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Court of Appeals declares FHFA structure unconstitutional

Majority opinion finds GSE regulator violates separation of powers

For the third time in recent memory, a government agency borne out of the housing crisis has been declared unconstitutional by a federal court.

The first two times it was the Consumer Financial Protection Bureau. But now, it’s the Federal Housing Finance Agency that has been found to be operating in violation of the Constitution.

The Court of Appeals for the Fifth Circuit ruled this week that the federal government’s regulator of Fannie Mae and Freddie Mac is not constitutionally structured.

Much like the earlier rulings involving the CFPB, the FHFA ruling deals with the agency’s leadership structure and whether a single director that wields as much authority as the CFPB director or the FHFA director is a violation of the Constitution’s separation of powers.

The CFPB was initially ruled unconstitutional in a majority opinion authored by Supreme Court Justice nominee Brett Kavanaugh. That initial ruling was later overturned by the full Court of Appeals, which ruled the CFPB’s structure to be constitutional.

But the CFPB wasn’t out of the woods. Just last month, District Judge Loretta Preska of the New York Southern District declared the CFPB unconstitutional, citing Kavanaugh’s ruling repeatedly.

Kavanaugh’s ruling in the CFPB case, which stemmed from a lawsuit from PHH Corp., comes into play frequently in the FHFA ruling.

In a majority ruling, the Court of Appeals for the Fifth Circuit rules that the CFPB is unconstitutionally structured.

The ruling comes as the result of a lawsuit brought by Fannie and Freddie shareholders who challenged both the structure of the FHFA and the so-called “Third Amendment Sweep.”

Over the years, many observers have questioned whether it was necessary for the federal government to modify its conservatorship agreement with Fannie and Freddie to sweep all the profits from the government-sponsored enterprises into the government’s coffers, an arrangement referred to as the “Third Amendment Sweep” or the “Net Worth Sweep.”

At the time, the government claimed that the GSEs were on the brink of collapse, and amended the terms of the GSEs’ conservatorship to ensure that the government had enough money to bail them out again if necessary.

In the aftermath, a series of Fannie and Freddie shareholders sued the government, claiming the “Third Amendment sweep” was not only unnecessary but illegal as well.

The Preferred Stock Purchase Agreements were modified late last year to allow Fannie and Freddie to hold some capital to “cover other fluctuations in income in the normal course of each Enterprise’s business,” but the lawsuits were still making their way through the courts.

In this case, Patrick Collins, Marcus Liotta, and William Hitchcock, referred to as Fannie and Freddie shareholders, challenged the FHFA’s structure and the “Net Worth Sweep.”

The Court of Appeals held that the FHFA was not constitutionally structured but ruled that the agency was within its statutory authority when it enacted the net worth sweep.

As for the net worth sweep, the court cited several other previous rulings in other courts as background for a similar decision to uphold the sweep.

“The Shareholders’ statutory claims mirror the claims made against the FHFA that the D.C., Sixth, and Seventh Circuits have all rejected. We reject the Shareholders’ statutory claims based on the same well-reasoned basis common to those courts’ opinions,” the Court of Appeals ruling states.

On the other hand, the Court of Appeals ruled that the shareholders were correct when they claimed that the FHFA is unconstitutionally structured.

“We hold that Congress insulated the FHFA to the point where the Executive Branch cannot control the FHFA or hold it accountable,” the ruling reads. “We reach this conclusion after assessing the combined effect of the: (1) for-cause removal restriction; (2) single-Director leadership structure; (3) lack of a bipartisan leadership composition requirement; (4) funding stream outside the normal appropriations process; and (5) Federal Housing Finance Oversight Board’s purely advisory oversight role.”

Much like the previous CFPB rulings, the FHFA ruling address whether the president has the authority to remove the agency’s director at will or for cause only.

Currently, the FHFA director is removable only for cause, a condition that is in violation of the Constitution’s separation of powers, the court ruled.

From the court’s ruling:

Congress encased the FHFA in so many layers of insulation—by limiting the President’s power to remove and replace the FHFA’s leadership, exempting the Agency’s funding from the normal appropriations process, and establishing no formal mechanism for the Executive Branch to control the Agency’s activities—that the end “result is a[n] [Agency] that is not accountable to the President.” The President has been “stripped of the power [the Supreme Court’s] precedents have preserved, and his ability to execute the laws—by holding his subordinates accountable for their conduct—[has been] impaired.” In sum, while Congress may create an independent agency as a necessary and proper means to implement its enumerated powers, Congress may not insulate that agency from meaningful Executive Branch oversight.

Therefore, the Court of Appeals rules that the FHFA director should be removable at will, but leaves the remainder of the FHFA’s previous actions, including the Third Amendment Sweep, intact. Thus, in the eyes of the court, the FHFA “survives as a properly supervised executive agency.”

The FHFA said that it will not be commenting on the court’s ruling.

To read the court’s decision in full, click here.

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