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Investments

Was the Third Amendment sweep of Fannie, Freddie a sham?

One leading legal scholar says yes; shareholders get louder

July 13, 2015

Last week in a teleconference hosted by Investors Unite, one of the guests — noted legal scholar Richard Epstein, the Laurence A. Tisch Professor of Law at NYU and a senior lecturer at the University of Chicago — didn’t mince words about what he thought of the Department of the Treasury’s “Third Amendment sweep” of GSE profits. 

He called it a “sham transaction.”

The Federal Housing Finance Agency showed "no pretense" of acting in the best interest of Fannie Mae and Freddie Mac despite the obligations it had as conservator, an attorney for Perry Capital said during the Investors Unite last week.

Epstein previously wrote an op-ed in Forbes where he compared the AIG and GSE lawsuits alleging improper action by the government in those high-profile interventions. 

During the call, Epstein discussed Perry Capital, Fairholme Funds, and the individual shareholders in Iowa, all of which are involved in litigation against the Treasury.

But more interesting was his take on the veil of secrecy that pervades the GSE conservatorship.

"It's an open scandal that the government continues to demand secrecy. The Obama Administration has pledged to be the most open, and they have completely failed in this regard," Epstein said. "The strategy here by the government is to delay the release of documents in the Fairholme case because it will completely change how the appeal looks.

"When you take all the money from somebody, that's not mere regulation – that's an outright confiscation, and that's what's going on here," he added.

Now, I’m neither a forensic accountant (shocker, I know) nor a legal scholar, but it doesn’t take either to know that when there’s a legal dispute with the government, and the government wants to use its unilateral power to keep key documents secret, something stinks.

Has anything good ever come from a cover up?

Or to use the words of the government’s own NSA supporters against it — If Treasury and the Obama administration did nothing wrong, what do they have to hide?

Matthew McGill, a partner at Gibson, Dunn and Crutcher, which is representing Perry Capital in its lawsuit against the federal government, said during the call that although shareholders he represents are willing to agree to a settlement, "to date, the government has expressed no interest in that."

He was also pretty damning when it came to the Federal Housing Finance Agency’s conduct as a conservator.

“The most fundamental point is that the FHFA actions as conservator totally disregarded the fiduciary duties they held as conservator," McGill said. "There has been no pretense of acting in the best interest of the companies."

McGill also raised again the point that pro-FannieGate people have made in a forensic accounting report on the health of Fannie Mae and Freddie Mac back in 2008.

The claim is that Treasury’s actions and the justification for those actions infusing the GSEs with cash and putting them in conservatorship is "conclusively false."

In a statement from Investors Unite, they noted that McGill said the dividends that the enterprises were required to pay to the Treasury could be paid "in-kind" and did not have to be paid in cash.

"Therefore, it was a ‘remarkable turn of events’ that, when the companies were suffering tremendous losses that were almost entirely non-cash accounting losses imposed by the FHFA as conservator, the write-down of deferred cash created an enormous hole that Treasury was obliged to fill,” the statement from Investors Unite concludes. “Conveniently then, after the Third Amendment Sweep was enacted, the loan-losses were reversed and tax assets written back up resulting in the companies sitting on billions of dollars in assets that were subsequently handed over to the Treasury.”

McGill said that the Third Amendment sweep was an executive action.

"It was an agreement between agencies so the administration could put through today another agreement to end the sweep," McGill said. "That is within their purview."

The Treasury and the administration may have been 100% right in every action they took. What looks like shady financial legerdemain and bait-and-switch may have been perfectly legal and justified. Maybe the GSE's should be gotten rid of, or evolved into something like Ginnie Mae, or one of the many other options.

But there's a right way and a wrong way. Ripping off shareholders doesn't fit the former. And it’s not a conspiracy theory when it’s more than just someone trying to connect dots — there is some there, there.

And nothing the administration has done in withholding documents and playing fast and loose with legal definitions inspires confidence.

“The conspiracy to destroy Fannie Mae is not a conspiracy theory, which would be based on a series of suspicious-looking dots that appear to connect," says David Fiderer. "The damning evidence is much more precise and concrete, and quite apparent when you follow the flow of funds, the debits and credits, and the repayment of principal and interest. It is impossible to compare the public statements with Federal statutes and regulations and numbers and avoid the inference that a lot of high ranking officials at Treasury, the SEC and FHFA (and its progenitor, OFHEO) lied to Congress and to the public.”

And while we’re talking about this whole Treasury “Third Amendment sweep” — remember the Fifth Amendment?

Thanks to bad TV police procedurals, everyone remembers the part about not incriminating yourself, but it also has this to say:

“No person shall … be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.”

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