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Is Government’s Defense in Fairholme Suit Valid?

paperwork-filesA federal judge unsealed documents related to Fairholme Funds’ lawsuit against the government over the sweeping of GSE profits into Treasury that may be undermining to the government’s position that the profit sweep was in fact a way to protect taxpayers, according to media reports.

The federal government amended the terms of the bailout in August 2012 to sweep virtually all of Fannie Mae’s and Freddie Mac’s quarterly profits into Treasury. Fairholme, a Florida-based mutual fund that is one of the biggest GSE investors, sued the government in 2013 over the profit sweep, and the suit is still pending. The year 2012 was the first year of profitability for Fannie Mae and Freddie Mac after they received a $188 billion taxpayer bailout in 2008 to avoid insolvency. Under the pre-August 2012 terms of the bailout agreement, the GSEs were required to pay only a 10 percent dividend on their draw from Treasury.

Lawyers for Treasury claimed early in Fairholme’s suit that the GSEs were financially weak and that the profit sweep was a way to protect taxpayers from another bailout. Judge Margaret M. Sweeney in the U.S. Court of Federal Claims, who is presiding over the Fairholme lawsuit, unsealed depositions this week related to the case that point out that the government was aware of the profitability of Fannie Mae and Freddie Mac in 2012, however.

One of the documents unsealed this week was a deposition taken last July from Fannie Mae’s former chief financial officer, Susan McFarland. In that deposition, McFarland said she told high-level officials at Treasury in August 2012 that Fannie Mae was “now in a sustainable profitability, that we would be able to deliver sustainable profits over time,” according to the New York Times. McFarland also said in her deposition she told the Treasury officials that Fannie Mae would soon receive $50 billion in income from a deferred tax asset

A little more than a week after McFarland met with Treasury officials, Treasury announced to the Federal Housing Finance Agency, the GSEs’ conservator, that the terms of the bailout agreement had changed. McFarland said in the deposition that her meeting with Treasury officials is what prompted the government to change the terms and sweep all of the GSEs’ profits into Treasury.

“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.”

Richard X. Bove, Rafferty Capital Markets

“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,” said Richard X. Bove, VP of Equity Research at Rafferty Capital Markets. “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.”

Another deposition released this week was from Mario Ugoletti, a former Treasury official and also a special adviser to the director of FHFA. Ugoletti signed an affidavit stating unequivocally that neither Treasury nor FHFA anticipated in the months prior to August 2012 that the GSEs’ deferred tax assets would be reversed and that such a move was “not intended to increase compensation to Treasury, according to the New York Times.

The New York Times filed a motion with the Court of Federal Claims in July 2015 requesting that the government unseal depositions from key government officials related to the Fairholme suit, including that of Ugoletti.

"The government would like to make people believe that the bailout of Fannie and Freddie was unique and unprecedented. It wasn't,” said Tim Rood, chairman of business advisory firm the Collingwood Group. “The government's 'bailout playbook' has been battle and market tested with the automakers and AIG. The government infuses the companies with capital in exchange for debt and stabilizes the businesses and allows them to rebuild capital. And once the businesses are sufficiently healthy and well capitalized the government converts its debt to equity and liquidates position. The GSEs inherited debt that they were contractually never able to repay under any circumstances. Government owned less than 80 percent of the companies yet swept 100 percent of their profits and reserve capital.”

About Author: Brian Honea

Brian Honea
Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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