Today, the Supreme Court finishes up the current series of public hearings for the December sitting, with a 90-minute session on the financial woes of the two giants in the home mortgage field, Fannie Mae and Freddie Mac.  After nearly collapsing in the housing market crisis of 2008, the two sort-of-private entities have been watched over – and financially rescued – by the federal government.  In return, they have handed over hundreds of billions of dollars in dividends and other transfers to the U.S. Treasury.  Sorting out the highly-complex legal details of that relationship is the task before the Supreme Court.  The audio portion of the hearing by telephone hookup will be broadcast “live,” and is expected to be available for listening at C-SPAN.org/supreme court, starting at 10 a.m. (Eastern).

Background:  Home ownership is the dream of many Americans, and in a real way it helps to define the nation’s middle class.  It would not be possible, though, if everyone wanting to buy a home had to pay for it in cash. Most people don’t have that much available to spend at once.

Supplying the loans, in the form of mortgages, is the business of the mortgage market.  And there are two national organizations that keep money flowing into the market so that loans continue to be available.  Typical, and very popular in that market, are loans that last for 30 years, paid off a month at a time.

Those two funding organizations are “Fannie Mae,” the popular short name for the Federal National Mortgage Association (created by Congress in 1938), and “Freddie Mac,” the short version of Federal Home Loan Mortgage Association (set up by Congress in 1970).  They function mainly as private corporations that sell their stock to private investors.   But the government is supposed to stand behind them, to make sure they don’t fall.

The two operate somewhat differently, but what matters for the moment is that they both buy mortgage loans from banks or other lenders, freeing more lending. They also bundle the mortgages in their portfolios, and sell the bundles as investment securities, bringing in still more money to buy up home loans.  The Treasury guarantees those securities bundles, so they supposedly are sound.

Basically, the whole housing market depends upon Fannie and Freddie, since they have at times held in their portfolios about half of all mortgages outstanding in the nation.  Thus, America’s entire economy shuddered in 2008, when a combination of economic catastrophes (including many defaults on mortgage payments and falling home prices) drove the entire housing market into deep distress.  Fannie and Freddie were hit especially hard: they lost $108 billion in 2008 alone, exceeding the $95 billion they had earned over a four-decade span.

Congress came to the rescue in July 2008, creating a new government entity, the Federal Housing Finance Agency, to manage the two corporations.   The agency is headed by a single director (and that fact leads to one of the issues the Supreme Court is considering), who serves a four-year term and cannot be fired by the President simply on a whim; there has to be a valid cause to unseat the director.

This agency is given the authority essentially to take over Fannie and Freddie by appointing itself as their “conservator.” The power is very strong: the agency can actually shut down the two if needed.  In that role, it assumes all the powers of the corporations and all the rights of their private stockholders.  The agency, though, is given a duty to do what it can to make Fannie and Freddie sound financially and to conserve their assets.

When this wide range of powers was actually exercised by the agency in September 2008, private shareholders began protesting publicly that Fannie and Freddie were being “nationalized.”  In time, the grievances would become the lawsuit that is now before the Supreme Court.

With three private shareholders on one side, and the Treasury and the housing finance agency on the other side, the case is taking on two sharply contrasting characteristics in the legal papers filed with the Justices.

The shareholders’ filings complain of “nationalization” of Fannie and Freddie, accuse the Treasury and the agency of grossly mismanaging the two corporations’ affairs, shunting aside the private shareholders and scuttling their rights.  They blame the Treasury for pushing Fannie and Freddie almost to the point of collapse, and then, when the two corporations’ financial fortunes began to improve markedly with economic recovery, Treasury moved in to generate even more benefits for itself.  Ultimately, the shareholders told the Court, “the nationalization of Fannie and Freddie had netted the federal government an astonishing windfall of $124 billion.”

For their part, the government agencies portray the 2008 collapse of the housing market as a threat to the entire U.S. economy, describe every step of the intervention by Treasury and the finance agency as totally necessary to save Fannie and Freddie, and to protect the U.S. taxpayers for the huge investment that the Treasury put into those two companies.

The Supreme Court probably will have to look beyond the rhetorical flourishes, in order to parse a very complex federal law against the background of a bewilderingly convoluted series of business transactions that apparently saved Fannie and Freddie but left the shareholders with little left but to protest.

As part of the rescue, the 2008 law gave the Treasury the authority to buy securities issued by Fannie and Freddie and to exercise the rights that go with those instruments.  Using that power, Treasury initially committed to buy up to $100 billion of stock each in Fannie and Freddie.  In return, Treasury was given the right to dividends from the two corporations, plus the priority to get its money back if the two failed and actually went out of business. (Under this deal, the more money Treasury put forth, the higher the dividends it would get.)

The initial Treasury promise proved to be too little, so the agency and the Treasury agreed to double the amount for each corporation, and a bit later Treasury agreed to provide unlimited funds through the end of 2012.

Still in dire condition, Fannie and Freddie could not afford to pay Treasury the dividends, so Treasury handed over more funds to cover that expense, with the obvious effect of pushing up the dividends further.  Fannie and Freddie, at that point, apparently were near to going under.

So, in August 2012, the agency and the Treasury reached a new deal, the so-called “Third Amendment.”  The dividend rate was shifted to a variable rate, tied to the two firms’ net worth.  Each quarter, the dividend would match their net worth.  Fannie and Freddie were not allowed to build up their capital beyond a reserve set by the Amendment.

As part of the rescue package, Congress restricted the power of the federal courts to review how the agency and the Treasury used their authority.  Fannie and Freddie were given permission to sue to challenge the creation of the conservator appointment but for only a brief period.  Otherwise, the courts were barred from reviewing the action of the agency director as conservator.

And the Third Amendment is what finally stirred three of the corporations’ stockholders to sue.  Their lawsuit contended that the Third Amendment was illegal as beyond the agency’s power as conservator, that Treasury had illegally bought more securities than it had power to do, that the Treasury’s actions were arbitrary, and that the structure of the housing agency – headed by a single director who could not be fired at will by the President – was an unconstitutional violation of presidential authority.

A federal appeals court made a compromise decision, ruling that the shareholders were entitled to sue to challenge the Third Amendment, that the agency as conservator had gone too far by moving toward winding down Fannie and Freddie instead of keeping them going, that the agency director had not displaced the rights of the shareholders to sue, and that the single directorship of the agency was unconstitutional as an intrusion on presidential power.   But it also ruled that the Treasury had not acted illegally or arbitrarily.   The court also decided that the remedy for the invalid directorship arrangement was not to scuttle the Third Amendment deal with the Treasury, but simply to make the director subject to be fired by the president.

The Treasury had refused in court to defend the single directorship arrangement.

The three stockholders appealed to the Supreme Court, seeking to scuttle the Third Amendment altogether, based on the constitutional flaw they had challenged.  The Treasury and the housing agency and its director filed their own appeal, arguing that the terms of the rescue package barred the courts from reviewing how the conservatorship was carried out.

The Supreme Court granted review of both appeals on all of the issues raised.  Since the government agencies were not defending the directorship arrangement against the shareholders’ challenge, the Court named a Utah law professor to act as amicus curiae (friend of the court) to argue that the arrangement was not unconstitutional.

Questions before the Court:  Were the stockholders barred from filing their challenges, was the single directorship arrangement unconstitutional and, if it was, must the actions of the director in agreeing to the Third Amendment be nullified?

Significance:  The combined appeals in this case are playing out even as Congress is pondering whether it should step in to restructure Fannie and Freddie, from turning them over to entirely private management, to keeping them permanently in the status of government-run entities, or some other option.  The Supreme Court will not take any of that maneuvering into account, but will focus on the meaning of the 2008 law and whether that was carried out legally and constitutionally by Treasury and the housing finance agency.

Only one specific outcome, among the issues at stake, seems already to be predictable: the end of the single directorship not subject to removal at will by the president.  Last term, the Supreme Court ruled unconstitutional a similar arrangement involving the head of the Consumer Financial Protection Bureau, and the arguments on both sides in that case are being made again in the Fannie and Freddie case.

The more significant issue is what the Justices do as a remedy for that constitutional flaw.  In the consumer protection agency case, the remedy was simply to make the director subject to being fired for any reason, or no reason, by the president.  That limited approach was done to preserve the operation of that bureau as a whole.

In the Fannie and Freddie case, a more sweeping remedy – such as nullification of the Third Amendment — would almost certainly require an extremely complex attempt to untangle the layers of financing and internal management roles within Fannie and Freddie as well as Treasury and the housing agency.  If the Court were to go so far as to find that Amendment invalid, it probably would send the case back for a lower court to try to sort it out first.  At that point, the new Biden Administration may have some ideas of its own what to do as a more permanent destiny for Fannie and Freddie.

In the meantime, Fannie and Freddie appear to be doing very well financially now, and the housing market was well on its way back to normalcy, at least until the pandemic health crisis has unsettled the entire economy.  Still, hovering over their apparent success is the legal cloud, now in its 12^th year with no promise of a ruling by the Court until sometime next year.

With the conclusion of the Wednesday hearing, the Court will not hold any hearings until January 11.  It has already announced that it will continue the remote telephone hookup for hearings in the January sitting.