Fannie, Freddie Investors File Suit Challenging U.S. Treasury's 2012 "Sweep Amendment"

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1 FOR IMMEDIATE RELEASE July 7, 2013 CONTACT Robert Terra, (O) , (M) Tony Fratto, (O) , (M) Fannie, Freddie Investors File Suit Challenging U.S. Treasury's 2012 "Sweep Amendment" Today, Perry Capital, on behalf of several institutional investment funds, filed suit in the U.S. District Court of the District of Columbia, challenging the 2012 Third Amendment to the government's preferred stock purchase agreements (PSPAs) entered into by U.S. Treasury and the Federal Housing Finance Administration (FHFA). The so-called "Sweep Amendment" illegally changed the rules regarding the government's investments in Fannie Mae and Freddie Mac. Treasury's action violates the Housing and Economic Recovery Act (HERA), the statute authorizing the government's 2008 decision to take the firms into conservatorship. The Sweep Amendment has caused irreparable harm to all private investors in these companies, including community banks, insurance companies, pension funds, university endowments, foundations, and mutual funds. While Treasury's illegal sweep is set to continue indefinitely, the payment to Treasury of $66 Billion on June 29, 2013 demonstrates the capacity of Fannie Mae and Freddie Mac to pay back taxpayers with interest. It is critically important to our economy and for the future of housing finance in the United States that investors have confidence that the rule of law not populism or politics will guide government policy over securities. "This lawsuit seeks to uphold the rule of law," said Theodore B. Olson, partner at Gibson, Dunn & Crutcher and former Solicitor General of the United States. "HERA established very specific rules about the government's limits and obligations under conservatorship. Investors had every right to expect these rules to be followed. If the government wanted to assume the powers of receivership, it could have chosen that course. Instead it chose conservatorship, and with the Sweep Amendment it overreached, exceeding the legal boundaries of the statute and failing to meet obligations of conservatorship mandated by Congress under HERA." Acting pursuant to its authority under HERA, the FHFA placed Fannie Mae and Freddie Mac into conservatorship in Therefore, private investors reasonably expected that the principles of conservatorship not receivership would guide the government's actions. Perry Capital, in fact, began purchasing securities in 2010, well before the rules were changed. As conservator, the statute requires FHFA to preserve the assets of Fannie Mae and Freddie Mac, not liquidate them. When changing the rules governing Treasury's investment, Treasury and the FHFA announced that they were beginning the process of winding down the companies the

2 exact opposite of what the statute explicitly requires, and depriving private investors of their rights. Taxpayers are projected to be paid in full, plus 10 percent interest, by the end of this year or early in 2014, and will retain the right to nearly 80 percent of the companies' common shares. Yet, under the Sweep Amendment, Treasury ignores this reality and detrimentally overrides the rights of all private shareholders. Perry Capital manages investment funds for the benefit of retirement plans, university endowments, foundations, insurance companies and other institutional and private investors. Over its 25 year history, Perry Capital has made significant investments in many different housing related securities. Perry Capital supports efforts to reform Fannie Mae and Freddie Mac and to strengthen the overall housing market. At the same time, it is equally important that all policy decisions regarding the companies be made in accordance with contractual rights and applicable law. The government's respect for the rule of law has given the United States the deepest, most liquid securities market in the world, and it is vital to our economy and our housing finance system that we retain this essential characteristic. For these reasons, Perry Capital has filed suit to protect the rights of its clients. Timeline of Events: ### July 2008: Congress passes the Housing and Economic Recovery Act (HERA), creating the Federal Housing Finance Agency (FHFA), and providing the option to place Fannie and Freddie into conservatorship or receivership. September 6, 2008: FHFA chose to place Fannie Mae and Freddie Mac into conservatorship. This left approximately $34 billion of privately held preferred shares outstanding. September 26, 2008: Treasury enters into preferred stock purchase agreements (PSPAs) with FHFA to purchase senior preferred stock of both Fannie Mae and Freddie Mac and to receive warrants for 79.9 percent of the common stock of each company. May 6, 2009: The First Amendment raises the maximum aggregate amount of funds permitted to be invested by Treasury into Fannie Mae and Freddie Mac from $100 billion to $200 billion. December 28, 2009: The Second Amendment removes the cap on funds available through 2012 to provide stability in the mortgage market. December 31, 2009: Treasury's statutory authority to set the "terms and conditions" of Fannie Mae and Freddie Mac security purchases expires. November 2010: Two years after the rules of conservatorship are established and after Treasury's authority to set the "terms and conditions" of security purchases expires, Perry Capital begins to purchase Fannie Mae and Freddie Mac securities for its institutional clients. August 2012: Treasury and FHFA revise PSPAs via Sweep Amendment from 10 percent annual dividend to quarterly sweep of all profits. Further, these payments will not redeem the

3 senior preferred stock or otherwise reduce the balance owed by Fannie Mae and Freddie Mac, essentially wiping out private investors, and liquidating, rather than conserving, the companies. 2012: Both GSEs become profitable. June 29, 2013: Fannie Mae and Freddie Mac pay a combined $66.4 billion payment to Treasury. With these payments, Fannie Mae has now paid $95 billion of the roughly $116 billion it has received, while Freddie Mac has repaid roughly $37 billion of the $71.3 it received. 2014: Fannie Mae and Freddie Mac are expected to fully pay back the taxpayers plus 10 percent interest. Further Background: In 2008, to provide confidence in the economy, Congress passed the Housing and Economic Recovery Act (HERA). HERA created the FHFA to oversee the entities and gave them the option to place them into conservatorship or receivership. Soon after HERA passed, FHFA determined that Fannie Mae and Freddie Mac should be placed into conservatorship. There were many benefits to this decision. Particularly, by avoiding nationalization, Treasury did not have to consolidate the balance sheets' of the companies in the national debt. However, Treasury and the FHFA have obligations under conservatorship. HERA explicitly states that under conservatorship the companies are to be restored to a "sound and solvent condition" and to "conserve [the companies'] assets and property." HERA also provided temporary authority to Treasury to offer financial assistance to the companies. When offering financial assistance, Treasury was required to determine that financial support was necessary to "provide stability to the financial markets," "prevent disruptions in the availability of mortgage finance," and "protect the taxpayer." When making these determinations, Treasury, among other things, had to consider "the Corporation's plan for orderly resumption of private market funding" or "the need to maintain the corporation's status as a private shareholder company." In September 2008, Treasury exercised this authority and entered into preferred stock purchase agreements (PSPAs) to purchase senior preferred stock of both Fannie Mae and Freddie Mac. The stock had a liquidation preference equal to its purchase price and was entitled to a cumulative dividend equal to 10 percent of the outstanding value. Previously issued classes of preferred stock, which are held by community banks (often at the strong guidance of government), pension funds, university endowments, insurance companies, mutual funds, and other institutional investors, were subordinated to Treasury's senior shares. Between 2008 and 2012, largely because of accounting reserves taken, Fannie and Freddie continued to experience paper losses and were therefore unable to pay the 10 percent dividends owed to Treasury. As a result, Treasury purchased more senior preferred stock, allowing Fannie and Freddie to pay dividends owed to Treasury out of the proceeds of those sales. The sale of additional senior preferred stock to Treasury increased the amount of Treasury's aggregate liquidation preference, and thus the amount of dividends owed to Treasury. Over this time period, Treasury invested a total of approximately $188 billion in

4 Fannie and Freddie and received approximately $55 billion in return in the form of dividends and other fees. As the housing market improved in 2012, the financial outlook for Fannie and Freddie also brightened. The companies began posting sizable quarterly profits. It was at this moment in August 2012 that Treasury and FHFA revised the PSPAs so that instead of the 10 percent dividend, Fannie and Freddie would pay Treasury a quarterly dividend equal to all of the companies' respective net worth above a capital reserve amount that steadily declines to zero in Under the Sweep Amendment, Treasury is entitled not only to every dollar of net profit of Fannie and Freddie, but eventually all of its capital reserves. Over time, this arrangement will reduce the entities to a state of perpetual weakness. The Sweep Amendment was designed to ensure that Fannie and Freddie could not be returned to the private sector and that Fannie's and Freddie's private investors would be wiped out. The Sweep Amendment directly undermines both the rules of conservatorship and Treasury's statutory requirement for providing financial assistance to the companies as explicitly stated in HERA. First, Treasury acted beyond its statutory authority because its authorization to purchase securities of Fannie and Freddie and to set the "terms and conditions" of those purchases expired on December 31, Because the Third Amendment fundamentally changes the nature of the senior preferred stock to allow Treasury to recover all the net income of Fannie and Freddie as long as they remain in operation, the agreement impermissibly altered the terms and conditions of the securities and otherwise constituted a constructive purchase of a new security in violation of this sunset provision. Second, the Sweep Amendment deprives Fannie and Freddie of any ability to rebuild capital or accumulate net assets and therefore does exactly the opposite of "preserv[ing] and "conserv[ing]" their assets. In fact, the press release issued by Treasury regarding the Sweep Amendment emphasized that the amended agreement was the "next step toward responsibly winding down Fannie Mae and Freddie Mac." The Sweep Amendment is thus inconsistent with FHFA's statutory responsibilities. Further, HERA sets forth specific rules governing Treasury's financial assistance to the companies. Because the Sweep Amendment essentially wiped out the value of all private investors in Fannie and Freddie, Treasury's actions were clearly inconsistent with "the orderly resumption of private market funding or capital market access," and the "need to maintain the Corporation's status as a private shareholder-owned company." Stripping capital from the companies keeps the taxpayer in the first-loss position while removing private capital from the mortgage market. This works to ensure that private investors will be completely wiped out, despite HERA and the choice by Treasury to pursue conservatorship explicitly directing the opposite. Lastly, by unilaterally wiping out all minority shareholders, the Sweep Amendment is not consistent with the fiduciary duties majority shareholders owe to the corporation's minority. Under applicable principles of corporate law, a corporation's controlling shareholder owes fiduciary duties to the corporation's minority shareholders. Treasury, as the dominant shareholder of Fannie and Freddie, ignored those duties when it conspired with FHFA to enter

5 into the Sweep Amendment and expropriate the value of the privately held preferred stock for the sole benefit of the federal government. Indeed, there is no evidence that Treasury considered the interests of other holders of Fannie and Freddie securities at all, making its actions unlawful. Highlights From Legal Complaint: The Sweep Amendment, or Third Amendment, Sweeps All Profits From The Companies. "In Treasury s words, under the Third Amendment, it is owed a full sweep of 'every dollar of profit that each firm earns going forward.'" (Paragraph 48) The Sweep Amendment Illegally Destroys The Value Of All Privately Held Securities. "The Third Amendment fundamentally and unfairly alters the structure and nature of the securities Treasury purchased under the PSPAs, impermissibly destroys value in all of the Companies privately held securities, and illegally begins to liquidate the Companies. This blatant overreach by the federal government to seize all of the Companies profits at the expense of the Companies and all of their private investors is unlawful and must be stopped." (Page 2) The Dividends That Will Be Paid Under The Sweep Amendment Are "Expected To Result In A Torrent Of Cash." "The dividends that will be paid under the Third Amendment are expected to result in a torrent of cash to Treasury." (Paragraph 49) "Treasury's additional profits from the Third Amendment are enormous. On or about June 30, 2013, Fannie and Freddie collectively paid Treasury the largest dividend in history: $66.3 billion. By contrast, without the Third Amendment, Treasury would have received $4.7 billion." (Paragraph 10) " the President s proposed Fiscal Year 2014 budget estimated that by the end of the next 10 years, Treasury will have collected more than $238 billion from the Companies, approximately $50 billion more than it cost Treasury to purchase the Government Preferred Stock." (Paragraph 13) The Sweep Amendment Goes Beyond Treasury And FHFA's Authority To Destroy The Value Of The Companies' Preferred Stock. "The Third Amendment enriches the federal government through a self-dealing pact, and destroys tens of billions of value in the Companies' preferred stock." (Paragraph 14) "As the FHFA s inspector general recently observed, the PSPAs mean that 'preferred and common shareholders of [the Companies]... effectively lost their investments. (Paragraph 17) "Treasury s temporary statutory authority to purchase securities issued by Fannie Mae and Freddie Mac expired at the end of 2009 the FHFA lacks any authority to initiate the wind down of Fannie Mae and Freddie Mac." (Paragraph 18)

6 The Sweep Amendment Impairs The Companies' Ability To Operate "In Direct Contravention Of HERA's Statutory Command." "The Third Amendment intentionally impairs the Companies ability to operate as going concerns, preventing them from ever rebuilding capital, achieving financial health, or returning to private ownership." (Paragraph 83) "This dissolution of the Companies is in direct contravention of HERA s statutory command that the FHFA 'conserve [their] property and assets' and undertake those actions necessary to place the Companies in 'a sound and solvent condition '" (Paragraph 84) "Treasury s stated purpose of winding down the Companies, which necessarily involves dissipating their assets and property, is incompatible on its face with FHFA s charge to put the Companies back into 'a sound and solvent condition' and to 'conserve [their] assets and property.'" (Paragraph 55) The Sweep Amendment Turns Temporary Authority Granted By HERA Into "An Unconstrained, Permanent Authority." "Treasury executed the Third Amendment, creating a new equity interest that seizes all of the Companies gains for itself." (Paragraph 63) "This turn[s] HERA's grant of temporary authority to Treasury to purchase the Companies securities under certain conditions into an unconstrained, permanent authority Treasury has thus arbitrarily and capriciously failed to provide a reasoned explanation for its conduct, which results in the government s appropriation of tens of billions in private shareholder value." (Paragraph 65)