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.
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."
For several years, subsequent "draws" on the Treasury by the GSEs were in great part used to cover dividends on the government's preferred shares. Yes, the GSEs were borrowing from the government to pay the government. Then in August 2012, the government stopped playing the dividend game with the GSEs, and simply required them to pay all income over to the Treasury as dividends, less a minimal $3 billion capital buffer for each GSE. But the weakest part of the complaint is that following their placement into conservatorship, the government used Fannie and Freddie "as a vehicle to restore investor confidence in the mortgage market by providing a mechanism for other financial institutions to unload their bad mortgage debts." There are no numbers backing up this claim, in the complaint. The shareholders in the complaint go on to quote Fannie Mae alone in saying the company "provided approximately $2.3 trillion in liquidity to the mortgage market in 2009 through 2011 through
its purchases and guarantee of loans." Fannie and Freddie have indeed greatly increased their role in the secondary mortgage market, however, loans originated from 2009 and later were underwritten under much more strict criteria than they were before the housing crisis began. These newer loans are providing a great deal of the GSEs current profitability. Neither Hagens Berman Sobol Shapiro nor Spector Roseman Kodroff & Willis immediately responded to requests for comment. -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn