Rafferty Capital Markets’s Richard X. Bove digs deep into the Fannie Mae / Freddic Mac issue, arguing that the government has been a little too heavy-handed, perhaps overstepping its bounds, much to the chagrin of non-government shareholders.

Fannie Mae and Freddie Mac’s conservatorship

It is becoming increasingly clear that the United States may have overstepped its legal rights in the handling of the Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) conservatorship. While I have no legal background I strongly believe that the government will lose its case against the numbers of companies now suing it relative to its expropriation of the profits of Fannie Mae (and Freddie Mac).

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The issues are very simple. Under the Home and Economic Recovery Act of 2008 (HERA) the United States established a conservatorship to operate Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) until these companies could be returned to their charter status owned by their shareholders.

In 2012, the U.S. Treasury unilaterally changed this law without the approval of Congress. Under the so-called third amendment, the Treasury stated that all of the profits of Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) would be handed to the Treasury and none of these funds would be made available to the preferred and common shareholders of these companies.

Abrogation of the property rights

In effect, the Treasury nationalized these companies without any action taken by the Congress and for the sole benefit of the Treasury. This was a de facto expropriation of the firms without any compensation to the public holders of the preferred and common stock of the companies. From my perspective, it was a clear abrogation of the property rights of the owners of these companies without due process of law. In fact it was a clear repudiation of a law set up by the Congress.

In its court filings as to why it decided to override the law of the United States, the Treasury said it acted because the companies were under duress and would lose all of their cash. This view in hindsight was totally incorrect and it misrepresented the terms of the Treasury’s senior preferred stock. Under these terms, Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) was under no obligation to make cash payments to the government; it could have met its obligation by paying stock.

Information made available by the New York Times is also suggesting that Treasury is guilty of withholding material information from shareholders relative to Treasury’s intentions. If so this would be a securities fraud.

In sum, at this stage it appears that the Treasury may have broken more than one law and if so its defense of its actions is very weak.