A lawsuit challenging the manner in which profits from Fannie Mae and Freddie Mac (the GSEs) have been allocated to the U.S. Treasury was dismissed on Tuesday by a U.S. District Court judge.  The suit, brought by institutional investors Perry Capital, LLC, Fairholme Funds, Inc. and Arrowood Indemnity Company, contested a change in the Senior Preferred Stock Agreement negotiated between the GSEs and the Treasury Department in August 2008 when the GSEs were placed in government conservatorship. 

The three companies originally filed separate lawsuits in July 2013 but it appears that they may have been combined by the courts into a single action.  The investors maintained that the 2012 changes violated the original terms of the government's 2008 bailout agreement and that they unlawfully impair shareholder value.

Under the terms of the original agreement the GSEs were permitted to make a quarterly draw from the Treasury to cover net worth deficits up to a cap of $100 billion each, later increased to $200 billion.  In return the GSEs gave Treasury senior preferred stock with an initial value of $2 billion which increased dollar-to-dollar with each draw made from the Treasury.  As of December 2012 Treasury held senior preferred stock with a liquidation preference of $189.5 billion for the two GSEs - the original $2 billion plus an aggregate of $187.5 billion in draws to that date. No further draws have been made since that date. 

The GSEs also agreed to provide Treasury with quarterly dividends at an annual rate of 10 percent of the liquidation preference.  As a result, even before Treasury provided any funds to the GSEs, they each owed Treasury dividend payments of $100 million per year.  The structure of the agreement meant that the quarterly net deficit of each GSE was increased each quarter by the amount of the required dividend as was the size of the necessary Treasury draw. 

In August 2012 both GSEs announced they had generated positive quarterly earnings and two weeks later Treasury and the Federal Housing Finance Agency (FHFA), the GSE conservator, announced modifications to the PSPAs in five areas one of which was a change to the structure of the dividends.  As of January 1, 2013 the payment would no longer be based on a fixed percentage of the liquidation preference but on a positive net worth model in which Treasury would simply do a quarterly "sweep" of the entire positive net worth of each GSE above a buffer.  The buffer was originally set at $3 billion of each GSE and would gradually be reduced to zero over five years.   

At the time it was filed the Fairholme suit argued that The GSEs are not allowed to build any capital reserves and the amounts paid to Treasury do not count toward paying back the billions of dollars Treasury contributed to shoring up the companies as they rebuilt their businesses.    The Perry lawsuit said, "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,"  The Perry suit maintained that the U.S. Treasury could collect more than $200 billion of profit from the two companies. 

As of the September 2014 dividend payment Fannie Mae will have paid a total of $130.5 billion in dividends to Treasury in comparison to $116.1 billion in draw requests since 2008 and Freddie Mac's dividends will total $88.2 billion against $72.3 billion in Treasury support.

In dismissing the suits yesterday' the court stated that Treasury and FHFA had been given the power by Congress under the Housing and Economic Recovery Act (HERA) to take the companies' profit, although he said it was understandable for the sweep to "raise eyebrows or even engender a sense of discomfort."

The judge cited the "unambiguous" language of HERA's statutory provisions and the "unequivocal language" of the senior preferred stock certificates issued under the original agreement.  These, he said, compelled the dismissal of the plaintiffs' claims.  He suggested that the investors take up their grievances with Congress.

Both Perry and Fairholme are known to have invested heavily in the GSEs since they were put in conservatorship.  While the extent of Perry's holdings are not known, Fairholme had confirmed its acquisition of $2.3 billion in GSE stock prior to filing its lawsuit.