A hedge fund hoping to capitalize on the comeback of Fannie Mae and Freddie Mac claims in a lawsuit the government illegally seized the profits of the two mortgage finance giants.
The suit, filed Sunday by Perry Capital LLC, says the government violated a 2008 law that put Fannie and Freddie into conservatorship, through an amendment changing the terms of the government's bailout.
Under original terms, Fannie and Freddie paid fixed quarterly dividends equal to 10% of the government's stake.
But in 2012, the U.S. Treasury Department amended the terms of the bailout and began taking all Fannie and Freddie's quarterly profits.
Theodore Olson, an attorney representing Perry Capital, said in a news release the 2008 law "established very specific rules about the government's limits and obligations under conservatorship. Investors had every right to expect these rules to be followed.
"If the government wanted to assume the powers of receivership, it could have chosen that course," Olson said. "Instead, it chose conservatorship, and with the [amendment] it overreached, exceeding the legal boundaries of the statute and failing to meet obligations of conservatorship mandated by Congress" under the 2008 law.
Amendment said to Hurt Private Investors in Fannie Mae, Freddie Mac
The lawsuit claims the amendment has hurt private investors and that the government "maneuvered to ensure that Treasury would be the sole beneficiary of the companies' improved financial position."
Perry Capital's lawsuit, which does not seek monetary damages, asked that the U.S. District Court in Washington to rule the amendment illegal and prevent the government from enforcing it.
Perry Capital has been purchasing preferred shares in Fannie and Freddie since 2010 – it wouldn't disclose its stake – and argues the 2008 law required the Federal Housing Finance Administration to preserve the assets of the two companies.
"It is critically important to our economy and for the future of housing finance in the United States that investors have confidence that the rule of law – not populism or politics – will guide government policy over securities," the news release said.
Hedge funds including Perry Capital and Paulson & Co. Inc., both of which bet heavily against housing before the financial crisis, have reportedly lobbied to keep Fannie and Freddie alive.
The hedge funds have invested in junior preferred shares of Fannie and Freddie, both of which have recently returned to profitability.
The U.S. Treasury holds about $188 billion worth of senior preferred bonds in Fannie and Freddie – the amount of the government bailout – and has received from the companies $132 billion in dividend payments (classified as return on the government's investment and not repayment). The government also has warrants on 80% of the common stock.
Gilani: Government Could Have Taken Ownership
Money Morning Capital Wave Strategist Shah Gilani said he supports Perry Capital in the lawsuit.
"The government had no legal right to 'sweep' all of Fannie and Freddie's profits into their pockets," Gilani said.
"If the government wants to own the two monsters, they should exercise their warrants, take their 80% position and take their chances as equity owners. Then they could pay themselves whatever dividends they want, since they would essentially own the two giants."
The case has nothing to do with the public's outrage over bailing out banks, Gilani said.
Rather, he said, "This is about a hedge fund that is well and smartly run making a private decision to invest in what are essentially public companies under the conservatorship, not the ownership, of the U.S. Treasury, and the government's overreach under the cover of, 'We bailed you out and we will do what we want with your profits to show the public we are good custodians of taxpayer money.'"
The suit comes about two weeks after a bipartisan group of U.S. senators proposed eliminating Fannie Mae and Freddie Mac and replacing them with a government reinsurer, the Federal Mortgage Insurance Corp.
"It lessens the footprint of the federal government in housing and winds down Fannie and Freddie," Bob Corker, R.-Tenn., one of the bill's lead co-sponsors, said at a news conference. "But at the same time, it keeps the housing industry in a liquid state."
President Barack Obama backs the measure, White House spokeswoman Amy Brundage said. "The president strongly supports comprehensive housing reform that would forever end Fannie Mae and Freddie Mac's flawed business models that put the American taxpayers on the hook," she said.