Godzilla Defeats the Thing
Judge Lamberth blocks a revival of the old Fannie Mae scam.
ENLARGEFederal Judge Royce Lamberth did a service for taxpayers on Tuesday by dismissing claims against the federal government brought by private investors trying to profit once again from Fannie Mae and Freddie Mac . The judge saw through a plaintiffs’ argument that combined dubious legal reasoning with junk economics.
The two mortgage giants would have failed without a 2008 federal bailout that eventually poured $188 billion into the firms. But investment funds including Perry Capital and Fairholme that own shares in Fannie and Freddie have argued that they now deserve to reap the rewards of the taxpayer rescue.
These shareholders point out that dividends paid to the Treasury for the rescue have totaled more than $218 billion—apparently exceeding the rescue funds. They argue that Treasury has used a 2012 amendment to the bailout agreement to unfairly collect all of Fan and Fred’s profits.
Nobody has written more about this Administration’s legal abuses than we have, but Judge Lamberth appears to be right on this one. His ruling cites the “plain meaning” of the 2008 law under which the government put Fan and Fred into federal conservatorship, which says that “no court may take any action to restrain or affect the exercise of powers or functions” of the company’s conservator. The senior jurist suggests that if investors have a gripe, it’s with Congress for writing the law.
Judge Lamberth is arguably being too kind to the plaintiffs, because the $188 billion in direct support was hardly the only public assistance to Fan and Fred. According to Larry Wall, a researcher at the Federal Reserve Bank of Atlanta, “The claim that the taxpayers and Treasury have been fully repaid for their support of Fannie Mae and Freddie Mac is based on an accounting calculation that does not withstand economic analysis.”
He adds that, among other problems, this claim “attributes no value to the government guarantee to absorb whatever losses arose in the pre-conservatorship book of business, and arguably reflects Treasury setting too low of a dividend rate on its senior preferred stock. Moreover, the profits that are being used to pay the dividends did not arise from the contributions of private shareholders but rather entirely reflect risks borne by the Treasury and taxpayers.”
Every nickel the mortgage monsters earn comes courtesy of the taxpayers. The firms have two principal businesses: guaranteeing bundles of mortgages sold to other investors, and investing in mortgages themselves. Neither business would exist without Uncle Sugar.
As Alex Pollock of the American Enterprise Institute has noted, “What is the value of a guaranty from a guarantor with hugely negative capital? Zero. It is solely the fact that the government guarantees Fannie and Freddie’s obligations that gives this business any revenue or profit at all.”
But even the mortgage-guarantee business hasn’t been generating profits for Fannie, say Andy Laperriere and his colleagues at Cornerstone Macro. They note that its “net earnings are completely due to its large portfolio of mortgages it holds. These earnings come from earning a spread on its mortgages compared to its cost of borrowing. So how does an insolvent company borrow at close to a risk-free rate and earn a spread on its massive portfolio of mortgages? Only because of the government support, of course.”
If Judge Lamberth’s ruling withstands appeal, it will have the side benefit of breaking up the political constituency that has sustained the economically disastrous policy at the core of Fannie and Freddie. The two firms were designed to serve Washington and Wall Street. The politicians collected campaign contributions from Fan and Fred while using the firms to allocate credit. Meanwhile, Fan and Fred investors and banks were able to profit from the implied government guarantee.
The shareholders in the suit are mainly big-money speculators who hope to make a killing on the upside if the politicians revive Fan and Fred. Gambling on politics is their right, but it’s a little rich to then whine when the politicians they’re canoodling with decide to confiscate their taxpayer-guaranteed profits.
This brawl has been like watching Godzilla vs. The Thing. With private subsidy-seekers perhaps out of the picture, taxpayers may now have a better shot at beating Godzilla.