How Freddie and Fannie are held captive

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 © Kevin Lamarque/Reuters

When Washington took over the beleaguered mortgage giants Fannie Mae and Freddie Mac during the collapse of the housing market and the financial crisis of 2008, it was with the implicit promise that they would be returned to shareholders after being nursed back to health.

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But now, with the unsealing of documents this week that were produced as part of a lawsuit filed against the government, new evidence is coming to light on how intimately the White House was involved in the Treasury’s decision in August 2012 to divert all the companies’ profits to the Treasury Department. That move effectively maintained Fannie and Freddie’s status as wards of the state.

An email from Jim Parrott, then a top White House official on housing finance, was sent the day the so-called profit sweep was announced. It said that the change was structured to ensure that the companies couldn’t “repay their debt and escape as it were.”

The documents also show Treasury moving to modify the terms of the mortgage finance giants’ $187.5 billion bailout shortly after a July 2012 meeting when the Federal Housing Finance Agency, Fannie’s and Freddie’s regulator, learned that they were about to enter “the golden years” of profitability.

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Since then, Fannie and Freddie have returned to the Treasury over $50 billion more than they received in the bailout. The amount they owe to the government remains outstanding.

The new materials cast further doubt on arguments made in court by government lawyers that the profit sweep came about because Fannie and Freddie were in a death spiral and taxpayers needed protection from future losses. Documents unsealed last month also served to undermine that legal stance.

A Justice Department spokeswoman declined to comment.

The trickle of documents comes years after Fannie and Freddie shareholders filed suits against the government, contending that its decision regarding the companies’ profits was illegal. Defending against an array of these suits, lawyers for the Justice Department have requested confidential treatment for thousands of pages of materials. In a case brought in Federal Claims Court, the government’s lawyers asserted presidential privilege in 45 documents.

Treasury’s integral role in the profit sweep comes through clearly in the new materials, indicating that it was in charge of decisions on Fannie and Freddie, and that the Federal Housing Finance Agency, created by Congress in 2008 as a purportedly independent regulator, did as directed.

In the law setting up F.H.F.A., Congress required officials to ensure that the companies were operated in a safe and sound manner with an adequate capital cushion. The profit sweep, the aggrieved shareholders contend, violated that part of the law because it barred the companies from being able to amass capital.

Preventing the companies from using their profits to rebuild a strong capital position was an explicit goal of the Obama administration, the newly unsealed materials show. In an email sent the day the profit sweep was announced, Mr. Parrott said diverting Fannie’s and Freddie’s profits would eliminate “the possibility that they ever go (pretend) private again.”

Sending a message to Fannie’s and Freddie’s shareholders that they should have no hope of profiting from the companies’ recovery was top of mind to Mr. Parrott, the documents show. In another email sent the day the sweep was disclosed, he assured Treasury officials that “all the investors will get this very quickly.”

Investors got the message. But some viewed the action as illegal and began filing lawsuits against the government.

Unlike shareholders of other bailout recipients, including Citigroup, Bank of America and even the insurer American International Group, Fannie and Freddie investors have not been able to participate in the rebound at the companies as their operations boomed.

Mr. Parrott, now a fellow at Urban Institute and owner of Falling Creek Advisors, a consultant to financial institutions, declined to comment on the matter.

The unsealed documents indicate an intense desire to get rid of Fannie and Freddie as independent entities once and for all. They do not show any concern among Treasury officials that their actions on the profit sweep might violate the law.

Only a small portion of the materials produced in the case in Federal Claims Court has seen the light of day. Approximately 50 documents were released on Wednesday to lawyers representing Arnetia Joyce Robinson, an individual investor who sued the government in Kentucky Federal District Court last October.

According to that lawsuit, Ms. Robinson, a retired bank manager and loan officer, bought Fannie and Freddie shares in September 2008 to help fund her retirement.

Ms. Robinson’s suit is one of several that have been filed by investors, some of them giant institutions and speculators in Fannie and Freddie who bought shares after the bailout, contending that the government’s profit sweep was illegal. One case from 2013 was brought under the Administrative Procedure Act, which governs actions taken by government agencies.

Royce C. Lamberth, the district court judge overseeing the 2013 suit, dismissed it in September 2014, but the case is on appeal. In dismissing the complaint, Judge Lamberth seemed to rely on the government’s contention that Fannie and Freddie were in a death spiral.

But the documents released on Wednesday indicate that financial projections for Fannie and Freddie the judge received were significantly out of date. These projections, showing large losses in the near term were produced to the court by the Treasury in a document dated June 2012, but they actually contained figures from September 2011, when the companies’ operations had not yet begun to turn around.

Those projections, produced by Grant Thornton for the Treasury to use in valuing its investment in Fannie and Freddie, did not account for improvements in the housing market that took place in late 2011 and early 2012. As the unsealed materials show, Treasury officials knew in the summer of 2012 that Fannie and Freddie had turned the corner and appeared to be well on their way to a strong recovery.

Experts disagree about what the government’s role in housing should be and whether Fannie and Freddie should be wound down, replaced by some sort of new mortgage finance guarantee.

The significance of these documents, however, goes well beyond the future of housing finance. They demonstrate the perils of allowing the government to act in secrecy. In asking for confidentiality surrounding its actions, the government argued that the release of such documents would roil the financial markets. What seems clearer all the time is that their release will instead help the public understand what the government did here and why.

How Freddie and Fannie are held captive