Fannie and Freddie: Collins on Remand at the 5th Circuit, Rop on Appeal at the 6th Circuit, and How to Judge a Beauty Contest

The Set Up

Fannie and Freddie investors have cycled through the alternative pathways of an administrative and litigation solution to the GSEs’ conservatorship. Treasury’s nationalization of the GSEs and the consequent economic theft of GSE shareholders’ interests continues, all legitimized by SCOTUS in Collins as an “incidental power” that Congress supposedly granted FHFA to pursue its own self-interest, which SCOTUS concluded (without textual authority in HERA) also extends to FHFA’s pursuing Treasury’s interest as the nationalizing agent.

To be clear, this was amateur hour at SCOTUS.

So, what remains of the administrative and litigation pathways?

On the administrative front, POTUS Biden nominated career bureaucrat Sandra Thompson as FHFA director, who apparently subscribes to the Mel Watt school of weak-kneed, do-nothing-unless-instructed-by-Congress FHFA directorship. You remember Director Watt, who justified the Net Worth Sweep (NWS) by saying the “agreement [NWS] changed the law” (as opposed to the agreement must conform to law).

At her Senate confirmation hearing, Ms. Thompson clearly indicated that she has no interest in resolving the GSEs’ conservatorship, going so far as to aver that this was solely a job for Congress. Sen. Toomey correctly admonished her that, no actually, in HERA Congress has already spoken on the issue, and Congress clearly said that ending conservatorship was the job of the FHFA director.

So the Biden administration evidences no inclination to attempt an administrative release during the POTUS Biden term.

Which is a rather absurd position for the Biden administration to take. After all, POTUS Biden could desperately use a huge $100 billion win for affordable housing by monetizing Treasury’s warrants in connection with a GSE recapitalization, which would not require any Congressional action (that’s right, no need to convince Senator Manchin! nor endure a Senate filibuster!). One would think POTUS Biden would look for a massive progressive policy win that doesn’t require Congressional action, after working in vain on Build Back Better legislation during the first year of his term.

On the litigation front, SCOTUS has found in Collins that FHFA was unconstitutionally structured after Director Watt began his term, and backward relief would clearly be available to plaintiffs in SCOTUS’s view if the unconstitutional director removal position harmed the plaintiffs. In Rop, plaintiffs have alleged that the FHFA acting director that executed the Net Worth Sweep was unconstitutionally appointed, acting as a principal officer for three years without necessary Senate confirmation.

So it is time to reassess the litigation status of this (to date) quixotic quest to remedy the most flagrant and sizable financial ripoff in memory, making Madoff look like a two bit grifter wannabe. I will end with a rumination on how to make predictions about the GSE litigation merits.

Collins on Remand

The 5th Circuit Court of Appeals en banc heard oral argument in Collins on remand from SCOTUS on Wednesday, January 19, 2022. You can listen to a recording of the proceeding at https://www.ca5.uscourts.gov/OralArgRecordings/17/17-20364_1-19-2022.mp3.

Recall that SCOTUS held that FHFA was unconstitutionally structured under its organic statute, HERA, during the period of the conservatorship beginning with Director Watt’s term. As to the availability of backward relief, SCOTUS intimated that plaintiffs “clearly” would be entitled to damages if the unconstitutional FHFA director removal for cause provision caused plaintiffs harm.

To buttress the claim of plaintiff harm, plaintiffs produced the Trump Letter, in which Mr. Trump stated he would have removed Director Watt on Day 1 of POTUS Trump’s term but for the unconstitutional removal provision. Mr. Trump proceeded to make clear that he would have ordered the end to the conservatorship, by recapitalizing the GSEs and monetizing Treasury’s warrants, and Treasury would have had to write down its senior preferred stock preference in order to monetize the warrants. This would have resulted in massive financial gains for plaintiffs. Because the unconstitutional removal provision prevented the Trump administration from beginning this process on Day 1, the constitutional violation directly led to plaintiffs’ harm.

This involves a counterfactual inquiry, requiring proof by a preponderance of the evidence that such a recapitalization would have occurred during the Trump POTUS term (if plaintiffs bear the burden of proof), or alternatively would have not occurred (if the government bears the burden of proof), if there had been no unconstitutional director removal for cause provision.

Typically, the plaintiffs bear the burden of proof with respect to their claim. It bears emphasis that shifting the burden of proof onto a defendant is an unusual result.

But in its opening brief on remand before the 5th Circuit, Plaintiffs smartly asked for the en banc court to shift the burden of proof onto the government, in order for the government to prove that the unconstitutional director removal provision caused plaintiffs no harm.

• “The Supreme Court’s decision does not articulate a detailed doctrinal framework for this Court to apply when fashioning a remedy for the constitutional violation, nor does it specify which side should bear the burdens of proof and persuasion. While the Court must largely write on a blank slate to answer these questions, we submit that at least where a plaintiff makes a prima facie case [ie, the Trump Letter] that an unconstitutional removal restriction prevented a presidential administration from pursuing policies that would have benefitted the plaintiff, the burden should shift to the government to establish that the constitutional violation caused no harm. Consistent with this approach, any uncertainty about what would have happened but for an unconstitutional removal restriction ought to be resolved in Plaintiffs’ favor.” and

• “Shifting the burden to the government in cases like this one would also accord

  with another principle that guides courts when they decide how to allocate the

  burdens of proof and persuasion: “[W]here the facts with regard to an issue lie

  peculiarly in the knowledge of a party, that party has the burden of proving the

  issue….The public record outlined above demonstrates a strong prima facie case

  that with an additional two years of control over FHFA, the Trump Administration would have been able to achieve its goal of amending the purchase agreements to allow Plaintiffs and other shareholders to benefit from the Companies’ continued strong financial performance. Any non-public facts relevant to this issue are in the exclusive possession of Defendants and their former officers and employees. Under these circumstances, Defendants ought to bear the burden.”

In the oral argument, plaintiffs and the government both tried to end the case without further remand to the district court for trial.

Plaintiffs tried to show that given the Trump Letter and the Trump administration’s recapitalization effort for the two years after Director Watt’s eventual removal, plaintiffs would have been beneficiaries of recapitalized GSEs had the process started two years earlier, and that the process would have started two years earlier in the absence of the constitutional violation.

The government argued that since POTUS Trump always controlled the Treasury Secretary during the entire four year term, POTUS Trump could have eliminated the senior preferred stock preference at any time, so that the unconstitutional FHFA director removal provision created no harm.

It appears from the oral argument that the 5th Circuit en banc had no interest in doing anything other than remanding the case to the district court in order to enter judgment in favor of plaintiffs on the unconstitutionality of the removal for cause provision, and to conduct a trial upon order of SCOTUS to determine whether the plaintiffs are entitled to compensable harm arising from the constitutional violation.

But who bears the burden of proof in connection with this trial in the counterfactual world where POTUS Trump could have removed Director Watt on Day 1 and begun the GSE recapitalization process at the beginning of the term? The judges betrayed no view on whether the 5th Circuit en banc would itself instruct the district court that the government should bear this burden of proof. I suspect the 5th Circuit en banc will leave that burden of proof question to be decided by the district court.

Rop on Appeal

In plaintiffs appeal brief to the 6th Circuit Court of Appeals in Rop, plaintiffs argue that i) FHFA acting director DeMarco was acting in violation of the Appointments Clause of the US Constitution when Mr. DeMarco adopted the NWS, after having served for three years as an acting director without Senate confirmation, and ii) the same additional compensable harm claim with respect to the unconstitutional removal provision as they do in Collins before the 5th Circuit. Plaintiffs seek as relief vacating the NWS, insofar as DeMarco was invalidly acting as a “principal officer” without Senate confirmation, and the same write down of the senior preferred stock preference as in Collins regarding the unconstitutional removal provision.

In summary (and I do expect to write another substack article on the Appointment Clause claim as briefing and oral argument in Rop concludes), the Constitution requires that principal officers such as the FHFA Director be nominated by POTUS and confirmed by Senate. FHFA acting director DeMarco was never Senate confirmed.

The Constitution text does authorize an acting principal officer to serve as a “recess appointment” until the end of the next Senate session, but this period cannot (by virtue of calendar requirements for the holding of Senate sessions) last longer than two years. Moreover, SCOTUS has provided an exception for a non-Senate confirmed officer to act under “special conditions” that are “limited” and “temporary,” in a 120 year old case involving an acting counsel general of Bangkok for 10 months, when the exigencies of 19th century communication and travel so required.

The recess appointment constitutional text exception, which cannot last longer than two years, and the court exigency limited exception are the only exceptions to the constitutional requirement that principal officers obtain Senate confirmation.

The Rop federal district court sidestepped the constitutional appointment clause claim by declaring that the issue as to whether acting director DeMarco had authority to adopt the NWS three years after his POTUS nomination without Senate confirmation was a “political question”, and therefore nonjusticiable. Essentially, the Rop federal district court held that the constitution does not provide a legal rule for the judiciary to enforce regarding the authority of non-Senate confirmed acting directors.

This is a remarkable holding, as the Constitution does contain a i) bright-line rule requiring Senate confirmation, and ii) a single textual exception whose length of time cannot in any event exceed two years, and there is a single 19th century SCOTUS exception that is plainly inapplicable. So the federal district court in effect concluded that the Constitution requires principal officers to be Senate confirmed when POTUS can get the Senate to confirm POTUS’ nominee…and it is up to the other two branches of government to fight this out as a matter of political pugilism, a fight the judiciary has no remit to resolve.

This is the ultimate POTUS “work around” of the Senate (to use POTUS Biden’s Chief of Staff Klain’s now infamous retweet)…although POTUS is required to secure Senate confirmation for principal officers, POTUS can simply nominate an agency director, and should the nominee fail to get Senate confirmation, POTUS simply continues onto the next pressing matter, with the unconfirmed director blithely carrying on with business as if confirmed.

This cant be right.

Judging Beauty Contests

This leads me to the question posed by John Maynard Keynes, as to how to judge a beauty contest

¹

, as it pertains to GSE litigation handicapping. Do I predict a litigation outcome based upon my own view of the legal merits (who I think should be the winning beauty contestant), or based upon what I think the court will decide as to the legal merits (who I think the beauty judges may think is the winning beauty contestant)? These need not end up as the same result.

So as to Rop, should an investor and GSE junior preferred shareholder think “this can’t be right”, or “this can’t be what the court will think is right”?

In this article and my previous writing, I have always been guided by my legal analysis of the merits, leading me to believe what i) I believe should be the court decision, and not ii) what I necessarily believe the court will necessarily decide. Some have argued that “you can’t fight city hall”, and litigating against the government is sisyphean, so that one should always discount litigation against the government irrespective of the merits of plaintiffs’ claims. Indeed, with most GSE litigation results to date, the judges have confounded my own legal analysis.

Why should I stick with what I think is correct, as opposed to what I think the judges will think is correct? Regret avoidance.

Put simply, I do not want to do what I think is the right analysis, but then outsmart myself by concluding that the court will think otherwise, only to have the court conclude as I thought in my original analysis. That would put me into regret hell.

Think things though as best one can, place your bet and let the dice roll.

PS

Yes, judges decide cases, not impersonal automatons, and it is relevant to know a little bit about who are these judges. The Rop merits panel will be three judges selected from the current 6th Circuit roster.

1. In “The General Theory of Employment Interest and Money,” Keynes compares the stock market to a beauty contest. He described a newspaper contest in which 100 photographs of faces were displayed. Readers were asked to choose the six prettiest. The winner would be the reader whose list of six came closest to the most popular of the combined lists of all readers. The best strategy, Keynes noted, isn’t to pick the faces that are your personal favorites. It is to select those that you think others will think prettiest. Better yet, he said, move to the “third degree” and pick the faces you think that others think that still others think are prettiest. Similarly in speculative markets, he said, you win not by picking the soundest investment, but by picking the investment that others, who are playing the same game, will soon bid up higher.