Shareholders of Fannie Mae and Freddie Mac, the two government-sponsored enterprises bailed out by the government, have some hubris.
Like some shareholders of the American International Group, the Fannie and Freddie shareholders have stooped to lawsuits as a way of trying to garner millions from the same government that rescued the entities. As was the case with the A.I.G. shareholders who have sued, they ought to know better.
In the case involving Fannie and Freddie, the shareholders acknowledge that the government takeover of the two entities likely saved Western civilization, but they still blame the government for bailing the two entities out.
That maybe that’s a bit of an oversimplification, but it has a kernel of truth.
The thrust of the argument in the lawsuit is that during the financial crisis, the government first enacted a new conservatorship process for the government-sponsored enterprises, put those enterprises into that process and finally provided lots of new money to the two at a senior level in the capital structure (relative to the old shareholders) to keep the companies afloat.
The result of those actions has been that the previous preferred and common shareholders have been in a kind of limbo ever since. It’s not clear that there is much value left for their junior interests, especially since many politicians would rather shut down and liquidate the two.
There is a kind of high-risk, high-reward play at work with regard to the preferred shares, but the common shares are largely thought to be entirely out of the money as a result of the bailout.
In such a situation, it makes some sense to see whether there might not be some other source of value that might at least put a good face on a lousy outcome. Hence the litigation.
The complaint tries to suggest that there were many other options available to the government, including the notion that Fannie and Freddie didn’t really need to be rescued. That is an argument that seems to ignore the twin threat that they presented to both the global financial system, because of the ubiquity of their securities, and the entire American home lending system.
But ultimately, the complaint boils down to a single claim that the conservatorship process amounts to an unconstitutional taking under the Fifth Amendment, although sometimes the claim seems to slide into a due process claim, too.
The conservator process was enacted as part of the Housing and Economic Recovery Act of 2008. That law does not indicate which power Congress was using when it enacted the act. Arguably, the conservatorship provisions might be deemed an exercise of power under the Bankruptcy Clause, which gives Congress the power to enact bankruptcy laws.
While the Supreme Court has held that laws enacted under the Bankruptcy Clause are subject to the limits of the Fifth Amendment, it has done so only in cases involving
creditors. Our plaintiffs here are not even unsecured creditors; they are shareholders, meaning that they are at the bottom of the capital structure in the event of a bankruptcy.
Therefore, it’s not even clear that the plaintiffs have an interest in “property†that is protected by the takings clause of the Fifth Amendment. That would seem to be kind of important if one is bringing a takings claim.
Stephen J. Lubben is the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and an expert on bankruptcy.
