The U.S. Court of Appeals for the Third Circuit recently upheld the legality of the Federal Housing Finance Agency’s (FHFA’s) actions as the conservator of Fannie Mae and Freddie Mac, and the validity of agreements which require Fannie and Freddie to give 100% of their future profits to the government.
Fannie and Freddie are government-sponsored enterprises which support liquidity and stability in the mortgage marketplace by buying mortgages and repackaging them into mortgage-backed securities. Fannie and Freddie guarantee the securities against default, and this guarantee is implicitly backed by the United States government. During the 2008 financial crisis, which saw very high rates of mortgage defaults, Fannie and Freddie were required to pay large sums of money—far more than they had—pursuant to the guarantees. Congress passed the Housing and Economic Recovery Act of 2008 (HERA) to ward off a potential default by Fannie and Freddie. Among other things, the statute created the FHFA and gave it the power to appoint itself conservator to Fannie and Freddie. FHFA, as conservator, had Fannie and Freddie enter into agreements with the U.S. Treasury by which the U.S. government would cover their shortfalls (which ultimately amounted to more than $180 billion). In return, the government became Fannie and Freddie’s main shareholder and is entitled to receive 100% of Fannie and Freddie’s profits into perpetuity. Among other things, this means that Fannie and Freddie cannot pay dividends to other shareholders.
In Jacobs v. FHFA, other Fannie and Freddie shareholders challenged the legality of the agreements. The district court dismissed the shareholder’s claims as being precluded by HERA, and the Third Circuit affirmed. Specifically, HERA prohibits the courts from restraining or affecting any exercise of FHFA’s powers or functions as Fannie and Freddie’s conservator. Claims will be barred so long as FHFA is 1) acting in its capacity as conservator; 2) does not exceed its statutory authority; and 3) the remedy sought would affect the exercise of that authority.
The Third Circuit found that HERA gave FHFA many discretionary powers in its role as conservator for Fannie and Freddie, including the powers to take over, and preserve and conserve, their assets; operate them using all of their officers’, directors’, and shareholders’ powers; and take such action as may be necessary to put them in a sound and solvent condition. The Third Circuit held that these powers gave FHFA the authority as conservator to have Fannie and Freddie enter into the agreements whereby they received massive funding commitments from the U.S. Treasury in exchange for 100% of their future profits. Requiring Fannie and Freddie to unwind these agreements would restrain and affect FHFA’s otherwise-lawful exercise of its powers.
For a copy of the opinion, click here.