What Latest GSE Bill Could Mean for Shareholders

WASHINGTON — The Senate Banking Committee's efforts to reform the mortgage finance system have been lauded by a variety of stakeholders, but details from a new bill are stoking fresh concerns from Fannie Mae and Freddie Mac shareholders.

Just as lawmakers seek to wind down the two government-sponsored enterprises and replace them with a new housing finance structure, lawsuits — claiming investors in the GSEs are owed profits that were made after the firms went into conservatorships in 2008 — have gone unresolved.

Before Committee Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho, unveiled their 442-page GSE overhaul bill, Crapo had reassured investors last week that the treatment of the non-government shareholders would be "made in the courts," not in the legislation.

But observers reviewing the text of Johnson and Crapo's plan argue their legislation would simply reinforce a Treasury Department policy change that investors and their advocates say would effectively cut them out of their fair share. The policy change was enacted through what is known as the third amendment to the Senior Preferred Stock Purchase Agreement, which governs treatment of shareholders under the conservatorships.

"Johnson-Crapo codifies the third amendment to the SPSPA into the statute," said Brandon Barford, a partner at Beacon Policy Advisors. "Even though the bill is unlikely to go the distance this Congress,it clearly shows the intent of a number of committee members and what their views are in this area."

Michael Bopp, a partner at Gibson, Dunn & Crutcher, which represents the hedge fund Perry Capital in one of the ongoing cases, argued that if the Johnson-Crapo bill were to pass "you would have a law in place that prejudices the litigation proceeding in the courts."

"This would be Congress stating not only that the third amendment is legal, but that it has to stay in place," Bopp added, noting that even having the bill's language floating around "could impact the ability and likelihood of litigants to sit down and work out a settlement."

The Johnson-Crapo plan builds on legislation introduced last summer by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., which contained similar language to effectively limit the shareholder returns. And ever since GSE reform has heated up on Capitol Hill, lawmakers have signaled support for limiting shareholder returns, saying that returning more profits to investors would further the notion that the conservatorships were taxpayer-funded bailouts.

"At the end of the day, I just want to triple underline, these entities would not have had one penny of earnings had the taxpayers not have stepped in," Corker said at an industry-sponsored event in January.

Still, lawmakers have expressed sympathy with plaintiffs in the ongoing lawsuits. Warner said last week in a TV interview that the investors "ought to have their day in court."

At issue is the Treasury Department's 2012 decision to "sweep" future profits from Fannie and Freddie to the government, a loss for investors who had purchased shares of the GSEs either before or after their 2008 bailout. Several hedge funds have since filed civil actions over the policy change, and that litigation is still winding its way through the legal system.

The fight has made for some strange bedfellows on Capitol Hill. The activist Ralph Nader, a shareholder in the GSEs, has rallied a group of investors alongside hedge funds pursuing the matter in court to win back a share of the companies' profits. Sen. Pat Toomey, R-Pa., and Rep. Mike Capuano, D-Mass., typically on opposite sides of the ideological spectrum, have also both spoken out in favor of investors.

"Since the 2008 bailout of Fannie Mae and Freddie Mac, and the beginning of their conservatorship, the stockholders of these two companies, of which I am one, have been stripped of their basic rights as shareholders," Nader said in a November press release.

The Johnson-Crapo plan goes further than the Corker-Warner bill by removing a so-called waterfall provision that would, at least in theory, call for profits to flow from senior preferred shareholders to junior preferred and then common shareholders, instead of mandating profits be maximized solely by the government.

"That SPSPA is essentially concrete on top of capital structure — no money can flow down," said Isaac Boltansky, a policy analyst at Compass Point Research & Trading.

The most recent legislation also incorporates language from a 1992 statute for winding down the GSEs, rather than language in the 2008 Housing and Economic Recovery Act. The earlier provision had allowed regulators more flexibility in how they structure a wind-down, including what happens to profits from the sale of the GSEs.

"By using the 1992 statute instead of HERA, the Committee chose a circuitous route to avoid having to follow the very prescriptive steps of receivership," Barford said. "This new process, or ‘wind down,' gives more discretion and latitude to regulators."

Critically, the Johnson-Crapo legislation also calls for steps to fund the GSEs' wind-down that would effectively limit potential shareholder returns. Using funds from the GSEs to support the transition to a new system — rather than returning profits — is seen as a much more politically palatable step than using other outside source of appropriations. That means that the pot of money for investors could be further reduced even if they prevail in the courts.

"Fannie and Freddie essentially becomes a piggybank for the new system," said Edward Mills, policy analyst at FBR Capital Markets.