Executive Summary 

• After 15 years seeking redress via the courts, this week shareholders of mortgage giants and government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were awarded $612 million as a federal court ruled that the Federal Housing Finance Agency (FHFA) had acted in breach of contract by locking them out of future earnings in perpetuity. 
• The decision stems from the FHFA’s 2012 amendment of the contractual agreement establishing “temporary” conservatorship of Fannie and Freddie, which directed the companies to return nearly all of their profits back to the Treasury, in what came to be known as the “net worth sweep.” 
• This is a small victory for the GSEs’ shareholders, however: The $612 million represents an extremely small fraction of the billions of dollars in profit the GSEs have subsequently sent to the federal government, and it is likely the FHFA will appeal the court’s decision. 

Context and the Net Worth Sweep

In the wake of the 2008 financial collapse, the federal government created regulatory bodies to oversee aspects of the financial services industry, most notably the Federal Housing Finance Agency (FHFA) and the Consumer Financial Protection Bureau (CFPB). Congress passed the Housing and Economic Recovery Act of 2008 (HERA), and in so doing, created the FHFA as a brand-new supervisory agency to regulate the housing market. HERA was designed to prevent the collapse of mortgage giants and government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, but just six weeks after HERA was signed the FHFA made both wards of the state via conservatorship. 

The federal government became the financial managers of the GSEs in exchange for a Senior Preferred Stock Purchase Agreement that would pay back the billions of taxpayer dollars used to ensure their solvency during the crisis. Under the terms of the deal, the Department of the Treasury offered the GSEs up to $200 billion in capital support in exchange for warrants of over 79.9 percent of common stock together with some preferred stock. Initially, the support carried a 10 percent cash dividend. This assumption was initially envisioned as a temporary measure to help the GSEs return to their normal business operations of providing liquidity, stability, and affordability to the housing market, as mandated by their government charter. 

Four years later, there were few signs that the conservatorship of the GSEs was ending. Conversely, the government had realized the unprecedented control that effective nationalization of the mortgage giants gave them over housing markets. This was only one of the key benefits of retaining the GSE conservatorship; it has been subsequently alleged that key government figures were aware that the GSEs stood to turn a tidy profit. Against this backdrop, Treasury and the FHFA doubled down on the conservatorship, creating what came to be known as the “net worth sweep.” The Senior Preferred Stock Purchase Agreements were amended to direct the GSEs to return all profits generated to Treasury, excluding the bare minimum required to keep them afloat, canceling the 10 percent dividend and essentially locking shareholders out of receiving dividends from their investments in perpetuity. 

Berkley Insurance Co. v. FHFA 

For 15 years, shareholders of the GSEs have petitioned the courts in a variety of cases for lost financial gains in relation to the financial arrangement made on their behalf between the GSEs and Treasury. In the most significant of these cases, Collins v. Yellen, the Supreme Court ruled that while the organizational structure of the FHFA was unconstitutional (in that it is led by a single director who can only be fired for cause, following a similar decision against CFPB leadership in Seila Law v. the CFPB) the FHFA had acted within the scope of its powers in creating the net worth sweep. A previous case, more specifically on the net worth sweep in October, resulted in a hung jury, after the Fifth Court of Appeals had found in 2018 that the net worth sweep was within the FHFA’s powers and in 2019 that it wasn’t. The Supreme Court declined to hear the issue in January 2023 and had the case sent back to the lower court.  

In Berkley Insurance Co. v. FHFA shareholders asserted that the FHFA had “shortchanged them $27 billion” and that the net worth sweep represented a breach of contract. The plaintiffs sought $1.6 billion in damages related specifically to the drop in value of their stocks. After an eight-hour deliberation, jurors found that the FHFA had breached an implied covenant of good faith and that its actions had harmed shareholders. The jury awarded Freddie Mac shareholders $312 million and Fannie Mae shareholders $299 million for a combined $612 million in damages in the first court case to decide in favor of the GSEs’ shareholders. 

Conclusions 

While there is an argument that the GSEs profits were “owed” to the federal government given the emergency bailout the GSEs received in 2008, that money has been returned and then some. Even without the creation of the net worth sweep, the federal government stood to make a profit on its investment. The net worth sweep gave Treasury and the FHFA access to all profits of the GSEs in perpetuity, and there is little reason to justify this even if it weren’t a fairly clear breach in contract by removing the dividend owed to shareholders.  

This is a small victory, however, as the $612 million represents an extremely small fraction of the billions in dollars in profit the GSEs have subsequently sent to the government. The question of whether the GSEs’ shareholders are entitled to redress has also had a surprisingly tortured case history, with the court’s decision seemingly antithetical to the view of the Supreme Court in Collins v. Yellen. It is likely the FHFA will appeal. 

Under the Fifth Amendment, private property cannot be taken for public use by the government without just compensation. Berkley v. FHFA represents the first steps taken in 15 years to provide some financial redress for shareholders. More important, it represents the first time the courts have recognized that the net worth sweep represented a breach of contract that amounted to little more than government seizure of property. If only the same progress could be seen in unwinding the GSE conservatorships.