Taxpayers caught in the middle of costly Fannie lawsuit

Feb. 17 (Bloomberg) -- Peter Wallison, co-director of financial policy studies at the American Enterprise Institute, talks about the state of the U.S. mortgage industry and the need to dismantle Fannie Mae and Freddie Mac. Wallison, speaking with Tom Keene on Bloomberg Television's "Surveillance Midday," also discusses causes of the housing crisis and the federal budget deficit. (Source: Bloomberg)
Washington Post Staff Writer
Tuesday, March 8, 2011; 8:49 PM

What could be worse than taxpayers paying more than $100 million to defend a shareholder-owned company and its former executives in a private lawsuit?

Losing that lawsuit.

When the government seized Fannie Mae during the financial crisis, it was clear it was taking control of a big, deeply troubled mortgage company that was hemorrhaging money on bad loans made during the housing bubble.

But it wasn't as obvious at the time that the government was also becoming a key actor in a soap opera of alleged corporate mismanagement, shareholder feuds and eye-popping legal bills.

Now that uncomfortable role is coming into focus.

Investors who say they suffered massive losses because of an accounting fraud at Fannie are demanding billions of dollars in compensation.

At the same time, Fannie is spending tens of millions of dollars to defend itself and its former executives, leading lawmakers to question the firm and its federal regulator about why they are not containing costs.

Stuck in the middle are U.S. taxpayers.

When the government seized Fannie, it placed it in a conservatorship, a legal term roughly meaning rehabilitation for a badly damaged company. In that role, the government has taken a nearly 80 percent stake in the firm and pledged to inject cash to keep it afloat. So far, the Treasury has invested more than $50 billion in Fannie.

But the arrangement also means that taxpayers are on the line for legal costs. Money Fannie spends defending itself is money it is not using to plug other losses at the company or repay taxpayers. But if Fannie settled the case, it might expose taxpayers to far greater expense if aggrieved investors are paid anything near the damages they are claiming.

"It's a Catch-22. You've got taxpayers on both sides of the transaction," said Rep. Randy Neugebauer (R-Tex.), who leads the House Financial Services Committee's oversight panel. "The only people benefiting on this are lawyers."

Ohio Attorney General Mike DeWine, who is the lead plaintiff in the case, said harmed investors should be compensated whether or not taxpayers will be responsible for making payments.

"We represent a class of 30 million specific individuals who were wronged, and it would be a very sad day in this country if we're not going to compensate these people . . . simply because the federal government took over the company with partial ownership," DeWine said.

But Fannie's top lawyer argues that the plaintiffs should reconsider what they are demanding in light of the government seizure of Fannie.

"We are mounting a vigorous defense to this plaintiff's class-action case that seeks to impose billions of dollars of liability on Fannie Mae and taxpayers," general counsel Tim Mayopoulos said. "We have had discussions with the plaintiffs' lawyers about resolving the case, but they have not been reasonable in their demands, particularly in light of the existing conservatorship."

Neugebauer said he is particularly concerned that Fannie is advancing legal costs for former executives accused of wrongdoing, including former chief executive Franklin Raines. According to his committee's research, Fannie has advanced nearly $8 million to defend Raines since the federal government took charge. A lawyer for Raines declined to comment.

While government officials say they recognize that it is frustrating that Fannie must pay these costs, the company has legal indemnification agreements to cover former executives. When officials took over Fannie, they inherited those agreements, too.

Not defending the executives "risks added lawsuits from the former executives that would likely add to conservator costs," said Stefanie Johnson, a spokeswoman for the Federal Housing Finance Agency, which oversees Fannie.

The questions may take on added urgency as Congress and the Obama administration begin the process of winding down Fannie and a similar firm, Freddie Mac. The Obama administration recently proposed eliminating Fannie and Freddie, which were among the causes of the financial crisis and are its most costly legacy. But that process is expected to take five to seven years, or longer.

The current legal saga began in 2004, when a group of investors joined together to file a class-action suit against Fannie, its auditor and the three executives.

The suit followed findings by the company's federal regulator that it committed a massive accounting fraud whose goal was to line the pockets of the executives.

In those days, Fannie was one of the nation's most successful financial services companies, and a shareholder dream. But the company's shares plummeted, causing losses for investors across the country.

In 2008, deeply wounded by the housing crisis, Fannie fell into the arms of the government. Executives were let go and shareholders were wiped out.

But the suit dragged on.

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