Stupidest Lawsuit Ever Has Us Suing Ourselves: Jonathan Weil

Of all the absurdities to emerge from the government’s never-ending bailout of the U.S. financial system, here’s a new one that’s hard to top: The government, through Freddie Mac, in effect is now suing itself.

Never let it be said that Bailout Nation doesn’t have a sense of humor. It would be only a slight hyperbole to say this may be the stupidest lawsuit ever.

Here’s what happened. In July the Internal Revenue Service told Freddie Mac, the congressionally chartered housing financier, that it owed $3 billion of back taxes and penalties for the years 1998 through 2005. Rather than pay up, the McLean, Virginia-based company sued the IRS on Oct. 22 in U.S. Tax Court to contest its claims.

Before Freddie Mac could do that, it had to seek written permission from its conservator, the Federal Housing Finance Agency. FHFA, whose mandate is supposed to include looking out for taxpayers, consented. Freddie Mac disclosed the suit last week in a footnote to its third-quarter financial report.

Talk about biting the hand that feeds you. Here we have a government-sponsored enterprise -- which depends on Treasury’s financial support to remain solvent -- suing an arm of the Treasury Department. Some thanks this is. To date, Treasury has injected about $64 billion into Freddie Mac and collected $8.4 billion of cash dividends on its senior preferred stock in the company.

The Treasury Department also holds a warrant to buy 79.9 percent of the company’s common stock for a nominal price. So Freddie Mac can’t claim it’s simply protecting shareholders by taking on the IRS. Under its conservatorship, the company’s board answers only to the FHFA, which has complete authority over Freddie Mac’s affairs.

Lawyers Win

The details of the tax dispute are beside the point. No matter how the case turns out, the result more or less should wind up being a wash for taxpayers. The only people who stand to make money from the litigation are Freddie Mac’s outside attorneys at Shearman & Sterling.

Consider some possible scenarios. If the IRS loses, that would be a win for taxpayers in the sense that Treasury won’t need to send as much bailout money to Freddie Mac in the future. Yet the public also would lose because the government wouldn’t get its $3 billion of revenue.

Alternatively, if the IRS wins, it would be a victory for taxpayers, too. Of course, they would still lose because Freddie Mac would have an even bigger capital hole after paying the $3 billion. The Treasury then would have to inject more money into the company to keep it from becoming insolvent and falling into mandatory receivership.

Matter of Principle

An IRS spokesman, Eric Smith, declined to comment. So did Robert Rudnick, a partner at Shearman & Sterling in Washington. Corinne Russell, an FHFA spokeswoman, declined to comment when I asked why the agency gave Freddie Mac permission to sue the IRS. FHFA’s acting director, Edward DeMarco, didn’t return phone calls.

A Freddie Mac spokeswoman, Sharon McHale, cast the company’s decision to sue the IRS in terms of principle.

“We believe that we did not in prior years have federal tax deficiencies and that we are not liable for any penalties,” she said. Freddie Mac, she added, “has an obligation to run the company according to the laws of the land. And in an instance where we believe we’re in the right, we believe we have an obligation to assert that.”

No Call

OK, fine. But shouldn’t it also have been the job of someone in the government to exercise some common sense here? Surely the head of FHFA could have picked up the phone and called someone at Treasury to work out a truce. Or, if that wasn’t possible, FHFA could have told Freddie Mac to pay its IRS bill, tap Treasury for more bailout money, and stop ringing up legal fees.

For what it’s worth, I checked the disclosures at Freddie Mac’s cousin, Fannie Mae, which also was seized by the government in 2008. Fannie Mae reached a settlement with the IRS over its tax returns for 1999 through 2004. Score one for cooler heads.

Freddie Mac said in its latest quarterly report that “it is reasonably possible” the company will reach a settlement with the IRS within the next 12 months. We can only hope.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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