A D.C. Circuit Court of Appeal’s decision earlier this year, Perry Capital LLC v. Mnuchin, 848 F.3d 1072 (D.C. Cir. 2017), highlights the breadth of the government’s ability to take actions that harm creditors of federally regulated financial institutions while in conservatorship or receivership. Perry affirms the government’s broad statutory power to divert assets for the government’s benefit, to arrogate contractual rights and to circumvent statutory priorities and other creditor protections, all without judicial review.
While creditors may view Perry as an ad hoc decision related to the specific facts — the financial distress of two widely maligned entities, Fannie Mae and Freddie Mac — the court’s decision is of relevance to investors in federally regulated financial institutions generally. The provisions on which the court based its ruling are also found in statutes that govern bank holding companies, national banks and significant non-bank financial companies.
Background
The 2008 financial crisis resulted in the government taking drastic measures to stanch the decline of the national economy. One such measure related to Fannie Mae and Freddie Mac, referred to as “government sponsored entities” or “GSEs,” which provide liquidity to the housing mortgage market by securitizing mortgages that they purchase from lenders. During the financial crisis, the GSEs experienced significant financial stress, and in order to provide the government with the flexibility to keep these entities afloat, Congress passed the Housing Economic Recovery Act of 2008 (HERA). Under HERA, the GSEs were put into conservatorship by their regulator, the Federal Housing Finance Agency (FHFA). Between 2009 and 2012, the U.S. Department of Treasury injected over $187 billion of capital into the GSEs in the form of a preferred stock investment.
Under the terms of its initial capital infusion, Treasury was entitled, among other things, to a fixed quarterly dividend of 10% of the liquidation preference of its preferred stock investment and periodic commitment fees. However, in August 2012, Treasury and the FHFA amended the terms of the preferred stock investment such that all of the GSEs’ quarterly profits were transferred to Treasury. This amendment, referred to as the “net worth sweep,” was made for no additional consideration. Instead, Treasury and the FHFA simply declared that the net worth sweep was necessary so that the GSEs would not draw on Treasury’s funding commitment to pay dividends on the preferred stock.
The net worth sweep proved to be a boon for Treasury. Shortly after its effectiveness, the GSEs had significant profits and required no further capital infusions from Treasury. Through May 2017, Treasury had earned $271 billion on its investment of $187 billion.1
The GSEs’ preferred and common stockholders objected to the net worth sweep, for obvious reasons. Because of the net worth sweep, the GSEs could never redeem the preferred stock issued to Treasury, and consequently would never be able to make distributions on the equity held by private investors.
HERA is modeled on the Federal Deposit Insurance Corporation’s statutory conservatorship authority found in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). HERA grants the FHFA broad rights as conservator of the GSEs. Among other things, the FHFA is appointed as conservator “for the purpose of reorganizing...
