Did the government really need to bail out the GSEs?
In the years since the federal government modified its conservatorship agreement withFannie Mae and Freddie Mac to sweep all the profits from the government-sponsored enterprises into the government’s coffers, many observers, including those with a serious financial interest, have questioned whether the so-called “Third Amendment sweep” was even necessary.
At the time, the government claimed that the GSEs were on the brink of collapse, and amended the terms of the GSEs’ conservatorship to ensure that the government had enough money to bail them out again if necessary.
In the aftermath, a series of Fannie and Freddie shareholders sued the government, claiming that the “Third Amendment sweep” was not only unnecessary, but illegal as well. HousingWire is reaching out to government officials for comment. Those, if made available, will be included in a future article.
As of right now, the investors’ cause grew from several court cases into a viral movementon Twitter, where “#FannieGate” has become shorthand for the government’s supposed theft of Fannie and Freddie.
Now, it appears that #FannieGate movement may have a point about the government’s sweep.
According to an article published Tuesday by the New York Times, a series of now-unsealed depositions given in the shareholders’ lawsuits show that not only were Fannie and Freddie on track to be profitable for at least 10 years, the government allegedly knew that fact, and more, before choosing to sweep away the GSEs’ profits.
The New York Times article, by Gretchen Morgenson, cites a deposition given last year by Susan McFarland, who is Fannie’s former chief financial officer, who testified that in 2012, she told Department of Treasury officials that Fannie Mae was well-positioned to be profitable for the foreseeable future.
From Morgenson’s piece:
In a deposition taken last July, for example, Susan McFarland, Fannie’s former chief financial officer, said she told high-level officials at the Treasury on Aug. 9, 2012, that the company was, in fact, “now in a sustainable profitability, that we would be able to deliver sustainable profits over time.”
In addition to telling Treasury officials in early August 2012 that Fannie would be able to sustain profits, Ms. McFarland said that Fannie could soon reap about $50 billion in income because of the reversal of an accounting entry, known as a deferred tax asset, required under accounting rules when the company began earning profits again.
Morgenson also cites a copy of a presentation that McFarland made to the Treasury about Fannie’s future, in which she said that Fannie would not need any additional taxpayer bailout money for a period of at least 10 years.
Again from Morgenson:
In her deposition, Ms. McFarland said that she believed her conversation with the Treasury propelled the government to change the terms of the bailout to seize Fannie’s and Freddie’s profits. “When the amendment went into place,” Ms. McFarland testified, “part of my reaction was they did that in response to my communication of our forecasts and the implication of those forecasts, that it was probably a desire not to allow capital to build up within the enterprises and not to allow the enterprises to recapitalize themselves.”
The documents, which can be read in full here, do not paint the government’s decision in a positive light.
Richard Bove, equity research analyst at Rafferty Capital Markets, who’s been on the FannieGate trail for quite some time, reviewed the depositions and told clients Tuesday that government’s decision was made in clear violation of the Housing and Recovery Act of 2008.
“I have had the opportunity to read snippets from these depositions. They are clear in indicating that it has always been the intent of the Administration to eliminate Fannie Mae and Freddie Mac,” Bove writes. “Moreover that it would attempt to do so by weakening their capital base and their ability to generate net income. This is directly contrary to the Congressional intent for these companies as stated in HERA.”
Bove calls McFarland’s deposition “enlightening,” echoing Morgenson’s points about Fannie’s sustained profitability, and McFarland’s presentation of that information to the Treasury.
“Apparently days after this information was made available to the Treasury and the FHFA, these entities moved as quickly as possible to institute the amendment that would sweep all of the profits of Fannie Mae to the government. The reason given for the sweep was that Fannie Mae might need more funding,” Bove writes.
“If Ms. McFarland’s testimony is correct, then the reason given for the sweep was a falsehood since the Treasury was well aware that the company could pay its dividend,” Bove continues. “Apparently, the government was also aware that Fannie Mae did not have to pay the dividend in cash. In essence, even the reason that the sweep was necessary to save Fannie Mae’s cash position was incorrect and the Treasury knew it.”
Bove goes on to say that the “key point” of the depositions is that the government was “intent upon disobeying HERA and destroying these two companies.”
Bove adds the reasoning provided for instituting the cash sweep “did not square with the facts” if McFarland’s testimony proves correct.
“What is also very discouraging is that the portion of the depositions I read were more than 50% composed of government lawyers objecting to every question asked,” Bove writes.
“The President, Congress, and the Treasury have publically stated repeatedly, when putting rules in place for the banking industry, that transparency is absolutely required,” Bove concludes. “It is an embarrassment for this country that the government, itself, violently disagrees with what it preaches when it comes to the government providing transparency.”
And it appears that may be just the beginning of the government’s reasons for concern.
In an email to clients this morning, Josh Rosner, vocal conservatorship critic and managing director at Graham Fisher & Co, summarized the development as follows:
“The documents unsealed by Judge Sweeney demonstrate that the UST and FHFA knew, before implementing the 3rd Amendment to the PSPA which swept all future profits of Fannie Mae & Freddie Mac, the GSEs were:
1- On the verge of resumed profitability;
2- Were close to being able to use their deferred tax asset (DTA);
3- The DTA was worth close to $50 billion; and
4- The profit sweep likely was driven by the budget battle;
5- The FHFA violated key sections of the 2008 Housing and Economic Recovery Act by:
a) choosing to rely on new legislation rather than requiring the GSEs to submit a capital plan and rebuild capital;
b) violating HERA’s requirement that FHFA act independently and without interference by any other government agency or department;
c) forcing the dissipation of GSE assets.”