Hedge Fund sues U.S. over “confiscating” profits

US Treasury Secretary Henry Paulson addr

In 2008 at the height of the U.S. subprime mortgage crisis, two prominent Federal housing finance agencies established as Government-Sponsored Enterprises (GSEs) were placed in conservatorship by an act of Congress. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) were placed under the authority and control of the Federal Housing Finance Agency (FHFA), which was created by the Federal Housing Finance Regulatory Reform Act of 2008. At the time, U.S. Treasury Secretary Paulson strongly endorsed the move, stating that “conservatorship was the only form in which I would commit taxpayer money to the GSEs. I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction.” While it is generally acknowledged that both agencies were mismanaged and in need of close supervision, some critics claim the oversight move was the first step in shutting down these unwieldy bureaucracies. Investors in Fannie Mae and Freddie Mac allege just such an intention.

Two Lawsuits in Two Days

A New York-based firm described as an “activist hedge fund management company” filed suit against the U.S. government last week claiming that Fannie Mae and Freddie Mac regulators syphoned off profits from the two agencies thereby depriving holders of their common stock of rightful profits. The complaint alleges that since 2012 FHFA has diverted such profits into the U.S. Treasury at the expense of investors. The action has been characterized as a “confiscation,” and the amount claimed is estimated to reach $130 billion by next month. Although both suits are similar—attacking the terms of the government bailout mechanism—the latest suit seeks injunctive relief against “net worth sweeps” and a declaratory judgment that the modified bailout terms and accompanying sweeps are illegal. According to the complaint, “The net worth sweeps make plaintiffs—and all of the other common shareholders—’shareholders’ in name only.”

Constitutional Claim

The plaintiffs allege that the FHFA actions violate the Fifth Amendment of the U.S. Constitution: i.e., the taking of private property for public use without just compensation. The Court of Federal Claims asserts that the intention of the conservators is to “to strip profits from the companies.”  Accordingly, it seeks damages, disgorgement, and restitution for the investors.

Other Hedge Funds File Separate Suits

About 20 other hedge funds and investors have previously filed lawsuits over the government’s channeling of Fannie Mae and Freddie Mac profits away from investors; however, those actions are based on the claims of preferred stockholders—whose dividends were eliminated in 2012—as opposed to the interests of common shareholders.