Can shareholders of a government-sponsored enterprise successfully challenge the constitutionality of a government takeover of the entity? Shareholders of Fannie Mae and Freddie Mac will try to do so in a $41 billion class action filed against the United States in the Court of Federal Claims on June 10, 2013. Plaintiffs allege that even though the Federal Housing Finance Authority’s 2008 takeover of the mortgage giants benefited the nation as a whole, it harmed the companies’ shareholders and violated their constitutionally protected private ownership rights.
Congress established Fannie Mae and Freddie Mac to expand the nation’s secondary mortgage market by increasing the availability of funds to finance mortgages and home ownership. The government operated Fannie and Freddie until 1968 and 1989, respectively, when the companies were reorganized as “government-sponsored enterprises,” or federally chartered private corporations. Since then, both companies have operated as shareholder-owned, publicly traded corporations. But in 2008, in the midst of the financial crisis, both companies were placed under the conservatorship of FHFA, pursuant to the Housing and Economic Recovery Act (HERA).
Plaintiffs allege that prior to the 2008 takeover, the government adjusted the companies’ lending standards and capital restraints to encourage the companies to purchase a greater number of risky subprime securities. While this ultimately led to significant weaknesses in the companies’ portfolios, Plaintiffs contend that the companies nonetheless remained adequately capitalized and financially sound, and did not need the conservatorships. According to Plaintiffs, the government improperly bullied the companies’ boards into acquiescing in the takeover.
Plaintiffs also claim that the government took control of the mortgage companies not because of their financial condition, but in order to pump liquidity into the nation’s mortgage market and to force the companies to hold the nation’s toxic debt. They also claim that the government destroyed shareholder value through stock agreements through which the Treasury Department would receive from each mortgage company: $1 billion in senior preferred stock, preferences for the senior preferred stock, warrants to acquire 79.9% of each company’s common stock for $0.00001 per share, and 100% of the companies’ quarterly profits, starting January 2013.
Plaintiffs contend that the government takeover was, in fact, “beneficial to the economic welfare of the nation.” However, they claim that the government’s public policy goals were not sufficient grounds to divest the companies’ shareholders of their shareholder rights or render their stock worthless. Thus, the suit claims, the takeover was a misappropriation of private property in violation of the Constitution’s due process and takings clauses.
Plaintiffs have several hurdles to cross before they can expect to prevail on the merits. They have to convince the court that the government, acting in the midst of the financial crisis, was wrong in concluding that the mortgage companies were financially unsound and in need of conservatorship. They also must ask the court to second-guess FHFA’s actions as the mortgage companies’ conservator, despite the broad discretion granted to the agency under HERA. Finally, they must convince the court to apply the Constitution’s takings clause, despite the fact that the clause does not specifically address a takeover of government-sponsored entities that, arguably, are being used for the purposes for which they were originally created.