Shareholders of Freddie Mac, Fannie Mae On Weak Legal Ground In Lawsuit Against US Government

Shareholders of Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) sued the U.S. government seeking damages of $41.5 billion for taking over the mortgage giants in 2008, in a case that analysts believe does not stand on firm legal ground.

Seattle-based law firm Hagens Berman Sobol Shapiro, which filed the suit on behalf of the shareholders of Fannie Mae and Freddie Mac said, that while the takeovers were "beneficial to the economic welfare of the nation, destroyed the value of Fannie Mae's and Freddie Mac's common and preferred stock and trampled the private ownership rights and property interests of shareholders.”

According to the complaint filed in the U.S. Court of Federal Claims in Washington, the government “bullied and coerced the companies’ Board of Directors” to accept the conservatorship that fleeced the private shareholders.

Analysts point out that shareholders, despite their grievances about the government's perceived unfair treatment, are on weak legal ground as the companies are government-sponsored enterprises, or GSEs, by nature.

“We question if a court would side with the plaintiffs as [the GSE regulator] has broad discretion as conservator to do what it sees as best,” noted Jaret Seiberg, a policy analyst with Guggenheim Securities, in a research note, MarketWatch reported.

“The Constitution bars the government from taking private property without “just compensation,” but doesn’t address GSEs, he added.

Fannie and Freddie, which are both GSEs, were taken over by the U.S. government during the 2008 financial crisis, as they moved closer to bankruptcy. The Federal Housing Finance Agency took over the companies and infused billions of dollars to keep the companies afloat, and to prop up the housing and mortgage sectors.

The complaint claims that both Fannie Mae and Freddie Mac were doing well on their own before the government takeover, and also that the government pressured the companies to take on risky subprime and Alt-A mortgage purchases, which subsequently exposed them to liquidation risk.

Shareholders said that the GSEs' “financial status did not warrant the imposition of conservatorships,” and the problems were of a "momentary nature," which the companies with adequate market capitalization could have survived.

The compensation sought has been calculated on the basis of the difference in the market value of the companies from the closing price on Friday, Sept. 5, 2008 and Monday, Sept. 8, 2008 -- the day when stocks opened for trading following the government's takeover.

The complaint also challenged the government’s amendment of an agreement with Fannie and Freddie, which gave the government the right to all profits of the two companies, instead of a 10-percent dividend based on a previous deal, while their liabilities were not to appear on the government’s balance sheet.

According to the analysts, more suits could be filed by shareholders as both companies have started making strong profits, sparking demands for their exit from the conservatorship.

However, according to analysts, there are no provisions for their exits under the agreement with the federal government and they could continue to stay under government control. Analysts believe that it is unlikely that the U.S. government will let go of the mortgage giants when the cash flow from the companies are serving to bridge the federal deficit.

In April, an influx of cash from Fannie Mae and Freddie Mac -- to the tune of $95 billion -- helped the U.S. government to post a budget surplus. The government is unlikely to see these profits as a repayment of the debt owed by Fannie Mae and Freddie Mac, and would treat the revenue as returns on their investment in the companies.

The case is Washington Federal v. U.S., 13-cv-00385, U.S. Court of Federal Claims (Washington).