Perry Capital Appeals Fannie, Freddie Bailout RulingMargaret Cronin Fisk
Fannie Mae and Freddie Mac investor Perry Capital LLC appealed a ruling dismissing lawsuits claiming the U.S. government improperly grabbed post-bailout profits owed to shareholders.
Perry and other investors including Bruce Berkowitz’s Fairholme Capital Management LLC sued over what they called an illegal “taking” of dividends under the U.S. Constitution.
U.S. District Judge Royce Lamberth rejected their claims Sept. 30, finding that the government is allowed under a 2012 amendment to the companies’ bailout agreements to sweep “nearly all” profits from Fannie Mae and Freddie Mac to the U.S. Treasury.
Perry filed a notice of appeal in federal court in Washington yesterday, saying it will request a review of the ruling by the federal appeals court for the District of Columbia.
“The district court’s decision overlooks important points of law and improperly resolved key questions of fact,” Theodore B. Olson, Perry Capital’s attorney, said in an e-mail. “The merits of this case deserve to be heard in court.”
The Treasury didn’t take the investors’ property, lawyers for the U.S. Justice Department said in court papers. Shareholders in Fannie Mae and Freddie Mac “do not possess an unfettered right to a dividend,” the department argued in a Jan. 17 filing.
Nicole Navas, a spokeswoman for the Justice Department, declined to comment on the case.
The lawsuits are among almost 20 related cases filed in U.S. courts. At least $33 billion -- the face value of potentially worthless preferred shares in the companies -- is at stake in the cases, as well as shareholders’ efforts to win congressional support for the idea of reviving Fannie Mae and McLean, Virginia-based Freddie Mac.
The companies’ preferred shares lost more than 50 percent of their value Oct. 1. Fannie Mae common shares lost 37 percent and Freddie Mac dropped 38 percent. The decline continued yesterday with Fannie Mae common shares dropping 11 percent to $1.51 in New York trading. One series of the preferred shares dropped 9.4 percent to the lowest level since April 2013.
The government is defending its $182 billion bailout of American International Group Inc. at a federal trial in Washington in a case brought by Maurice “Hank” Greenberg’s Starr International Co., which was AIG’s biggest shareholder when the financial crisis struck. Starr claims the assumption of 80 percent of AIG stock by the U.S. in September 2008 in exchange for an $85 billion loan amounted to an unconstitutional taking of private property.
Perry and the other Fannie Mae and Freddie Mac investors challenged the arrangement in which the U.S. Treasury takes all of the companies’ quarterly profits. The practice, known as the Third Amendment, began in 2012, replacing an earlier arrangement in which the two companies paid a quarterly 10 percent dividend as a return on the U.S. bailout.
Fannie Mae and Freddie Mac, which were seized by regulators in 2008 as they neared bankruptcy, package mortgages into guaranteed bonds. They drew $187.5 billion in taxpayer funds to stay afloat before they returned to profitability. The rescue gave the U.S. the right to take stakes of about 80 percent in the companies.
Treasury was authorized to “purchase any obligations and other securities issued by” Fannie Mae and Freddie Mac, a provision which also allowed it to “exercise any rights received in connection with such purchases,” Lamberth wrote in his Sept. 30 ruling.
The related amendment “requires Fannie Mae and Freddie Mac to pay a quarterly dividend to Treasury equal to the entire net worth of each” entity, minus a small reserve that shrinks to zero over time, Lamberth said.
The Third Amendment may “raise eyebrows, or even engender a feeling of discomfort,” Lamberth wrote in his decision. “But any sense of unease over the defendants’ conduct is not enough to overcome the plain meaning” of the text of the law under which the rescues were permitted, he said.
“Here, the plaintiffs’ true gripe is with the language of a statute that enabled FHFA and, consequently, Treasury, to take unprecedented steps to salvage the largest players in the mortgage finance industry before their looming collapse triggered a systemic panic,” Lamberth wrote, referring to the Federal Housing Finance Agency.
The decision “was out of left field and it caught the market by surprise and us by surprise and, if allowed to stand, represents a threat to corporate America in general,” said Michael Kao, founder of Akanthos Capital Management LLC, a Los Angeles-based hedge fund that bought preferred shares in late 2008.
This week, the fund somewhat boosted the face value of its position, he said, mainly on a long-standing belief that lawmakers will eventually realize that the companies can’t be replaced.
“We’ve always thought the road to ultimate resolution would be a bumpy one and fraught with headline risk,” Kao said in a phone interview.
“My central thesis, however, has not changed,” he said. “I never thought the be-all and end-all of this story would necessarily be a legal settlement. The court of public opinion could be just as powerful an influence.”
The case is In Re Fannie Mae/Freddie Mac Senior Preferred Stock Purchase Agreement Class Action Litigations, 13-01288, U.S. District Court, District of Columbia (Washington).