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Jacobs v. Federal Housing Finance Agency

United States Court of Appeals, Third Circuit

November 14, 2018


          Argued September 7, 2018

          On Appeal from the United States District Court for the District of Delaware (D.C. No. 1:015-cv-00708) District Judge: Honorable Gregory M. Sleet

          Christopher N. Kelly, Esq. Michael A. Pittenger, Esq. [ARGUED] Alan R. Silverstein, Esq. Potter Anderson & Corroon Myron T. Steele, Esq. Counsel for Appellants

          David B. Bergman, Esq. Howard N. Cayne, Esq. [ARGUED] Ian S. Hoffman, Esq. Dirk Phillips, Esq. Asim Varma, Esq. Arnold & Porter Kaye Scholer Robert C. Maddox, Esq. Robert J. Stearn, Jr., Esq. Richards Layton & Finger Counsel for Appellee Federal Housing Finance Agency

          Gerard J. Sinzdak, Esq. [ARGUED] Abby C. Wright, Esq. United States Department of Justice Civil Division Counsel for Appellee United States Department of Treasury

          Robert C. Maddox, Esq. Robert J. Stearn, Jr., Esq. Richards Layton & Finger Meaghan M. Vergow, Esq. O'Melveny & Myers Counsel for Appellee Federal National Mortgage Association

          Michael J. Ciatti, Esq. King & Spalding Robert C. Maddox, Esq. Robert J. Stearn, Jr., Esq. Richards Layton & Finger Counsel for Appellee Federal Home Loan Mortgage Corporation

          Before: HARDIMAN, KRAUSE, and BIBAS, Circuit Judges



         In 2008, the U.S. government strove to rescue the collapsing economy. Its extreme measures helped many, but others suffered as a result. One of the rescue measures, the Housing and Economic Recovery Act, authorized the government to act as conservator for Fannie Mae and Freddie Mac, two government-sponsored enterprises with critical roles in the home-mortgage market. Under that conservatorship, Fannie and Freddie made a deal with the Department of Treasury. The deal guaranteed Fannie and Freddie access to hundreds of billions of dollars. But in return, they had to give their net profits to the Treasury-in perpetuity. Fannie's and Freddie's junior shareholders had expected to share in those future profits, but the deal wiped out that expectation. So some of those junior shareholders now challenge that deal.

         We reject the shareholders' challenge on all fronts. First, the Recovery Act gave the government broad, discretionary power to enter into the deal. Second, the deal complies with the requirements of the Recovery Act, as well as Delaware and Virginia corporate law. And third, the relief sought would "restrain or affect the exercise of [the government's] powers" as conservator, which the Recovery Act forbids. 12 U.S.C. § 4617(f). That relief, even the monetary relief, would unwind the whole deal. So we will affirm the District Court's dismissal.

         I. Background

         A. Statutory framework

         1. Fannie Mae and Freddie Mac.

         In the wake of the Great Depression, Congress created Fannie, and later Freddie, to support the home-mortgage market. Pub. L. No. 91-351, 84 Stat. 450, § 301(b), as amended by Pub. L. No. 101-73, 103 Stat. 183, § 731(a) (codified at 12 U.S.C. § 1451 note) (Freddie Mac); 12 U.S.C. §§ 1716-17 (Fannie Mae). Fannie and Freddie do so by borrowing money, buying home mortgages, packaging them into guaranteed mortgage-backed securities, and selling those securities to investors. 12 U.S.C. §§ 1454-55, 1719.

         By buying mortgages and then guaranteeing the resulting securities, Fannie and Freddie make the mortgage market both more liquid and more stable. Perry Capital LLC v. Mnuchin, 864 F.3d 591, 599 (D.C. Cir. 2017) (Perry Capital), cert. denied, 138 S.Ct. 978 (2018). They relieve mortgage lenders of the risk of default and free up their capital to make more loans. As a result, lenders can keep lending to home buyers who meet Fannie's and Freddie's underwriting standards, secure in the knowledge that Fannie and Freddie will buy those mortgages. By 2008, Fannie and Freddie owned or guaranteed five trillion dollars' worth of mortgages and mortgage-backed securities- nearly half of the market. Id. In short, they are the backbone of the U.S. residential-mortgage market.

         Fannie and Freddie are government-sponsored enterprises; they were created by congressional charter but are owned by private shareholders. 2 U.S.C. § 622(8). Although Fannie and Freddie are privately owned and publicly traded companies, the public has long viewed their securities as implicitly backed by the federal government's credit. That perceived government guarantee has helped them to borrow money and to buy mortgages more cheaply than they otherwise could have. Perry Capital LLC v. Lew, 70 F.Supp.3d 208, 215 (D.D.C. 2014), aff'd in part, 864 F.3d 591. All that borrowing, lending, and buying propelled the housing market to record highs by the mid-2000's.

         2. The Housing and Economic Recovery Act of 2008.

         Then the housing bubble burst. House prices plunged, slashing the value of Fannie's and Freddie's mortgage portfolios. Fannie's and Freddie's guarantees put them on the hook not only for the mortgages they owned, but also for many mortgage-backed securities based on loans gone bad. Congress feared that they might default, threatening not only the housing market but the precarious national economy as a whole. Perry Capital, 864 F.3d at 599.

         To ward off that threat, Congress passed the Recovery Act. The Recovery Act created the Federal Housing Financing Agency and empowered it to supervise and regulate Fannie and Freddie. 12 U.S.C. § 4511. The Recovery Act gives the Agency many enumerated, mostly discretionary powers. For instance, it authorizes the Agency's Director to "appoint the Agency as conservator . . . for the purpose of reorganizing [or] rehabilitating . . . the affairs of" Fannie or Freddie. Id. § 4617(a)(1)-(2). As conservator, the Agency inherits all the "rights, titles, powers, and privileges" of Fannie, Freddie, and their officers, directors, and shareholders. Id. § 4617(b)(2)(A)(i). The Recovery Act also authorizes the Agency as conservator to exercise any "incidental powers as shall be necessary to carry out [its enumerated] powers." Id. § 4617(b)(2)(J)(i).

         3. Section 4617(f) of the Recovery Act.

         Having given the Agency sweeping authority and discretion, the Recovery Act strictly limits judicial review: "[N]o court may take any action to restrain or affect the exercise of powers or functions of the Agency as a conservator or receiver." Id. § 4617(f). This case turns in part on how to interpret and apply that subsection.

         B. Factual background

         In 2008, the collapse of the housing market cost Fannie and Freddie billions of dollars, threatening the U.S. mortgage market. The Treasury quickly took steps to prop up Fannie and Freddie. But the mortgage and financial markets remained perilous, and the financial crisis grew worse. So the Agency put both Fannie and Freddie into conservatorship.

         Under the Agency's direction, they entered into funding agreements with the Treasury. The Treasury gave each enterprise a funding commitment. When Fannie's or Freddie's liabilities exceed their assets, they can draw on that funding commitment to keep their net worth in the black.

         In return, the Treasury received one million shares of senior preferred stock in each of Fannie and Freddie. These shares gave the Treasury a liquidation preference in each enterprise equal to $1 billion plus all the money drawn from the Treasury's funding commitment. The shares also gave the Treasury an annual dividend equal to 10% of the liquidation preference, if paid in cash.

         The Treasury initially capped its funding commitment at $100 billion per enterprise. That was not enough, at least for Fannie. Two amendments to the funding agreement more than doubled that cap, and Fannie and Freddie wound up drawing $116.1 billion and $71.3 billion from the Treasury. But as Fannie and Freddie drew more and more money from the Treasury, they owed it larger and larger dividends. In a vicious cycle, they sometimes had to draw money from the Treasury just to pay the Treasury's dividends.

         In 2012, the Treasury and the Agency renegotiated the funding agreements and agreed to the Third Amendment. The Third Amendment replaced the 10% annual dividend with a quarterly variable dividend. It set that variable dividend equal to Fannie's and Freddie's positive net worth above a capital buffer, which was set to decrease with each dividend payment. The capital buffer is now down to zero. So each quarter, the dividend consumes each enterprise's entire positive net worth. The challengers call this arrangement the Net Worth Sweep.

         In other words, under the Third Amendment, if Fannie or Freddie has a positive net worth, it pays all that worth out as a dividend to the Treasury. If its net worth is zero or negative, it pays nothing. Fannie and Freddie pay only what they can. That way, they need never again draw from the Treasury to pay the Treasury's dividends. But they also have no money left over to pay dividends to junior shareholders or to redeem the Treasury's shares, exit conservatorship, and return to private control.

         C. ...

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