Last Resort: The Financial Crisis and the Future of Bailouts by Eric A. Posner

Author:Eric A. Posner
Language: eng
Format: epub
Published: 2017-08-23T16:24:00+00:00

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114 * chaPTer Five

Before the net worth sweep, Fannie and Freddie had recovered to the ex-

tent that they could have paid all their debts, fulfilled their obligations

to pay 10 percent dividends to Treasury, and still been worth something.

That residual was owned by the plaintiffs.11 The net worth sweep trans-

ferred that residual from the plaintiffs to Treasury. This exaction was not

authorized by law.

The actual arguments were more complex. HERA gave FHFA con-

siderable discretion to manage the GSEs after they were put in conser-

vatorship. Once FHFA determined that Fannie and Freddie were under-

capitalized—and Fannie and Freddie were undercapitalized in September

2008, as were all major financial institutions, if one uses the crisis- driven

prices at the time—then FHFA could place them in conservatorship. Con-

servators normally are given wide discretion to manage the firms under

their control, and FHFA was no exception. The law stripped courts of the

power to block FHFA’s action unless they were egregious.

The plaintiffs argued that FHFA’s actions were egregious. So were Trea-

sury’s. FHFA and Treasury both violated the law—FHFA by driving the

GSEs into what will eventually be liquidation rather than “conserving”

them, Treasury (as well as FHFA) by engineering the net worth sweep.

And if HERA authorized these actions, then Congress violated the Con-

stitution by passing a law that enabled FHFA and Treasury to expropriate

profits from the shareholders.

The Merits: Procedural Irregularities

The plaintiffs argue that FHFA and Treasury engaged in numerous proce-

dural irregularities. Several plaintiffs argue that Fannie and Freddie were

not undercapitalized or in violation of the law in any way in September

2008. FHFA failed to make a showing that they were and failed to give

the GSEs an opportunity to raise capital if necessary, as was required by

HERA. Instead, FHFA and Treasury “bullied” the directors of both GSEs

into accepting the conservatorship.

Once FHFA took control of Fannie and Freddie, it was required by law

to manage the GSEs in the interests of all stakeholders—shareholders as

well as creditors. When FHFA negotiated deals with Treasury, it should

have treated these deals as arms- length relationships and strived for the

best terms that it could get, just as a private company would if it were

negotiating for loans or investments from Treasury. Yet FHFA and Trea-

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