An Unexpected Ruling

This past Wednesday the Supreme Court made its ruling in Collins v. Yellen, and it went heavily against the plaintiffs. On the most important issue—the legality of the net worth sweep under the Administrative Procedures Act, or APA—plaintiffs lost outright. In an opinion authored by Justice Alito, the Court ruled that, “The ‘anti-injunction clause’ of the Recovery Act provides that…’no court may take action to restrain or affect the exercise of powers or functions of the Agency as conservator or a receiver,” and that, “Where, as here, the FHFA’s challenged actions did not exceed its ‘powers or functions’ ‘as a conservator,’ relief is prohibited.”

The ruling on the constitutional issues was more complex, but for plaintiffs not much better. Here, the Court made four major rulings: (1) “The Recovery Act’s restriction on the President’s power to remove the FHFA Director…is unconstitutional,” and the President may remove him or her at will (indeed, President Biden already has replaced Director Calabria with one of his three Deputy Directors, Sandra Thompson); (2) “Shareholders no longer have any ground for prospective relief” because the January letter agreement between Treasury and FHFA “eliminated the variable dividend formula that caused the shareholders’ injury” (I believe this is an erroneous ruling, since the letter agreement did not eliminate Treasury’s liquidation preference, and only temporarily suspended the sweep); (3) the Acting Director who agreed to the net worth sweep, Ed DeMarco, was removable by the President (although the statute is silent on this), which limits the retroactive relief plaintiffs may seek, and (4) the “harm caused by a confirmed Director’s implementation of the third amendment could then provide a basis for relief.” This last issue was remanded to the lower court, and my view on it is similar to that of Justice Kagan, who in her concurring opinion said: “It’s hard not to wonder whether…[the Court] intends for this speculative enterprise [the remand] to go nowhere,” while noting that the Court “may calculate that the lower courts on remand in this suit will simply refuse retroactive relief.”

I was not optimistic about the chances of success on the constitutional claims in Collins—although I was pleased that the Court paved the way for Director Calabria’s removal—but I had been highly confident that plaintiffs would prevail on the APA claim. I did not, though, count on all of the justices agreeing on a strained reading of the statute, nor on their giving no weight to the background facts on the case presented by plaintiffs (and me, in my amicus curiae brief). Yet that is what occurred.

Whether the anti-injunction provision in the Housing and Economic Recovery Act (HERA) bars relief on the APA claim depends on whether the net worth sweep exceeded FHFA’s statutory conservatorship powers. In the Perry Capital case, Judge Lamberth ruled that the sweep did not, because, he claimed, the statute said that the conservator “may,” rather than “shall,” take certain actions, and also because section 4716 (b) (2) (J) in HERA, titled “Incidental Powers,” said FHFA could “take any action authorized by this section, which the Agency determines is in the best interests of the regulated entity or the Agency.” The Fifth Circuit Court of Appeals hearing the Collins case en banc convincingly overturned both of these holdings in its decision. The government dropped the “may versus shall” argument in its brief to the Supreme Court, but kept the argument that the incidental powers provision in HERA turned FHFA into a conservator with essentially unlimited discretion. Justice Alito seized upon this to justify his ruling on the APA claim: “Instead of mandating that the FHFA always act in the best interests of the regulated entity, the Recovery Act authorizes the Agency to act in what it determines is ‘in the best interests of the regulated entity or the Agency (emphasis added).’ Thus, when the FHFA acts as a conservator, it may aim to rehabilitate the regulated entity in a way that, while not in the best interests of the regulated entity, is beneficial to the Agency and, by extension, the public it serves. This distinctive feature of an FHFA conservatorship is fatal to the shareholders’ statutory claim.”

Except that’s not what HERA says. Section 4716 (b) (2) is called “General Powers,” and it has 11 subsections, labeled (A) through (K). Section 4716 (b) (2) (D) is titled “Powers of Conservator,” and it reads in full: “the Agency may, as conservator, take such action as may be—‘(i) necessary to put the regulated entity in a sound and solvent condition; and ‘(ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.” After five more subsections comes subsection 4716 (b) (2) (J), “Incidental Powers,” and this is where the clause appears saying that FHFA may “take any action authorized by this section, which the Agency determines is in the best interests of the regulated entity or the Agency.”

Incidental means “accompanying but not a major part of something.” A plain reading of the statute, therefore, is that the permission granted FHFA to act in its own interest is limited to the exercise of its incidental powers, and does not extend to the conservatorship as a whole. Otherwise, what is the purpose of having specified those powers in section 4716 (b) (2) (D)? In a 2001 decision, Whitman v. American Trucking, Justice Scalia famously wrote, “Congress, we have held, does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.” Justice Alito looked into the mousehole of the “Incidental Powers” section of HERA and said he saw an elephant in there, and the other justices said they saw one too.

Equally unexpected was the Court’s accepting the government’s fictitious and disproven rationale for having entered into the net worth sweep. Justice Alito’s recounting of the context of the sweep could have been taken from any one of dozens of the government’s filings in the APA cases over the years: “Recall that the third amendment was adopted at a time when the companies’ liabilities had consistently exceeded their assets over at least the prior three years…. If things had proceeded as they had in the past, there was a realistic possibility that the companies would have consumed some or all of the remaining capital commitment in order to pay their dividend obligations, which were themselves increasing in size every time the companies made a draw. The third amendment eliminated this risk by replacing the fixed-rate dividend formula with a variable one.”

In its brief for the Court, counsel for the plaintiffs, Cooper & Kirk, told a very different story about how the sweep came about, and what its true purpose was. Cooper & Kirk discussed the temporary or estimated book expenses FHFA directed the companies to make, and how they had begun to reverse in the months before the net worth sweep was imposed. They noted in particular Treasury’s being aware of the imminent release of both companies’ deferred tax asset reserves, a Fannie executive’s expectation of a “golden age of earnings” ahead, and Treasury’s statement that “every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers.” And at Cooper & Kirk’s request I filed an amicus brief with the Court, laying out the facts in considerably more detail, with cites and footnotes. The Court neither acknowledged nor refuted any of these factual submissions; it simply ignored them. 

Cooper & Kirk had been concerned something like this might happen. In their brief they wrote: “Plaintiffs’ statutory claim comes to the Court on a motion to dismiss, and at this stage of the litigation the Complaint’s factual allegations must be accepted as true. Despite grudgingly acknowledging this most basic rule of civil procedure…Defendants contradict the complaint on nearly every page of their brief that discusses application of Section 4617(f) to the facts of this case….Defendants know that these statements contradict the Complaint, yet they persist in making them because the “risk” of unaffordable 10% cash dividends that the Companies supposedly faced in mid-2012 is the starting point and necessary factual premise for Defendants’ entire argument that the Net Worth Sweep preserved and conserved the Companies’ assets.” Cooper & Kirk concluded their argument on this point by saying, “The Court cannot credit this claim given the Complaint’s contrary factual allegations,” yet the Court went ahead and did precisely that.

So, what is one to make of a unanimous ruling on the APA claim in Collins by the highest court in the land that relies on a reading of section 4716 (b) (2) (J) of HERA so strained as to not be credible (virtually identical language exists in the Incidental Powers section of the FDIC Act, and it has never been read to apply to FDIC conservatorships as a whole), and a refusal to credit, or even consider, the facts of the case as alleged by the plaintiffs? We cannot know for certain, but there is a suggestive clue in the partial concurring opinion of Justice Gorsuch, in which he questions what he calls the “novel and feeble” direction to the lower courts in the remand on the constitutional issue to “inquire whether the President would have removed or overruled the unconstitutionally insulated official had he known he had the authority to do so.” In the midst of his discussion of this topic we find this sentence: “It is equally possible that—had Congress known it could not have a Director independent from presidential supervision—it would have deployed different tools to rein in Fannie Mae and Freddie Mac.“

Where did this notion that the purpose of HERA was to “rein in” Fannie and Freddie come from? That is not what was happening at the time. In the summer of 2008, when HERA was passed, the private-label securities market had collapsed, banks had pulled way back on mortgage lending because of soaring delinquencies, and Congress five months earlier had raised Fannie and Freddie’s loan limits from $417,000 to $759,750, making them “the only game in town,” as Treasury Secretary Henry Paulson described them to the Financial Crisis Inquiry Commission. No one was talking about “reining in” Fannie and Freddie as the crisis was unfolding. To the contrary, that’s why Paulson nationalized them. He knew they were the only game in town, and wanted them under governmental control in that situation. This also is when what I call the Financial Establishment created and began to disseminate its fictitious version of the financial crisis—that its cause was not the foolish experiment with unregulated private-label securitization, but Fannie and Freddie.

I believe this version of Fannie and Freddie as problems is the only one the Supreme Court justices have ever heard, and some may have been hearing it for thirteen years. All six of the conservative justices (Roberts, Thomas, Alito, Gorsuch, Kavanaugh and Barrett) are members of the Federalist Society, for which “reining in” or eliminating Fannie and Freddie has been a crusade for more than two decades. And it’s likely that even the liberal justices have not heard a kind word (or a real fact) about the companies throughout their careers.

This interpretation of the justices’ pre-oral argument mindset with respect to Fannie and Freddie not only would explain the bizarre unanimous verdict on the APA claim, but also could explain why the Court took the highly unusual step of granting certiorari on an interlocutory appeal of the decision on the APA claim by the Fifth Circuit en banc in the first place. The en banc panel had ruled that the lower court’s dismissal of this claim had been wrong on the law, and sent it back for a trial on the facts. There, plaintiffs almost certainly would have prevailed—likely in a motion for summary judgment—because of the vast amount of evidence produced in discovery for the Court of Federal Claims proving that Treasury knew that its stated rationale for the net worth sweep was false, had admitted this to itself, and then lied about it to the public (and the courts). An appeal to the Supreme Court of a decision favoring plaintiffs on the facts would have left scant room for reversal. It is not hard to envision some of the more virulent opponents of Fannie and Freddie in the Federalist Society going to one or more of their conservative justice colleagues and saying something to the effect of, “You shouldn’t wait for this case to come back to you after a ruling on the facts; if you grant cert now at the interlocutory stage, you still can rule against these terrible companies on the law, and avoid having to deal with the facts at all.”           

However it may have come about, there can be little question that the Court’s ruling on the APA claim in Collins was imposed upon the case rather than deduced from it. And this has implications for both of the major net worth sweep-related cases remaining in the lower courts—the breach of contract claims before Judge Lamberth in the DC Circuit, and the regulatory takings claim in the Court of Federal Claims previously before Judge Sweeney and now before Judge Schwartz. While the case for each has been strengthened by the loss on the APA issue in Collins (if the government has the right to take shareholders’ property, shareholders have the right to compensation for that action), the path to a final judgment favoring plaintiffs still runs through the Supreme Court. The Court’s ruling in Collins ought to reinforce to counsel in these cases the wisdom of anticipating heavy hands on the scales of justice as they prepare and present their legal and factual arguments.

In the meantime, the spotlight will shift to the Biden administration. It has inherited a mess. Fannie and Freddie are closing in on thirteen years in conservatorship. No one doubts they have been “conserved:” they are extremely profitable, and arguably now have the highest-quality books of credit guarantees in their histories. Yet (ex-FHFA Director) Mark Calabria has given them a ludicrously high target for the amount of capital they must attain before they can exit conservatorship, which would take them nearly a decade to reach through retained earnings alone, and they do not have access to the capital markets because even though the net worth sweep has been suspended, Treasury’s liquidation preference in the companies remains, and continues to grow with their retained earnings. Fannie and Freddie are thus stuck in limbo, with no evident way out on their own.

I believe the Biden administration understands that this is its problem to fix. If it does not attempt to, its economic team will look weak and ineffective. But beyond that, Fannie and Freddie have the potential to play enormous roles in helping to meet the administration’s priorities for housing in general, and affordable housing in particular. There is no chance of any housing-related legislation getting through this Congress, so the Biden team will need to rely on the tools it has. Two of its most important ones, Fannie and Freddie, have been hamstrung (deliberately, I believe, and for ideological reasons) by the now-departed FHFA director. With support from the administration’s top policy figures, a new FHFA director could take the lead on getting Fannie and Freddie properly capitalized and regulated, canceling the net worth sweep and settling the remaining lawsuits, and creating a path for the companies to quickly and safely exit conservatorship, thus putting them back in their traditional roles of buoying the economy by making mortgage credit more available and affordable to a wide range of low- moderate- and middle-income homebuyers. While this may not happen for a while, I am confident that it will at some point. And if it does, then last week’s unexpected Supreme Court ruling will have been only a temporary setback for the homebuyers who benefit from Fannie and Freddie financing, and the investors who must provide the new capital that make this financing possible.