Would you buy stock in a company that barred you from sharing in its future earnings? Of course not. Participating in the upside is what stock ownership is all about.
And yet, as of December 2010, holders of Fannie Mae and Freddie Mac common stock were subject to such a restriction by the United States government. They didn’t know it at the time, though, because the policy was not disclosed.
This month, an internal United States Treasury memo that outlined this restriction came up at a forum in Washington.
The memo was addressed to Timothy F. Geithner, then the Treasury secretary, from Jeffrey A. Goldstein, then the under secretary for domestic finance. In discussing Fannie and Freddie, the beleaguered government-sponsored enterprises rescued by taxpayers in September 2008, the memo referred to “the administration’s commitment to ensure existing common equity holders will not have access to any positive earnings from the G.S.E.’s in the future.”
The memo, which was produced in a lawsuit filed by Fannie and Freddie shareholders, was dated Dec. 20, 2010. Securities laws require material information — that is, information that might affect an investor’s view of a company — to be disclosed. That the government would deny a company’s shareholders all its profits certainly seems material, but the existence of this policy cannot be found in the financial filings of Fannie Mae. Neither have the Treasury’s discussions about the future of the two finance giants mentioned the administration’s commitment to shut common stockholders out of future earnings. Freddie Mac’s filings do refer, albeit incompletely, to the administration’s stance, noting that the Treasury “has indicated that it remains committed to protecting taxpayers and ensuring that our future positive earnings are returned to taxpayers as compensation for their investment.” Note that this reference does not say all earnings.
Lewis D. Lowenfels, a securities law expert in New York, found this statement insufficient. “If there is disclosure regarding future Fannie and Freddie earnings and the administration has a commitment that existing Fannie and Freddie common equity holders will never receive any future positive earnings,” he said, “this commitment would be material to investors and should be disclosed.”
When the memo was written, plenty of people held these stocks. Regulatory filings show that 18,000 investors held 1.1 billion shares of Fannie Mae common stock, while just over 2,100 investors held 650 million Freddie Mac shares.
Back in 2010 and 2011, of course, common stockholders of Fannie and Freddie had little hope of making much money. During those days of rampant mortgage defaults and losses, investors were warned about the uncertainty of their companies’ prospects. Fannie and Freddie shareholders were repeatedly told that the preferred and common stock would have value only if anything remained after taxpayers were fully repaid for the rescue. With the amount of that rescue peaking at $189.5 billion, that was a very big “if.” On the day the Treasury memo was written, the price of Fannie Mae shares closed at 34 cents.
But the companies staged a turnaround; in mid-2012, they began earning billions. With interest rates low and banks not lending, Fannie and Freddie became the only mortgage game in town. By Sept. 30 of last year, the companies had returned $185 billion to the Treasury.
Failing to disclose the administration’s hard line on the companies’ shareholders is disturbing for another reason. In bailing out Fannie and Freddie, the Treasury received warrants — optionlike securities that rise in value when the shares underlying them do. When investors, hoping for a housing recovery, flocked to the shares and pushed them higher, the value of the warrants increased. Fannie’s common stock now trades at $3.06 a share.
Given Treasury’s interest in a rising stock price, depriving common equity holders of future earnings was especially important for investors to know, Mr. Lowenfels said.
A spokesman for the Treasury declined to comment. Mr. Geithner did not respond to an email, and Mr. Goldstein, now a managing director at Hellman & Friedman, a private equity firm, did not return a phone call. (After the deadline for publication of this column had passed, spokespeople for the Treasury Department and Mr. Geithner offered comments.)
All of this has come to a boil because Fannie and Freddie have become so profitable. Yet because of a change in the repayment process dictated by the Treasury in 2012, the $189.5 billion debt technically remains outstanding. The profits generated by Fannie and Freddie have instead gone to the general treasury.
I have been critical of these companies, but this change in the bailout terms seems punitive, especially when considering how other bailout recipients were treated. And it has led to lawsuits against the government from Fannie and Freddie shareholders, including insurance companies, a mutual fund and a hedge fund. The plaintiffs contend that the government’s 2012 decision to take all the companies’ profit — just as it was starting to balloon — was illegal under the 2008 law that rescued them.
After all, back in 2008, the companies were not put into receivership, the equivalent of bankruptcy. Rather, they were placed under the care of a conservator — the Federal Housing Finance Agency. That conservator was supposed to put the companies “in a sound and solvent condition” and “preserve and conserve the assets and property” of each entity.
Siphoning off the entities’ profits is the opposite of conserving their assets and property, the plaintiffs contend. And they point to a 2009 Treasury memo stating that the conservatorship of Fannie and Freddie “preserves the status and claims” of preferred and common shareholders. One of those claims is surely having access to future earnings.
A spokeswoman for the Federal Housing Finance Agency declined to comment, citing the litigation. A spokesmen for Fannie declined to comment as well. A Freddie Mac official did not elaborate beyond pointing to the language in its filings.
Perry Capital, a hedge fund, is one of the plaintiffs suing the government. Its lawsuit seeks no damages, but asks that the government follow the 2008 law. The 2010 memo was produced by the Treasury in response to this lawsuit.
Do the Treasury’s actions amount to a backdoor nationalization of the companies? A full-fledged takeover would have required Treasury to put all the companies’ obligations — $4.9 trillion at the time — on the government’s balance sheet. A nonstarter.
Furthermore, nationalization would have required the government to provide compensation to shareholders for what it took. Now the government gets the benefits of the companies’ profits while avoiding any compensation payments.
“People disagree about what should happen to the G.S.E.’s,” said Matthew D. McGill, a lawyer at Gibson, Dunn & Crutcher in Washington who represents Perry Capital. “But if the plan is to wind them down, Congress provided a means to do that in the 2008 law — it’s called receivership, and it provides a host of procedural protections to claimants. What the Treasury cannot do is abuse its conservatorship powers to nationalize the companies and then, when it deems convenient, wind them down without the protections enacted by Congress.”