Fannie, Freddie Plaintiffs Claim Takeover Deepened Losses

NEW YORK ( TheStreet) -- A review of the court complaint filed by private shareholders of Fannie Mae ( FNMA) and Freddie Mac ( FMCC) against the federal government shows a strong set of arguments against the legality of the companies' takeover, but also includes a weak argument that their losses since September 2008 were fed by an expansion of their mortgage investments.

Fannie and Freddie -- together known as the government-sponsored enterprises, or GSEs -- were taken under government conservatorship in September 2008. The U.S. Treasury holds $189.4 billion in senior preferred share of the GSEs in lieu of bailout assistance, while dividends on all other share classes have been suspended since September 2008.

The complaint filed on Monday by Hagens Berman Sobol Shapiro LLP of Seattle and Spector Roseman Kodroff & Willis, PC of Philadelphia on behalf of a subsidiary of Washington Federal of Seattle, the Austin Police Retirement System and a private investor, seeks $41 billion in damages, alleging the government's takeover of the GSEs violated the U.S. Constitution.

The main argument of the complaint is that the government had no legal right to take over Fannie and Freddie, since the GSEs were not insolvent and had not violated any regulatory orders. Rather than simply provide bailout funds to prop up the GSEs, as the government did for so many of the nation's largest banks, the GSEs were taken over so the government could directly use Fannie and Freddie to shore up the U.S. mortgage financing market, according to the complaint.

"These actions, while beneficial to the economic welfare of the nation, destroyed the value of Fannie Mae's and Freddie Mac's common and preferred stock and trampled the private ownership rights and property interests of the shareholders who owned these publicly traded Companies -- the very same companies that the Government had privatized years ago for its own financial benefit," according to the complaint.

Pressure to Buy Subprime Mortgage Loans

The private shareholders in the complaint make a strong case that government pressure to increase GSE investments in subprime mortgage loans helped lead to the crisis faced by the GSEs in 2008. In August 2007, James Lockhart -- then the director of the Office of Federal Housing Enterprise Oversight (OFHEO), when then regulated the GSEs -- "adjusted the Companies' ending standards so that they could purchase as much as $40 billion, combined, in new subprime loans," according to the complaint.

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