“It’s late September and I really should be getting back to school,” sang Rod Stewart in Maggie Mae.
Fittingly, then, it was as September ended that the Hon. Royce Lamberth of the U.S. District Court for D.C. offered a scholarly tutorial to alpha-seeking funds on the one hand and to the government sponsored enterprises on which some of these funds have speculated, on the other.
The funds involved, including Perry Capital, owned either preferred or common stock in the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation, colloquially Fannie Mae or Freddie Mac respectively.
Lamberth acknowledges that there are other government sponsored enterprises, but says in a footnote that he uses the initials GSE in the remainder of this opinion to refer to those two specifically.
Receivership and a Net Sweep
The Federal Housing Finance Agency placed these two GSE’s in receivership at the height of the 2008 crisis. Just one day thereafter, the U.S. Treasury entered into stock purchase agreements with each of them, committing to provide up to $100 billion in funding to ensure that their assets were equal to their liabilities, and accepting senior preferred stock in consideration for this commitment.
The focus of this litigation was the so-called “third amendment” to this agreement, adopted in August 2012, which required the GSEs to pay a “net sweep” as a quarterly dividend. This meant that the Treasury gets everything that the GSEs earn beyond their net worth plus a capital buffer. The capital buffer was pegged at $3 billion in 2012, but was designed to decline over time and will entirely disappear in 2018.
The net sweep leaves, in essence, nothing for private investors such as Perry: hence their lawsuit.
Unfortunately for Perry et al., the statute that authorized the Fannie/Freddie agreement, the Housing and Economic Recovery Act (HERA) contained an explicit provision sharply limiting judicial review, section 4617(f), which says that “no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.”
The defendants successfully argued to the U.S. district court that granting relief to Perry would significantly restrain FHFA’s options as a conservator, so that any court action doing so would violate HERA.
Many of the plaintiffs’ arguments had turned on the validity or invalidity of the reasons that Treasury and FHFA have given for the Third Amendment. For example, Treasury has said that the new net sweep ended “the circular practice of the Treasury advancing funds to the [GSEs] simply to pay dividends back to the Treasury.” But the plaintiffs contend that this “circle” no longer existed by 2012, so such invalid reasoning suggests that the Amendment was actually arbitrary and capricious.
Judge Lamberth didn’t want to hear of it. The justifications, right or wrong, are “irrelevant for §4617(f) analysis.” Defendants win.
The decision has attracted a good deal of criticism, including some broadsides from Hoover Institute Senior Fellow Richard Epstein, who has argued against it in a series of well-written columns at Forbes.com.
I respect and admire Epstein, who has for decades made the case in powerful terms that the U.S. legal system took a profoundly wrong path in the era of the New Deal.
But I submit that there is a powerful policy argument case lying just beneath Lamberth’s decision. The losses that the alpha-seekers involved in this case have now taken, losses made vivid by the battering of the stock price of the GSE’s subsequent to the decision, can be understood as the manifestation of the risk that was present from the start in this sort of bet upon sovereignty.
Buying an interest in the GSEs, or just maintaining it for that matter, in the years since the 2008 bail-out has meant buying in to a government guarantee that the taxpayers have explicitly underwritten. It means buying in to 2B2F and crony capitalism. Those of us who are wary of cronyism, who believe that capitalism is better served if capitalists invest in entrepreneurs, and if both are allowed to fail, have to learn to cheer once in a while when such a bet goes bad, when confidence in one’s public-sector cronies proves unfounded.
As the editorial page of the Wall Street Journal has put it, the investors here were “gambling on politics,” and that is their right, but good hygiene is served when such a bet goes badly wrong.