The decision by retiring U.S. District Judge Royce Lamberth to dismiss one of the lawsuits brought against the Department of Treasury by Perry Capital and Fairholme Funds may have set back GSE investors. But it didn't stop them.

Those investors say they are forging ahead with their appeal and a concurrent lawsuit in Federal Claims Court.

That was the headline at the presentation of a new white paper commissioned by Investors Unite and executed by Clifford Rossi of Chesapeake Risk Advisors at the Dirksen Senate Office Building in Washington, this Thursday morning.

"We’re quite certain that Congress did not intend this interpretation of HERA, because that would be unconstitutional. Moreover, allowing the government to change the rules of the game will chill private capital participation in the mortgage market and in other government business, in general,” said Tim Pagliara executive director of Investors Unite and a shareholder invested in the GSEs Fannie Mae and Freddie Mac.

The primary reason for the presentation Thursday was to present Rossi’s paper, "The Government’s Path Out of Conservatorship for Fannie Mae and Freddie Mac."

Currently, Fannie and Freddie profits go to the government, and the investors are suing for their perceived share. They are also recommending the government begin to remove its controlling interest in the government-sponsored enterprises.

The investors add, that in their opinion, the government even taking over Fannie and Freddie in the first place is an unlawful act.

GSE investors in the District Court lawsuit argued that Treasury violated a 2008 law that placed Fannie and Freddie into conservatorship to prevent bankruptcy. Initially, Treasury was authorized by Congress to collect 10% dividend payments from Fannie and Freddie every quarter as a condition of the government’s $188 billion bailout of them.

In 2012, Treasury amended the terms of the agreement to channel most of the profits from Fannie and Freddie to Treasury, which is what is referred to as the “Third Amendment Sweep.”

Investors Unite was formed by Pagliara, a Tennessee activist investor and CapWealth Advisors Chairman and CEO. It is a coalition of nearly 1,000 private investors from all walks of life, committed to the preservation of shareholder rights for all invested in Fannie Mae and Freddie Mac.

Rossi is also Executive-in-Residence and Professor of the Practice at the Robert H. Smith School of Business, University of Maryland. 

Rossi held senior risk management positions at Freddie Mac and Fannie Mae and brings a risk-management perspective to consideration of GSE reform. He was Managing Director and Chief Risk Officer for Citigroup’s Consumer Lending Group (intimately involved in Citi’s TARP and stress test activities) and, before that, was Chief Credit Officer at Washington Mutual and at Countrywide. He started his career during the thrift crisis at the U.S. Treasury’s Office of Domestic Finance and later at the Office of Thrift Supervision working on key policy issues affecting depositories.

Rossi’s paper explains the path he has mapped out for GSE reform, which is currently stalled in Congress and unlikely to see any action before the 2016 presidential and congressional elections.

The following is excerpted from the executive summary:

The mechanism that granted extraordinary powers to the US Department of Treasury and to the Federal Housing Finance Agency (FHFA), the regulator of Fannie and Freddie; namely the Housing and Economic Recovery Act of 2008 (HERA) has now 6 years after both GSEs entered conservatorship effectively left the housing market in a form of financial limbo. To a large degree, Congressional inaction over this period has effectively forestalled any serious plan for bringing one or both agencies out of conservatorship. The sheer complexity of GSE reform coupled with a nearly unprecedented schism between political parties explains why comprehensive GSE reform is for the time being elusive at best.

Meanwhile, the US housing finance system languishes in a form of suspended animation that poses considerable uncertainty to private investors and potential homebuyers alike. The right outcome for GSE reform, namely comprehensive legislation addressing Fannie Mae and Freddie Mac is unlikely to occur, however, a solution that would bring private capital back to housing markets, significantly limit but not eliminate taxpayer contingent liability, and address the issues that precipitated the demise of the GSEs is feasible. This solution is already possible within the HERA legislation by granting the FHFA authority to bring the housing GSEs out of conservatorship. This paper presents a roadmap for this solution to GSE reform by outlining the statutory language affording FHFA the powers to unwind the conservatorships, the rationale for such a move, an examination of the causes for GSE conservatorship that have or can be addressed independent from Congressional action and a review of the steps needed to bring the agencies out of conservatorship. The paper provides support not only for why recapitalizing the GSEs makes sense from a public policy perspective, but how it could be done as well as the prerequisites for such action.

The principal factors directly attributable to the GSEs entering conservatorship; i.e., weak regulatory oversight, low capital requirements, unchecked retained portfolio growth, and poor underwriting standards have effectively been addressed other than establishing a set of stringent capital requirements on the GSEs. And with stronger regulatory oversight in place, such capital requirements would also be possible and a prerequisite to any post-conservatorship environment for the GSEs.

Designing an exit from conservatorship for the GSEs would need to be carefully crafted in order to not disrupt the mortgage market. But as mentioned in the previous section, such an outcome would be less likely to disrupt markets than receivership for one or both entities. The keys to ending conservatorship lie in meeting the following requirements:

  • Development of a recapitalization plan that complies with FHFA’s capital buffers for the agencies
  • Development of a set of stringent risk-based capital requirements that would be phased-in over a specified period of time
  • Termination of the sweep of profits from the GSEs to Treasury
  • Strict executive compensation requirements imposed by FHFA
  • Accelerated wind down of both GSEs’s retained portfolios