Abstract

http://ssrn.com/abstract=2410887
 


 



The Fannie and Freddie Bailouts Through the Corporate Lens


Adam B. Badawi


Washington University in Saint Louis - School of Law

Anthony J. Casey


University of Chicago Law School

March 18, 2014

University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 684

Abstract:     
In August of 2012, the Department of Treasury redirected the profits of Fannie Mae and Freddie Mac away from common shareholders and into the Treasury. Those shareholders have filed multiple lawsuits challenging this action. The complaints allege, among other claims, that the decision to wipe out equity violated the principles of corporate law. In this Essay — prepared for a symposium on the Future of Fannie and Freddie — we analyze that argument. We ask whether the shareholders of an ordinary public company could assert a similar claim under these circumstances. Those circumstances involve a lender of last resort converting a debt-like instrument to an equity-like instrument as means to protect its interests and the interests of other creditors. Indeed, our analysis of the financials of Fannie Mae and Freddie Mac shows that they were easily characterized as insolvent in August of 2012. Because bankruptcy law and corporate law permit the directors of a firm to take actions to protect creditors when a firm approaches insolvency, the only relevant question is whether equity had any worth at the time of Treasury’s 2012 action. Just as there is no right to wipe out positive equity value, there is no obligation to force creditors to bear the full cost of risky gambles that might create it value where it does not otherwise exist. And in 2012, the creditors of Fannie and Freddie were bearing significant risk as the obligations of those entities mounted. We argue that the merits of any claim the shareholders can bring, therefore, turn entirely on the value of equity in August of 2012. We then conduct a valuation of the common stock of Fannie and Freddie and find that, under any reality-based scenario, the substantial obligations owed to Treasury and the implausibility of never-ending growth in housing markets rendered the shares worthless. To the degree that the private market analogy is apt, the shareholders’ corporate claims should, thus, fail.

Number of Pages in PDF File: 37

Keywords: Fannie, Freddie, Bailouts, Law and Finance

JEL Classification: K00, K20, K22, K23

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Date posted: March 20, 2014 ; Last revised: May 17, 2014

Suggested Citation

Badawi, Adam B. and Casey, Anthony J., The Fannie and Freddie Bailouts Through the Corporate Lens (March 18, 2014). University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 684. Available at SSRN: http://ssrn.com/abstract=2410887 or http://dx.doi.org/10.2139/ssrn.2410887

Contact Information

Adam B. Badawi (Contact Author)
Washington University in Saint Louis - School of Law ( email )
Campus Box 1120
St. Louis, MO 63130
United States
Anthony Joseph Casey
University of Chicago Law School ( email )
1111 E. 60th St.
Chicago, IL 60637
United States
773.702.9578 (Phone)
HOME PAGE: http://www.law.uchicago.edu/faculty/casey
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