acting as conservator for Seller under Section 1367 of the FHE Act. The Board of Directors of Seller, by valid action at a duly called meeting of the Board of Directors on September 6, 2008, consented to the appointment of the Agency as conservator for purposes of Section 1367(a)(3)(I) of the FHE Act, and the Director of the Agency has appointed the Agency as Conservator for Seller pursuant to Section 1367(a)(1) of the FHE Act, and each such action has not been rescinded, revoked or modified in any respect.

I proved in an earlier post that Hank Paulson’s version of events on September 5 and 6, 2008 as described in his book On the Brink contradicts the official record of events as chronicled by the official Treasury calendar record. If anyone is ever allowed to review the corporate records of Fannie and Freddie it will either substantiate or refute my claim that the boards of both companies did not hold an official board of directors meeting. If there was no meeting, there was no board consent thus invalidating the entire conservatorship.

Also, if the Third Amendment is found to be illegal, there is a provision in the stock certificate that would reclassify the money returned to the Treasury as repayment of the money the Government injected into the companies:

Prior to termination of the Commitment, and subject to any limitations which may be imposed by law and the provisions below, the Company may pay down the Liquidation Preference of all outstanding shares of the Senior Preferred Stock pro rata, at any time, out of funds legalJy available… 

Further, the Government’s action with Fannie/Freddie has been compared to its action with AIG. In 2008, the Treasury and Federal Reserve committed $182B to bailout AIG. In return, the Government received $205B from AIG — netting the Government $23B. The Government received and exercised 79.9% warrants in AIG, similar to Fan/Fred. The point is that the warrants were used to pay down the money AIG borrowed from the Government.

Details of the payback can be found here and here.

According the the ProPublica Bailout Tracker, Fannie and Freddie received $182B (similar to AIG) and have returned $250B netting the Government $68B — approximately three times the amount returned by AIG.

It is clear the purpose of the warrants in both cases (both equalling $182B) was to recapture the money injected into the companies. Therefore, there is no need for the Government to exercise the Fan/Fred warrants.

The Financial Times had a recent article that stated if the Government exercised the Fan/Fred warrants it could realize up to $200B from the sale. Think about that for a moment… The Government injected $182B into Fan/Fred; received $250B (to date) in return and would make an additional $200B if they exercised the warrants — a combined return of $450B…!

It is simply ludicrous to suggest the Government is owed $450B on a $182B injection (which many believe was unnecessary in the first place).

If the Government thought they needed to exercise the Fan/Fred warrants to recoup their investment, they would have already done so. With AIG, the bailout occurred in 2008 and the Treasury concluded all of their warrant transactions by 2013.

In summary, the Government acted outside its legal authority when enacting the conservatorship and the original SPSPA. It then acted greedy and reckless when it enacted the Third Amendment. Therefore, the Government should pay the consequence by having the entire senior preferred stock purchase agreement rescinded and unwound as clearly stated in their own Non-Severability clause in the SPSPA.

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Repayment and Warrants

There has been much debate on whether Fannie and Freddie ever had the ability to repay the money that the Treasury forced upon them. Many in the government — and even in the media — claim that Fannie and Freddie lack the option to repay the money received from Fan/Fred by Treasury by stating that it is merely a return on investment.

However, reviewing this attached Treasury report published in 2012 it clearly states that Treasury believed then that Fan/Fred had not only the ability to repay, but also states repayment was likely.

Further, Treasury makes it clear that the warrants were merely a vehicle to recoup the investment into the entities. So, if all the money is returned to the Treasury, the warrants are pointless. This Treasury document claims nothing about “punitive terms” or “risk/reward return.” No, it clearly describes the purpose of the warrants — to recoup the original investment.

The following passage appears on page 8 of the Treasury report:

“Probability of the Enterprises and the FHLBs fulfilling the terms of their obligations – The structure of the PSPAs, with their liquidation preference over all other equity, including preferred equity, combined with the PSPAs’ restrictions on debt issuance, enhance the probability of both Fannie Mae and Freddie Mac ultimately repaying amounts owed.

Need to maintain the Enterprises’ and the FHLBs’ status as private shareholder-owned companies – Fannie Mae and Freddie Mac may emerge from conservatorship to resume independent operations, or they may emerge in some other form reflecting legislative changes to their congressional charters. Conservatorship preserves the status and claims of the preferred and common shareholders. The value of the warrants issued to the government under the terms of the PSPAs could potentially increase, thereby providing enhanced value to the taxpayers. Upon the government’s exercise of the warrants, the GSEs would be required under the terms of the PSPAs to apply the net cash proceeds to pay-down the liquidation preference of the senior preferred stock.”

 

The Treasury report can be found here: https://www.treasury.gov/about/budget-performance/Documents/CJ_FY2012_GSE_508.pdf

Give Me Love (Give Me Peace On Earth)

Give me love
Give me love
Give me peace on earth
Give me light
Give me life
Keep me free from birth
Give me hope
Help me cope, with this heavy load
Trying to, touch and reach you with,
heart and soul

OM M M M M M M M M M M M M M
M M M My Lord . . .

PLEASE take hold of my hand, that
I might understand you

Won’t you please
Oh won’t you

Give me love
Give me love
Give me peace on earth
Give me light
Give me life
Keep me free from birth
Give me hope
Help me cope, with this heavy load
Trying to, touch and reach you with,
heart and soul

OM M M M M M M M M M M M M M
M M M My Lord . . .

PLEASE take hold of my hand, that
I might understand you

A reflection on too big to fail

September 28, 2016

By Sally Greenberg

Nearly eight years after the Great Recession, where unscrupulous lending practices brought our global economy to a breaking point, we’ve learned that the Big Banks have learned little since the meltdown and returned to business as usual.

The latest culprit is Wells Fargo, where an investigation by the Consumer Financial Protection Bureau uncovered a fraudulent debit and credit card scam affecting millions of unwitting Wells Fargo customers. The executive who oversaw this rapacious operation, Carrie Tolstedt, announced over the summer she is retiring with a reported package of $124 million, and Wells Fargo has failed to hold anyone at the top responsible, while firing more than 5,000 of the workers who were forced to participate in this illegal activity.

And yet, this incident is not the first time we’ve seen the largest financial institutions game the system since the Great Recession. In recent years, Wells Fargo and other large banks have been fined and faced lawsuits and investigations regarding financial violations and misuse of ordinary Americans’ money.
How can this still be happening? In the eight years since the financial crisis, dozens of Congressional hearings, thousands of news stories, a host of best-selling books, and a blue ribbon commission promised to help us understand what went wrong and how to prevent a recurrence. The Dodd-Frank Act became law amidst much fanfare – and opposition. But since then, the nation’s biggest banks including Wells Fargo, have only gotten bigger, and as this newest episode demonstrates, old habits die hard.

Today, almost eight years later, the six largest U.S. financial institutions now have assets of some $10 trillion – that’s more than half of our nation’s GDP. Yet, against this backdrop of stratospheric growth, Wells Fargo has shown that nothing has changed and their leadership continues to look for ways to maneuver around the rules to drive profit. Importantly, these large financial institutions, now, would like to take over the secondary housing market. Already the largest mortgage lending bank in the nation, Wells Fargo has spent more than $20 million in the last few years lobbying Congress to replace mortgage backers Fannie Mae and Freddie Mac with – you guessed it – a more bank-centric model. Ironically, it was Wells Fargo that settled with the Department of Justice for $335 million over charges that it sold fraudulent loans to Fannie and Freddie.

Here are the facts: in the years since the global financial crisis, significant reforms to Fannie and Freddie have allowed them to become profitable again and repay $187 billion to the Treasury Department, plus another $60 billion in dividend payments. Still, some say that Fannie and Freddie not only caused the crisis, but are emblematic of big government cronyism and demand they be dismantled. Others say the two government-sponsored enterprises have helped tens of millions of Americans achieve the American Dream of homeownership and create wealth for future generations. So far, no one has come up with an acceptable alternative for keeping the nation’s mortgage market liquid and stable enough so qualified, creditworthy buyers can obtain sustainable long-term home loans.

The most common-sense solution is to continue reforming Fannie and Freddie, allow them to retain earnings and rebuild their capital base, and protect taxpayers against future bailouts. The most reckless decision would be to hand over their business to Wells Fargo or some of its big-bank peers and let them gamble away our future. Hopefully, policymakers have learned from the age-old idiom, “fool me once, shame on you; fool me twice, shame on me” – with the latter only hurting working Americans’ ability to achieve long-term economic security.

Sally Greenberg is executive director of National Consumers League.

http://webcache.googleusercontent.com/search?q=cache:http://origin-nyi.thehill.com/blogs/congress-blog/economy-budget/298370-a-reflection-on-too-big-to-fail

 

Fannie and Freddie Will Be Profitable After Their Next Bailouts, Too

AUG 8, 2016

 

The Federal Housing Finance Agency released the results of the annual stress tests for Fannie Mae and Freddie Mac on Monday, and the report is a nice little milestone. For the first time, the crisis-era government bailouts of the government-sponsored entities,combined with their hypothetical future bailouts, are profitable for the government. Here’s the accounting:

The government put $187.5 billion into Fannie and Freddie. It has gotten back $246.7 billion, so it’s up $59.2 billion. In the “severely adverse scenario” of the Dodd-Frank stress tests, it will have to put in another $49.2 billion. That will still leave it with a cool $10 billion in profit.

Now I am cheating here a bit. Strictly speaking, the stress tests found that “Fannie Mae and Freddie Mac could need as much as $125.8 billion in bailout money from taxpayers in a severe economic downturn.” That number is bigger than my $49.2 billion. The difference is a $76.7 billion “impact of re-establishing valuation allowance on deferred tax assets.” Basically, Fannie and Freddie lost a lot of money in the past, which reduces their income taxes in the future, unless they don’t have income in the future, in which case it doesn’t. And they count the future tax reductions as an (enormous) asset on their balance sheets, unless they don’t expect to have income in the future, in which case the asset goes away, reducing their equity and requiring — perhaps — another bailout. The FHFA ran the stress tests two ways, both assuming that the deferred tax asset went away and required more bailout funds, and not. The Fannie/Freddie deferred tax assets got quite a workout in the last bailout, and I can only assume that any future bailout would involve lots of contortions around them, but really who cares. The disappearance and reappearance of the deferred tax assets are not a real cash expense, and if everyone just agreed to ignore them, nothing in the world would be any different. So let’s just ignore them.

The FHFA might be cheating here a bit, too, in the boring sense that any time a government agency releases stress test results, you can complain that the test wasn’t stressful enough. The 2016 stress test scenario “is based upon a severe global recession which is accompanied by a period of elevated corporate financial stress and negative yields on short-term U.S. Treasury securities,” which sounds bad-ish, but which seems to leave Fannie and Freddie curiously untouched. The scenario results in credit losses equal to 0.56 percent of their combined portfolio, meaning that for every $100 of loans that they own, Fannie and Freddie would get back $99.44 even in a “severely adverse” stress scenario. That seems … maybe … a little generous? For “severely adverse”?

But I don’t make the stress test rules, and this stress test says another crisis would cost taxpayers just $49.2 billion in new Fannie and Freddie bailout money, less than the taxpayers have made in profits on the last bailout. And then, of course, after the new bailout, taxpayers would presumably go back to raking in money from Fannie and Freddie, and end up even further ahead. Until the next bailout, world without end.

There is a weird … idea? meme? accounting error? … that says all of this is somehow a risk to the taxpayers that can be solved by giving Fannie and Freddie more money now. The way Fannie and Freddie work now is that, in round numbers, they operate with zero capital: Any profits that they make each quarter go to the Treasury, and if they have a loss in a quarter, the Treasury makes up the difference. In recent years they’ve had profits and returned money to Treasury. (Thus the $59.2 billion of government profits.) But it’s always possible that in the future they will lose some money, and Treasury will have to come up with the extra money. For instance, if the stress test scenario occurred, Treasury would have to come up with an extra $49.2 billion. It would still be ahead, but less ahead.

That’s true: The government, in every practical sense, “owns” Fannie and Freddie, so it’s at risk if they lose money. The weird part is the idea that the government can avoid this risk by just letting Fannie and Freddie keep all the money that they make. This is called “building capital,” and the idea is basically that if, instead of paying that $59.2 billion to the Treasury, Fannie and Freddie had kept it, there would be much less risk that Treasury would have to come up with $49.2 billion to bail them out in the future.

Which, again, is true. It’s just that then Treasury wouldn’t have the $59.2 billion. Getting $59.2 billion and giving back $49.2 billion of it still leaves you with $10 billion. Just never getting the $59.2 billion in the first place is strictly worse.

But it is easy for me to say that, because I think of Fannie Mae and Freddie Mac as wholly owned subsidiaries of the U.S. Treasury. This makes the analysis easier. For instance, the stress tests aren’t about whether Fannie and Freddie “could need as much as $125.8 billion in bailout money from taxpayers,” or whatever; they’re just about how much that division of the government could lose in a recession. (In the same way that, when the U.S. Postal Service loses money, no one calls it a “bailout.” It’s just a loss.) It’s of no interest whether the division has a lot of capital, or a little capital, or no capital, or negative capital: The U.S. government has plenty of money, and that’s the relevant unit of account.

Not everyone agrees. I mean, Fannie and Freddie aren’t wholly owned subsidiaries of the government: They have common and preferred stock outstanding, and while the current terms of the bailouts prevent them from ever making payments on that stock, the shareholders have been suing for ages to try to reverse those terms and get their money back. They argue, with some justification, that the bailout terms are unfair and illegal, and that they should get back their rights as owners.

The government is fighting those lawsuits, but it too can’t quite bring itself to say that Fannie and Freddie are fully controlled agencies of the government. Partly this is an accounting issue — by not consolidating Fannie and Freddie, the government doesn’t have to count their debt toward the debt ceiling — but it is also sort of a political-philosophical issue. Nobody ever exactly made the choice to permanently nationalize the entire U.S. mortgage market. Fannie and Freddie are in “conservatorship,” a supposedly temporary state of government protection that happens to have lasted for the better part of a decade. There’s no mandate or plan to keep them nationalized forever, and everyone has to talk piously about the importance of returning private capital to the mortgage markets.

Everyone kind of knows the basic mechanics of how to do that: Create some privately owned mortgage companies, either from scratch or from the bones of Fannie and Freddie, to buy or guarantee mortgages. Raise capital for those companies from investors, perhaps giving existing Fannie/Freddie investors some credit for their existing holdings, perhaps not. Regulate those companies, and make sure they’re well enough capitalized to absorb any reasonable credit risk in the mortgage market. Let those companies buy some sort of backstop from the government, at a fair price, to further socialize the credit risk of mortgages.

And yet people have been talking about this for ages, and nothing much has happened. One reason for this is pretty obvious: For the government, keeping Fannie and Freddie as a branch of the government is pretty great. They’re easy to control, available as an instrument of housing policy, and, crucially, profitable. Perhaps things will change if Fannie and Freddie run into trouble again. But the latest stress tests suggest that even that may not change anything.

  1. The initial bailout and repayment figures come from ProPublica’s great bailout trackers for Fannie Mae and Freddie Mac. The stress test numbers come from the “Treasury draws required” lines in the “Results without re-establishing valuation allowance on deferred tax assets” column in the FHFA report, pages 6 and 7.Incidentally, the last time we talked about the Fannie/Freddie stress tests, two years ago, things looked much worse, with an $84.4 billion draw required even without accounting for deferred tax assets.
  2. It seems especially silly to get worked up about Fannie and Freddie’s potential tax liabilities when they are just divisions of the U.S. government anyway, but that’s the sort of thing that you’re not supposed to say, so I’m putting it in a footnote.
  3. It’s not really zero, though it will be by 2018. From the Fannie Mae 10-Q:

    In addition, as a result of our agreements with Treasury and dividend directives from our conservator, we are not permitted to retain our net worth (other than a limited amount that will decrease to zero by 2018), rebuild our capital position or pay dividends or other distributions to stockholders other than Treasury.

    Right now the “capital reserve amount” is $1.2 billion for each entity (see page 5 of the Fannie 10-Q and page 18 of the Freddie one), which is close enough to zero for our purposes.

  4. Of course even if Treasury had to come up with more — say, the $125.8 billion number that the stress tests also mention — getting the $59.2 billion first is still a good thing. Let’s say the government had left that $59.2 billion in the entities, and then they found themselves $125.8 billion short. The $59.2 billion would be wiped out, and the entities would still be $66.6 billion short, even after building all that capital. Then what? Well, maybe the government would just allow them to fail, and private creditors — holders of Fannie Mae and Freddie Mac securities — would eat the loss. But … um … probably not? One, because the government has funding commitments to provide up to $258.1 billion more in funding to the entities (see page 3 of the stress test results), but two, because those funding commitments are in place for a reason. Fannie and Freddie are not just random private companies that the government can cheerfully allow to fail if they eat through their capital: They are the underpinnings of the mortgage system. So Treasury rescued them in their last crisis, and without some sort of structural reform, it will rescue them in their next crisis.
  5. Ugh, I’m sure someone does, but please don’t tell me about it.
  6. So for instance:

    FHFA Director Melvin Watt in a February speech warned that the companies’ falling capital buffers could one day cause investors to doubt their guarantees of mortgage-backed securities. Such uncertainty would cause mortgage rates to go up.

    “The most serious risk and the one that has the most potential for escalating in the future is the enterprises’ lack of capital,” Watt said.

    This makes no sense if you think that investors think that the companies are government agencies, and that the government is on the hook for their guarantees. I think that, because (1) the government was effectively on the hook for their guarantees in 2008, and (2) since then the relationship between the government and the entities has gotten even closer. But the government can’t … just … say that. So the government has to pretend that it doesn’t back Fannie and Freddie, and that investors don’t think it backs Fannie and Freddie.

  7. And even do something about it, like the credit risk sharing deals that allow Fannieand Freddie to offload a portion of their credit risk to the private market — while still keeping the entities themselves in conservatorship.
  8. This paragraph, in broad outline, describes the Johnson-Crapo plan (which zeros the existing preferred shareholders), the Fairholme Capital Management plan (which gives those existing holders equity in the new entities), and even the Parrott-Ranieri-Sperling-Zandi-Zigas plan, which is a little different (involving fixed-dividend securities in a new national corporation) but has similar basic features.
  9. I wrote this two and a half years ago:

    My assumption has long been that the status quo is great for the government. Right now, Fannie and Freddie are completely controlled by the federal government, while keeping the technical trappings of private ownership (20.1 percent private shareholders, no explicit government guarantee) and thus staying off the Treasury’s balance sheet. They can be used as a tool of housing policy (particularly, they can keep guaranteeing cheap mortgages) without being explicitly federalized.

    Still true! Still the same status quo.

Happy Labor Day America!

Labor Day was established as a celebration of the contributions of the common person to the greater good of society. Labor Day reminds us to look past the successes of big business as a whole and focus on the smaller pieces of those successes made by simple men and women.

The success of Big Business in America has helped to make this country strong! However, left unchecked, Big Business (aka “The Establishment” or “The Man”) often exerts its tremendous power over seemingly weak individuals. Sometimes, organized individuals need to stand up to The Establishment to exert their rights.

Today, in my hometown of Minneapolis, 4800 Allina nurses are set to go on strike. Of course, the nurses would rather be caring for patients but contract negotiations have stalled and they apparently see a need to strike.

It’s symbolic that the nurses are staging a strike on Labor Day…

It’s also symbolic that Labor Day marks the eve of the 8th Anniversary of the government take-over of Fannie Mae and Freddie Mac.

The parallel here is that thousands of normal, everyday people (workers, taxpayers, retirees, policemen, firemen, teachers, etc.) were – and still are – shareholders of Fannie Mae and Freddie Mac.

On September 6, 2008, The Establishment illegally seized Fannie Mae and Freddie Mac from its shareholders. “The Man” in question here is a combination of actors whose common denominator is Big Banks. Wall Street has a revolving door to the US Treasury, who led the illegal take-over 8 years ago. Wall Street also backs congressional and executive branch politicians who are complicit in this longstanding scandal.

The Wall Street Establishment stands to gain if the Government is allowed to continue their plan to take Fannie and Freddie from shareholders and give them to Big Banks (under a new name, of course).

Most of you who are reading this blog already know these facts. However, this scandal attracts new individuals on a weekly basis. This blog post is for them…

There are numerous, well-informed people working to stand up to The Establishment in the fight against Fanniegate. Their great efforts can be found on other blogs, Twitter and occasionally in the media.

I don’t claim to have any special information or talent when it comes to exposing The Establishment’s wrongdoing. I have however, spent a great deal of time thinking, researching and writing about this topic (less so these days given the movement’s momentum in media and courts).

If you’re interested in learning more about Fanniegate from my perspective, I encourage you to read through this blog. There are numerous posts, so perhaps start with just a few:

Sept 2015: Fanniegate for Beginners 

Nov 2014: “You Can’t Handle the Truth!”

That’s a start… there’s a lot here…

However, on this Labor Day, I want to focus attention again on the common man in the Fanniegate struggle. Many individuals and groups had a significant portion of their retirement savings wiped out when The Man illegally took-over Fannie and Freddie.

These individuals as a whole (shareholders) were supposed to have representatives looking out for them. The Establishment has its power, but the common man has his rights!

The Board of Directors at Fannie Mae and Freddie Mac were supposed to look out for and defend the rights of shareholders. Both Boards failed on this day eight years ago when they allowed The Establishment (Treasury, Federal Reserve & FHFA) to take the companies away from individual shareholders. The next day, September 6, 2008, The Man proclaimed victory by announcing they had placed Fannie and Freddie into conservatorship.

I have a few posts on the blog that focused on the Boards.

One in particular was on Brenda Gaines, a Fannie board member since 2006 who just resigned on August 31, 2016.

Brenda, pictured here:

Gaines_Brenda

will miss the 8th Anniversary Celebration of “Establishment beats Common Man” (aka the conservatorship).

Mar 2016: Brenda Gaines

Here are the other posts on the boards of directors:

Nov 2015: Fannie and Freddie Boards did not consent…because they never met…!

Feb 2016: Fannie and Freddie Boards did not consent, cont.

Mar 2016: Acquiescing

Mar 2016: Silence is Not Always Golden

 

Labor Day Celebrations…

Seems like Hurricane Hermine will dampen holiday plans for thousands of Americans…

Just like Hurricane Henry (Paulson) has dampened retirement plans for thousands of fellow Americans…

Despite our struggles here…

…wishing everyone a Happy Labor Day!!

“Sacred cows make the tastiest hamburger.”  Abbie Hoffman

 

Called Out In The Dark

 

It’s like we just can’t help ourselves
‘Cause we don’t know how to back down
We were called out to the streets
We were called in to the towns

And how the heavens, they opened up
Like arms of dazzling gold
With our rain washed histories
Well they do not need to be told

Show me now, show me the arms aloft
Every eye trained on a different star
This magic
This drunken semaphore
And I

We are listening
And we’re not blind
This is your life
This is your time

We are listening
And we’re not blind
This is your life
This is your time

I was called out in the dark
By a choir of beautiful cheats
And as the kids took back the parks
You and I were left with the streets

Show me now, show me the arms aloft
Every eye trained on a different star
This magic
This drunken semaphore
And I

We are listening
And we’re not blind
This is your life
This is your time

Motive?

Before reading this blog post it is recommended to read Matt Taibbi’s January 2013 Rolling Stone piece: Secrets and Lies of the Bailout

The Rolling Stone article is lengthy, but informative by offering a scathing rebuke on how the past and current Administrations managed the financial crisis. The article identifies government lying, accounting trickery, and the implicit guarantee of TBTF, among other topics.

For those that choose to skip the recommended reading, highlights are as follows:

It was all a lie – one of the biggest and most elaborate falsehoods ever sold to the American people.

But the most appalling part is the lying. The public has been lied to so shamelessly and so often in the course of the past four years that the failure to tell the truth to the general populace has become a kind of baked-in, official feature of the financial rescue.

“It is the ultimate bait-and-switch,” says former bailout Inspector General Neil Barofsky.

The bailout deceptions came early, late and in between. There were lies told in the first moments of their inception, and others still being told four years later. The lies, in fact, were the most important mechanisms of the bailout. The only reason investors haven’t run screaming from an obviously corrupt financial marketplace is because the government has gone to such extraordinary lengths to sell the narrative that the problems of 2008 have been fixed. Investors may not actually believe the lie, but they are impressed by how totally committed the government has been, from the very beginning, to selling it.

…the bailouts were pushed through Congress with a series of threats and promises that ranged from the merely ridiculous to the outright deceptive. At one meeting to discuss the original bailout bill – at 11 a.m. on September 18th, 2008 – Paulson actually told members of Congress that $5.5 trillion in wealth would disappear by 2 p.m. that day unless the government took immediate action, and that the world economy would collapse “within 24 hours.”

So Paulson came up with a more convincing lie. On paper, the Emergency Economic Stabilization Act of 2008 was simple: Treasury would buy $700 billion of troubled mortgages from the banks and then modify them to help struggling homeowners. Section 109 of the act, in fact, specifically empowered the Treasury secretary to “facilitate loan modifications to prevent avoidable foreclosures.” With that promise on the table, wary Democrats finally approved the bailout on October 3rd, 2008. “That provision,” says Barofsky, “is what got the bill passed.”

But within days of passage, the Fed and the Treasury unilaterally decided to abandon the planned purchase of toxic assets in favor of direct injections of billions in cash into companies like Goldman and Citigroup.

Barofsky, the TARP inspector, asked Treasury to include a requirement forcing recipients to explain what they did with the taxpayer money. He was stunned when TARP administrator Kashkari rejected his proposal, telling him lenders would walk away from the program if they had to deal with too many conditions. “The banks won’t participate,” Kashkari said. Barofsky, a former high-level drug prosecutor who was one of the only bailout officials who didn’t come from Wall Street, didn’t buy that cash-desperate banks would somehow turn down billions in aid. “It was like they were trembling with fear that the banks wouldn’t take the money,” he says. “I never found that terribly convincing.”

This announcement marked the beginning of the legend that certain Wall Street banks only took the bailout money because they were forced to – they didn’t need all those billions, you understand, they just did it for the good of the country.

And in November 2009, Bernanke gave a closed-door interview to the Financial Crisis Inquiry Commission, the body charged with investigating the causes of the economic meltdown, in which he admitted that 12 of the 13 most prominent financial companies in America were on the brink of failure during the time of the initial bailouts.

This early episode would prove to be a crucial moment in the history of the bailout. It set the precedent of the government allowing unhealthy banks to not only call themselves healthy, but to get the government to endorse their claims. Projecting an image of soundness was, to the government, more important than disclosing the truth. Officials like Geithner and Paulson seemed to genuinely believe that the market’s fears about corruption in the banking system was a bigger problem than the corruption itself. Time and again, they justified TARP as a move needed to “bolster confidence” in the system – and a key to that effort was keeping the banks’ insolvency a secret.

What’s most amazing about this isn’t that Citi got so much money, but that government-endorsed, fraudulent health ratings magically became part of its bailout.

The article does mention Fannie and Freddie:

In one of the worst episodes, the notorious lenders Fannie Mae and Freddie Mac paid out more than $200 million in bonuses­ between 2008 and 2010, even though the firms (a) lost more than $100 billion in 2008 alone, and (b) required nearly $400 billion in federal assistance during the bailout period.

After Mr. Taibbi wrote his article in 2013, details about the government take-over of Fan and Fred came to light. Taibbi evidently conducted additional research and in April 2016 offered a different perspective in Why Is the Obama Administration Trying to Keep 11,000 Documents Sealed?

So consider, if the Government would lie by claiming that TBTF were healthy when in fact many banks were on the verge of collapse, then it is not too much of a stretch to assume the Government would do the opposite with Fannie and Freddie.  

Here’s what former FNMA CFO Tim Howard said in his Jacobs Amicus Curiae:

The takeover of Fannie and Freddie was not a rescue. Unlike all commercial or investment bank interventions during the crisis, Treasury’s decision to force the Companies into conservatorship was not a response to any imminent threat of failure. Rather, it was a calculated policy decision by Treasury, made at a time of Treasury’s choosing and with ample advance planning. That decision—which resulted in the effective nationalization of Fannie and Freddie— was made without statutory authority and after Treasury overrode the Companies’ own regulator, the Federal Housing Finance Agency (“FHFA”), which had deemed them to be in compliance with their capital standards and safety and soundness requirements.

Though it’s not always necessary to prove motive when prosecuting a crime, it certainly makes for a stronger case. On the other hand, intent is an important element of any crime, i.e. was the act intentional, reckless or accidental…

It becomes even more important to offer a plausible motive for UST’s illegal actions given their endless spinning of a tangled web of lies, with one lie contradicting another from one lawsuit to the next.

UST’s co-conspirator, the Federal Housing Finance Agency, has always merely followed UST’s directive. So, it is inconsequential to consider motive or intend regarding FHFA’s role in this malfeasance. FHFA’s transgression is that they don’t act independently, as mandated by statute.

One motive for the crimes against Fannie and Freddie is that UST has long wanted to destroy them. Going beyond mere desire, UST has apparently considered for years before the financial crisis on ways to eliminate Fan and Fred according to these theorists.

Close inspection of recently released documents, as well as testimony from Government officials, suggest that UST had been waiting for the right moment to take down Fan and Fred.

Here is how Henry Paulson described his thinking when announcing the conservatorships:

“Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBS.”

One could argue for or against an ambiguous situation, however it is not the role of the Administration to alter Fannie and Freddie’s role. Only Congress can change the company’s charters.

As with many crimes, there could exist multiple motives for carrying out misdeeds.

Another Consideration: The Debt Ceiling

The following is currently available on UST’s website regarding the debt limit:

The US Government for years has been operating its budget with deficits, i.e. spending exceeding income. Congress sets limits on how much debt the US is legally allowed to carry, but has always been reluctant to do so.

Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations – an unprecedented event in American history. That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans – putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession.  

Congress has always acted when called upon to raise the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. In the coming weeks, Congress must act to increase the debt limit. Congressional leaders in both parties have recognized that this is necessary. Recently, however, a number of myths about this issue have begun to surface.

That website page was last updated on January 29, 2016, which needs to be considered when reading the passage.

In order to increase the debt level, UST needs to present its case to Congress and, as we have learned from Taibbi’s piece, it’s clear that Treasury has not always been transparent and honest with their dealings with Congress.

UST practiced evil genius when they convinced Congress to raise the debt limit especially with its dealings associated with the conservatorships and the illegal expropriation of both company’s assets, in addition to the bailouts of TBTF.

UST was able to repeatedly request increases to the debt limit in order to “rescue” Fan and Fred, as well as for other rescue efforts. UST convinced Congress that allowing Fan/Fred to fail would be catastrophic to the US… and world economies. So, Congress provided additional funding to UST to “save” the economy – which required increases in the debt ceiling.

That’s called having your cake and eating it, too. The “rescue” actually profited UST and they received several increases to the debt ceiling along the way! Even though UST has profited from various bailout programs, the corresponding debt level increases were never reversed after the bailout money was returned. Neat trick!

The Congressional act that provided the Government with the ability to place Fannie and Freddie into conservatorship is called the Housing and Economic Recovery Act of 2008.

This Act was requested by Hank Paulson and basically raised the debt limit in the event that Fan and Fred needed to be rescued. At the time, Paulson (as well as James Lockhart, then FHFA Director) declared he was not sure that Fan/Fred would need to be rescued, but that didn’t matter – he got his debt limit increase that he requested. Congress raised the debt limit by $800 million. 

In an interview on September 8, 2008 on CNBC, Steve Liesman unsuccessfully tried a few times to have Paulson state how much the “bailout” was going to cost.

Liesman: Sorry, but I have to come back to this. There must be some analysis in your mind, is it in the tens of billions, in the hundreds of billions, how much are you prepared to pay?

Paulson: I don’t — there is no specific analysis. This was not — we didn’t sit there and figure this out with a calculator. This was about our financial markets, it was about confidence in the financial markets, confidence in our economy, and the validity of the mortgage finance.

Paulson could not provide a figure and instead said that placing Fan/Fred into conservatorship was more about building confidence. Sound familiar?

“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”

It sure appears easier to manage the finances of the US Government when Treasury Secretaries are allowed to receive more and more money to pay the bills. The problem never catches up with the Secretaries… they just blame the past Secretary and pass the problem to the next Secretary. Today, the US Government holds over $19 trillion of debt.

At the end of 2008 before President Obama took office, the national debt was approximately $8 trillion. Obama famously blamed his early problems on his predecessor. Obama is now set to return the favor and pass along nearly 250% more in debt to his successor.

It is clear that the “bailout” of Fannie Mae and Freddie Mac did not cost the US Treasury any money, rather they made billions (and counting) on the scheme. Plus, the Administration received additional debt ceiling increases after the one HERA provided in 2008.

Obviously, all of the debt limit increases were not related to the conservatorships of Fan and Fred. Though it does appear likely that “the most transparent Administration ever” does not want the actual facts behind how they conduct business – including their 10 debt limit adjustments (more that one per year!) –  to become public knowledge.

The cover-up can be worse than the crime… perhaps that’s why UST is fighting so hard to delay and conceal!

 

Will FNMA and FMCC Bring Extraordinary Returns to Investors This Summer?

By Katina Stefanova

July 26, 2016

Due to both the unprecedented actions taken by the government following the financial crisis of 2008, and the potential windfall that many private investors and hedge fund’s stand to gain, should a favorable decision be made on the plaintiffs’ case, Fannie Mae (FNMA) and Freddie Mac (FMCC) have been two of the most divisive stocks currently trading. Now, the issue comes to a head with greater urgency and more at stake than ever before as we seem to be inching slowly towards a legal resolution.

Simultaneously, the increased likelihood of a push for legislative reform following presidential elections and the pending earning reports due from the GSEs (August 2nd and 4th for FMCC and FNMA respectively) have drawn increased attention from investors. While there are dozens of cases currently underway across the country, the spotlight has been on the upcoming decision in the Perry Capital et al. v. Jacob J. Lew (the current Treasury Secretary) appeals case before the US Court of Appeals for the District of Columbia Circuit. On September 30, 2014 Judge Lamberth issued a controversial ruling on the case, declaring that while Third

Amendment, which was introduced to the arrangement in 2012, sweeps essentially all GSE profits the Treasury and is understandably controversial, he found the plaintiffs claim for injunctive relief on the grounds that the FHFA breached its fiduciary duties were inadequately supported. Many were surprised by the binary character of Lamberth’s ruling given his reputation as a traditional Republican. The plaintiffs responded to the ruling by appealing the decision, which is now being heard before a panel composed of Justices Ginsburg, Millet, and Brown. This specific appeal is the focus of our analysis as we believe it has the greatest impact on how other related cases still outstanding will be dealt with.

The panel recently surprised many observers by issuing a series of questions directed at the plaintiffs which seems to indicate there are some potential discrepancies between the Lamberth ruling and the panel’s view. Although the legal outlook is the most promising it has been since the Lamberth ruling, investors face other challenges.

The financial health of the two companies poses an additional risk to investors. The consequences of the net worth sweep have left cash reserves at precariously low levels of less than $2.5 billion for both Fannie Mae and Freddie Mac. Fannie and Freddie are also highly exposed to Treasury yield rates as well, 10 year notes hit record low yields this month of 1.35% (albeit before proceeding to rally higher at a record pace), reflecting further cause for due concern over the financial weakness of the two. So, stripped of any capacity to build a capital buffer by the introduction of the Third Amendment to the existing agreement between the GSEs and FHFA on August 17, 2012 and with only a little more than $1 billion remaining of Treasury capital left to cover any losses for each of the GSEs, any substantial Q2 loss for FNMA or FMCC would almost certainly result in another draw from the Treasury. It is difficult to assess the impact of such an event for investors.

Even if both entities post a profit in Q2 it remains likely that the two companies will need an infusion of capital from the Treasury at a date in the near future if the current arrangement persists given their current low cash situation. On the one hand, this could ultimately be to the benefit of investors, as a Q2 draw would likely attract the spotlight of popular political media to the ongoing tug of war for the fate of the GSEs. On the other hand, a further draw on the Treasury by FNMA or FMCC prior to the resolution of the outstanding appeals before the District of Columbia Circuit Court Appeals could also make it much harder for the plaintiffs to justify their case, if not in the eyes of the federal appeals panel, then certainly in the eyes of the public. Traumatic experiences of 2008 still loom large in Main Street’s memory, so regardless of the fact that the net worth sweep authorized by the government is what would most likely lead to the need for a further ‘bailout’ in the first place, a draw would still hurt the public’s perception of the plaintiffs’ case. Given the volatility of the situation and anticipation surrounding the upcoming earnings report, it is clear that this is a race against time. Ideally a legal outcome will be handed down before the capital situation of the GSEs deteriorates further declines– if the GSEs are forced to request additional funds before a legal resolution it would likely complicate the case against GSEs conservatorship greatly. Beyond concerns regarding government takeover of private property, the lack of a capital buffer coupled with the issue posed by the complete absence of meaningful legislative reform for the GSEs also is a threat to the existence of the affordable fixed rate mortgage and therefore the US housing market itself.

Attorney Tom Ogden at Wollmuth Maher and Deutsch LLP, whose dealings with litigation relating to the bailout of the GSEs have given him a familiarity with the issues at hand, provided some insight on the possible legal outcomes for the current appeals case. Mr. Ogden believes that it would be reasonable to expect a decision in this case before years’ end, although due to the volatile political nature and legislative interest, the considerable possibility of a legislative turnover in Congress, and the unusual circumstances surrounding this particular appeals case, the likelihood of any decision being made by the panel before the end of the presidential race is quite low. Whenever a ruling is passed however, there are three clear possible outcomes

An outright affirmation of Judge Lamberth’s ruling:

Given the highly unusual introduction of new evidence in the case before the appellate case by the plaintiffs, and the favorable nature of said evidence, this seems to be a very low probability outcome. Furthermore, considering the traditionally conservative leanings of Justices Ginsberg and Janice Brown, this seems to be the least likely outcome. In this scenario, there is also a possibility that the plaintiffs could successfully bring their case before the Supreme Court, although this would be a bit of a long shot as well.

An outright reversal of Judge Lamberth’s ruling:

This is the second least likely probability. Since this is an appeals case and appeals cases are typically made on previously established facts, the introduction of important information potentially contrary to that which Lamberth’s previous judgment was based on increases the probability of this outcome. The other factors mentioned above indicate that this remains a very low probability outcome however.

A remand back to Judge Lamberth from the Federal appeals panel with stipulations:

The third scenario outcome for the appeal is a remand of the case back to Judge Lamberth with some specific guidance on the law as to how to proceed. Many observers, including Mr. Ogden, see this as the most likely outcome. A partial reversal of some kind may also accompany such a remand, with some specific rulings against what Judge Lamberth did.

If the second scenario were to play out successfully, it would undoubtedly be the most beneficial outcome for investors. In this scenario it is highly like that both stocks could potentially reach a market value of $20, a price frequently cited by Bill Ackman, or more. Many observers have called for a 12-14x return on current share price in the event of a reversal of Lamberth’s ruling that enables recapitalization. The third scenario could potentially boost the twos stock prices as well, rising on the back of speculative buying. The worst case scenario for those long FNMA and FMCC, outcome one, would likely render the stock close to worthless for the foreseeable future.

Fannie Mae and Freddie Mac were originally created with the purpose of “promoting access to mortgage credit through the nation…by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing” U.S.C § 1716(3). Fannie Mae and Freddie Mac don’t accomplish this through the origination of loans themselves however; they buy and guarantee loans, then bundle loans with similar characteristics and risk profiles into mortgage backed securities (RMBS), which are then sold to investors in a tranche based system. A particularly unique aspect of the US mortgage system, the fixed-rate mortgage loan, is made possible by the stability and liquidity FNMA and FMCC add to the secondary MBS market through the securitization and guarantee of these vehicles. No other nation offers such a product, instead issuing their mortgage loans on a floating interest rate basis. This arrangement essentially shifts massive amounts of risk from private investors to the US government.

The unique relationship between the GSEs and the private markets is a double-edged sword however; while it enabled rapid growth of home ownership and mortgage origination volume in the US by encouraging private investment and participation in the residential mortgage loan market, it also played a significant role in promoting a riskier market environment which precipitated the eventual meltdown of the US financial markets, leading to the eventual government conservatorship of FNMA and FMCC.

On July 30, 2008, Congress enacted the Housing and Economic Recovery Act (“HERA”), authorizing the Treasury to invest in the GSEs on the basis of the “systematic danger that a Fannie Mae or Freddie Mac collapse posed to the already fragile national economy.” In exchange for the Treasury’s funding commitment, which as of August 8, 2012 amounted to $187.5 billion in total, Fannie and Freddie provided the Treasury with senior preferred stock, entitling the Treasure to four principal contractual rights:

First, the Treasury received “[a] senior liquidation preference of $1 billion for each GSE plus a dollar-for-dollar increase each time the GSEs drew upon Treasury’s funding commitment. Second, [the agreement] entitled Treasury to dividends equivalent to 10% of Treasury’s existing liquidation preference, paid quarterly. Third, Treasury received warrants to acquire up to 79.9% of the GSEs’ common stock at a nominal price. Fourth, beginning on March 31, 2010, Treasury would be entitled to a periodic commitment fee “to fully compensate [Treasury] for the support provided by the ongoing [funding] [c]ommitment”, (12 U.S.C § 1716(3). Under government conservatorship, FNMA and FMCC have respectively paid out dividends of more than $31.5 and $26.9 billion in excess of the principal loan they received to the Treasury over the past few years. While the dividend was initially fixed at 10% for the Treasury’s senior preferred shares, the change in initial terms in 2012 to require a variable rate dividend payout has prevented the improvement of FNMA and FMCC’s balance sheets, despite these past returns. So, for the past 8 years, FNMA and FMCC have been required to give all profits to the government in excess of $3 billion. This has not only prevented common and junior preferred shareholder from seeing any returns on their investment, but the building of capital by either GSE as well, an important step towards profitability for the two in a post-conservatorship scenario.

It is this stipulation which the plaintiffs find to be the most egregious offense of all. From a philosophical standpoint they argue that the rights granted in the arrangement between the FHFA, Treasury, and GSEs effectively amounted to the nationalization of a once private company, a fundamental violation of America capitalist history and democratic values.

Beyond this point, their legal aim is to establish that actions of the FHFA and Treasury constitute a violation of their respective fiduciary duties. The plaintiffs have further argued that the bailout was an unnecessary action, as the losses of the FMCC and FNMA were both largely exaggerated and significantly inflated due to a difference between government accounting methods and standard practices. Investors with interests in the mortgage financing twins also point out that, as newly introduced evidence has indicated, the government only stepped in and took action to provide the GSEs the capital necessary to backup their guarantees on securitized loan products they sold once it had already become clear that the two firms were on the verge of recovery and profitably. On these grounds a number of hedge funds including Perry Capital, Fairholme Funds and Arrowhead Indemnity Company are suing the government in hopes of reversing the net worth sweep and reestablishing the two firms.

While a resolution to FNMA and FMCC investors’ plight will likely come from the courts, a legislative solution is also on the table. Hilary Clinton, who would be unlikely to support calls to recapitalize Fannie and Freddie or to release them, has shared her views on the restructuring of the firms in the past; her plan would likely call for the merging of the twins as well as the implementation of some sort of catastrophic loss backstop which would mean the placement of a large buffer of private capital before government (and therefore taxpayers) would absorb any losses. A plan recently put forward and consistent with previous views offered by Clinton, indicates that this is a likely path to legislative reform under a Hillary Clinton Administration. A paper co-authored by Gene Sperling, who has already been tapped by Hilary Clinton as a top adviser, along with other high profile financial thinkers such as Jim Parrott, Mark Zandi, Barry Zigas and Lew Ranieri, calls for the merging of the GSEs and cites figures upwards of $100 billion for a potential capital buffer. On the whole however, the likelihood of a legislative solution favorable to investors appears to be quite low. Congress is also hugely undecided about what to do with the two firms, making any near term legislative solution even more unlikely, particularly before the conclusion of presidential elections.

Leaving aside probabilities and speculation, for those who bought into the GSEs at fire-sale prices, it has been clear from the beginning that an FNMA/FMCC investment was always destined for a binary outcome – the potential of a 10x return or none at all brought out investors inner daredevil. For those who took the bait, the opening of more than 120 previously sealed documents in the appeals case currently before Justices Ginsberg, Brown, and Millet seems to have significantly increased the prospects of investors realizing a return on their bets (which did not look promising after the Lamberth ruling).

Due to both the content of the supplementary evidence filed by the plaintiffs and the inherently unusual introduction of new evidence in a case such as this one, a key point made by Mr. Ogden, this turn of events is the most positive point supporting hopes for a favorable outcome for the plaintiffs and their proponents since the disappointing ruling by Judge Lamberth. Although some type of judicial resolution will likely happen before the end of the year, the risks remain high and the possibility of a complete loss is still a present danger. As the month of July winds down and we head into another midsummer earnings season, those with an interest in the GSEs as well as observers who are hoping to move in off of the sidelines would be wise to keep an eye out for upcoming earnings reports.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Forbes). I have no business relationship with any company whose stock is mentioned in this article.
Note: I am conducting research on trends and opportunities for disruption in asset management (www.disruptinvesting.com). If you have insight into the topic, feel free to contact me.