Here in the United States, corporations operate under laws that even the federal government must respect. It is a principle so deeply ingrained in our system that it should be almost unnecessary to point out, were it not for the troubling behavior of our public servants in Washington.
In a move that smacks of nationalization, the Federal Housing Finance Agency and the United States Treasury are pressing ahead with a plan that keeps two private companies — Fannie Mae and Freddie Mac — under government control at the expense of American investors.
Now two shareholders have filed suit to hold the federal government accountable in a case that could have far-reaching implications for property rights. Filed in federal court in Delaware, Jacobs v. Federal Housing Finance Agency challenges the government’s 2012 decision to send all of Fannie and Freddie’s profits to the U.S. Treasury. The case is shaping up to be a major test of the limits of federal power, given that these moves appear to violate state laws as well.
This lawsuit is the latest front in the battle over the two mortgage giants. Fannie and Freddie are privately owned mortgage-finance companies traded on the New York Stock Exchange. They are highly profitable: The companies together generated net income of $21.9 billion last year. While they are commonly referred to as “government-sponsored enterprises” (GSEs), the companies have operated in private hands for decades.
Like every major American financial firm, Fannie and Freddie faced acute financial distress during the financial crisis of 2007–08. Although the two companies were never deemed insolvent, the federal government stepped in to steady them. Congress passed the Housing and Economic Recovery Act of 2008 (HERA), injecting approximately $187 billion into the GSEs and naming the newly formed Federal Housing Finance Agency (FHFA) as their “conservator.”
As conservator, the FHFA was empowered to “take such action as may be — (i) necessary to put the regulated entity in a sound and solvent condition, and (ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.” This is in line with the meaning of “conservator” under standard state corporate-law principles: A conservator is bound by fiduciary duty to the shareholders — all of them — to maximize the companies’ assets for their benefit.
Unsurprisingly, under basic corporate law, a conservator is meant to “conserve” the companies’ profits — not hand them over to the federal government. But, unlike the case with other companies that were bailed out, the government does not want to let go of Freddie and Fannie now that they are profitable again.
In August 2012, soon after the two companies returned to profitability, Edward DeMarco, acting director of FHFA, and then–secretary of the Treasury Timothy Geithner unilaterally — without a congressional mandate and in violation of Delaware corporate law — amended HERA to “sweep” all of the companies’ profits back to the Treasury in the form of dividends then and forever, effectively wiping out millions of privately held shares. And while HERA had originally envisioned an arm’s-length negotiation between Fannie’s and Freddie’s independent boards and the Treasury, by 2012 the independent directors had been forced out and replaced with the director of the FHFA. The federal government was, in essence, negotiating with itself.
By early 2015, the two companies had given $239 billion to the government, yet private shareholders have received nothing.
Congress passed HERA with the intention of stabilizing the mortgage market by preserving the GSEs’ assets. Accordingly, under Section 1117 of HERA, Congress required that Treasury act in consideration of “the need to maintain the corporation’s status as a private shareholder-owned company” and work towards “the orderly resumption of private market funding or capital market access.”
By early 2015, the two companies had given $239 billion to the government — fully repaying their debt and an additional $40 billion in profits — yet private shareholders have received nothing and, unless the courts step in, will continue to receive no earnings, or even recompense on their investment.
The takings clause of the Constitution prohibits the government from taking private property without compensating the property owner. Nevertheless, the government — by virtue of an interagency agreement — has sought to eliminate Fannie and Freddie shareholders’ property rights in all future dividends and liquidation preferences associated with their shares in Fannie and Freddie.
This unprecedented abuse of governmental power should send chills down the spine of every American. The first secretary of the Treasury, Alexander Hamilton, wrote in 1794, “What is the most sacred duty and the greatest source of our security in a Republic? An inviolable respect for the Constitution and Laws.” The current secretary of the Treasury, Jack Lew, should heed his predecessor’s advice.
— Jonathan Macey is the Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School, and Logan Beirne is an ISP Fellow and lecturer in law at Yale Law School.