The Rule of Lawlessness

Former FDIC Chairman Bill Isaac's recent rant opinion piece in The Wall Street Journal (paid subscription required) was a masterful smackdown of the current administration's handling of the conservatorships of Fannie Mae and Freddie Mac. Basically, Isaac accuses the executive branch of acting illegally.

The FHFA as conservator is a fiduciary—or trustee—for the shareholders of Fannie and Freddie. Its job is to, as the law says, "conserve [the enterprises'] assets and property" for shareholders while Fannie and Freddie rebuild their capital base and eventually exit the conservatorship.

That's not what has happened. When presented with the once-unthinkable reality of Fannie and Freddie making enough money to retire the Treasury's senior preferred stock and build enough capital to meet their financial obligations without government assistance, the Obama administration moved in 2012 to confiscate all Fannie's and Freddie's profits and wind down the two mortgage giants. Investors in Fannie and Freddie have responded by suing in federal court.

The government is trying to deny the plaintiffs the right to discovery (sound familiar?) because, according to Isaac, it's afraid of what might be revealed.

This information could include emails and other documents demonstrating that the government's true intent was to seize current and future Fannie and Freddie profits for itself and leave shareholders with nothing. To justify its position against granting discovery to plaintiffs, the government argues that disclosure of current and future plans for the conservatorship could be "disruptive to the housing market and to the nation's economy." Almost laughably, the government also argues against disclosure because that could "create market perception that the Enterprises are not financially viable," and that "this would have a negative impact on sales of debt and mortgage-backed securities." Putting aside the circularity of these arguments, the real absurdity is that the government's own activities have deprived Fannie and Freddie of capital and kept them too weak to emerge from conservatorship. By taking all of the enterprises' profits, the government has left them undercapitalized and permanently unable to rebuild their capital.

Isaac asks an obvious, important question: what's does this hijacking mean for the future? His answer is sobering.

Given the government's dereliction in its duty to conserve value in Fannie and Freddie, an obvious question arises pertaining to any "reform" of housing lending proposed by the administration and enacted by Congress. If the administration plans to wind down Fannie and Freddie with no recourse for investors, or to nationalize them in creating a new federal housing entity, as a Senate housing reform bill would do, where will the capital come from to finance the new system? What investor would put capital into something so uncertain and so unprotected by law as Fannie and Freddie have proved to be?

There can be varied opinions over which reform is best for our country or what, if any, role Fannie and Freddie will have in a future housing market. But there should be no disagreement about the law. Capital follows the rule of law, and if investors can't count on that in the U.S. and in the housing markets, they will put their money elsewhere.

"Capital follows the rule of law" applies beyond Aunt Fannie and Uncle Freddie, as important as they may be to the housing market and the economy as a whole. It also applies to the entire banking business.

Those of us who've been representing banks for a number of years (October will mark my 40th year of wandering in that desert) can't recall a time, outside of the relatively brief episode surrounding the collapse of the savings and loan business in certain parts of the country, when the federal government has treated adherence to the rule of law with such elasticity. From the envelope-pushing "disparate impact" doctrine's foray into fair lending (and the use of every artifice to prevent the SCOTUS from having an opportunity to strike it down), to Operation Choke Point and its "informal" enforcement through "informal" regulatory examinations and supervisory pressure, to cases like those of Patrick Adams, whose David-vs.-Goliath struggle seems to serve no purpose other than sending a message that due process is a pipe dream if you fail to knuckle under to a brow beating, to the avalanche of regulations following the enactment of Franken-Dodd, I cannot recall a previous time when community bankers and credit union boards and management have had such a sense of anxiety that borders, in many cases, on despair.

I understand why capital would flow to the Too Big Too Fail. They get hit with a few hundred million here, a few billion there, and rarely miss a beat. They take a licking and keep on ticking. The Too Small To Save don't have that status, and they know it.

Perhaps it's cognitive dissonance. Perhaps its the blind hope that "this, too, shall pass." Perhaps it's simply the fact that "this is what I know how to do and it's all I know how to do, so I'm gonna keep on doin' it until they force me to stop." However, if you have options as to where your capital will flow, how long before you cash in your chips on the banking business and take it to a business where the regulators who can shut you down and/or sue you don't have to take remedial educational courses to learn the basics?

I'm not advocating a course of action, I'm merely asking a question.