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Fannie, Freddie Plaintiffs Claim Takeover Deepened Losses

Stocks in this article: FNMA FMCC

Later, as director of the Federal Housing Finance Agency, which now regulates Fannie and Freddie, Lockhart said at a June 2009 conference that "the affordable-housing goals set by HUD were, in retrospect, too high and caused both of them to do things they shouldn't have done, such as Fannie's getting involved in the subprime market, where it should never have gone."

Secrecy Heading Into Conservatorship

The complaint sets out the timeline leading to the GSEs' placement into conservatorship, while painting a picture of Lockhart and former Treasury Secretary Henry Paulson that's anything but pretty.

On July 10, 2008, Lockhart said in a press release that Fannie Mae and Freddie Mac were "adequately capitalized, holding capital well in excess of the OFHEO-directed requirement." Paulson on the same day made a similar statement before the House Banking Committee.

But OFHEO had in June "changed the mortgage loan loss severity formulas used in the Companies' regulatory risk-based capital stress test." The new standards were to have been applied at the end of the third quarter of 2008. Fannie Mae estimates the new standards would have raised its regulatory capital requirement by $7.3 billion.

Fannie and Freddie were placed under FHFA conservatorship on Sept. 7, 2008, after analyzing the GSEs' financial condition over the previous four weeks. But "FHFA Director Lockhart and Treasury Secretary Paulson blindsided the Companies and their shareholders," according to the complaint, because the analysis was done in secret, with no communications with GSE executives.

"The government intended to keep this plan secret until the last possible minute," according to the complaint. In a now famous quote, Paulson said to President George W. Bush on Sept. 4, 2008 that FHFA and the Treasury were "going to move quickly and take them by surprise. The first sound they'll hear is their heads hitting the floor."

According to the complaint, the consent of the GSEs' boards of directors to the conservatorship "was by no means voluntary," despite a statement to the contrary by Lockhart.

Cycle of Borrowing

The private investors make the case in the complaint that the "usurious" dividend rate on government-held senior preferred shares in Fannie and Freddie helped feed a "never-ending cycle of borrowing." The government-held preferred shares had an initial dividend rate of 10%, which was double the rate for the first five years on government-held preferred shares in bailed-out banks.

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