Wednesday, April 13, 2016
Documents Undercut U.S. Case for Taking Mortgage Giant Fannie Mae’s Profits
On a Friday in August 2012, the federal government changed the terms of its bailout of Fannie Mae and Freddie Mac, sending all the mortgage finance giants’ profits to the Treasury. The surprise decision prompted a lawsuit from shareholders, who argued that the collection of profits was an improper taking of private property without compensation.
As the lawsuit proceeds through Federal Claims Court, documents unsealed in the case on Monday undermine an important defense made by the United States government. Lawyers for the Justice Department maintained early on in the litigation that Fannie and Freddie were in a death spiral and financially weak. Funneling all their profits to the Treasury was a way to protect taxpayers from future losses at the government-sponsored enterprises, the Justice Department said.
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.”
The mortgage finance giants Fannie Mae and Freddie Mac remain wards of the state years after the credit crisis receded into memory. Under their original rescue, in 2008, they were required to pay a 10 percent dividend on the money they had drawn from the Treasury.
The revised deal, under which their profits are swept every quarter into the Treasury’s general fund, prompted shareholders to sue in Federal Claims Court. Fairholme Funds, a mutual fund company that owns shares in Fannie and Freddie, filed the suit in 2013.
Among the documents unsealed by Margaret M. Sweeney, the judge presiding over the litigation, are excerpts from three depositions taken in the case by lawyers for Fairholme. Those depositions center on what the government knew about Fannie’s and Freddie’s financial position in 2012; this is an important question because the government had justified the taking of profits as a way to protect taxpayers who had extended bailout money to the companies.
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.
A copy of the presentation that Ms. McFarland made to the Treasury was also unsealed. It contains 10 years of internal financial projections from Fannie, indicating that the company would not require further assistance from taxpayers.
A little over a week after her meeting with the officials, the Treasury announced the profit plan with the Federal Housing Finance Agency, the overseer of Fannie and Freddie.
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.”
A spokeswoman for the Justice Department did not immediately respond to a request for comment.
The unsealing of the documents casts a spotlight on a legal proceeding that has been shrouded in secrecy from the start. The court granted the government’s request for confidential treatment of thousands of pages of materials produced in the case; Justice Department lawyers have asserted presidential privilege in 45 documents.
Last year, The New York Times filed an amicus curiae brief asking that the judge unseal two of the depositions in the case. She released excerpts from one of those depositions on Monday.
Further testimony unsealed on Monday came from Mario Ugoletti, a former Treasury official who was a former special adviser to the director of the Federal Housing Finance Agency, the conservator overseeing Fannie and Freddie. In December 2013, Mr. Ugoletti signed an affidavit for the case stating unequivocally that neither the Treasury nor the Federal Housing Finance Agency envisioned that the companies’ deferred tax assets were about to be reversed in the months leading up to the profit sweep, generating huge profits. He also said that the move was not intended to “increase compensation to Treasury.”
But in the deposition in May, Mr. Ugoletti said he did not know whether the Treasury or the Federal Housing Finance Agency officials knew about the potential for the profits at Fannie and Freddie at the time of the sweep.
Mr. Ugoletti, who left government in the fall could not be reached for comment.
A document produced by Grant Thornton, the accounting firm hired by the government to do financial analysis on the companies, casts additional doubt on the government’s contention that it considered Fannie and Freddie to be in a dire financial condition in 2012, when it changed the terms of the bailout. The document, unsealed on Monday, shows Freddie’s financial results through the first quarter of 2012 alongside handwritten notes from an unknown Grant Thornton employee. That employee noted how Freddie’s profits would require that it reverse the accounting entry, known as releasing the valuation allowance.
The notes on the document state: “3 yrs. of cum. profits, you start to think about releasing the valuation allow. The valuation allow. When probably 2013, 2014.”
Since Fannie and Freddie returned to profitability in 2012, they have sent to the Treasury more than $50 billion over the amount they drew down in the bailout. Their profits continue to be funneled to the Treasury each quarter.