By Matt Stoller, the former Senior Policy Advisor to Rep. Alan Grayson and a fellow at the Roosevelt Institute. You can reach him at stoller (at) gmail.com or follow him on Twitter at @matthewstoller.
Last Friday, the SEC announced it was suing six top executives at Fannie Mae and Freddie Mac for misleading investors. Though the SEC can only sue on civil fraud charges, the announcement was greeted with fanfare, since it does relate directly to the housing bubble.
I noticed a tidbit in the FT that I think is more significant than commonly understood: “Fannie and Freddie are paying the legal fees of the former executives, officials said.” To be clear, it’s not Fannie and Freddie putting out these fees, it’s the taxpayer that owns and continually pumps capital into these companies.
The Federal Housing Finance Agency, led by acting Director Ed Demarco, made the choice to pay the legal fees for these executives facing the SEC. In effect, one government agency is putting forward resources to sue six individuals defended by the resources of another government agency.
And how much will this cost? Before this SEC suit, executives at Fannie and Freddie had other lawsuits against them. When I worked for Rep. Grayson in 2009, he asked, and found out that the taxpayer had already shelled out millions. Rep. Randy Neugebauer updated the costs in 2011, and found that it had cost something on the order of $100 million for pre and post bailout costs reimbursed to executives at Freddie and Fannie.
What I heard about these suits is that because legal fees were paid by the taxpayer, Frank Raines and his cohort were deposing “everyone in town”. And why wouldn’t they? Cost was no object. You can expect something similar with this suit with the SEC. The FHFA is ensuring that these six executives will have an unlimited budget to fight the SEC.
This is yet another example of executive compensation packages creating perverse socially destructive behavior, with the twist that this is explicitly done in collusion with a government agency. First of all, covering the legal liabilities of executives at corporations for misbehavior is a problematic risk shift. Second, when this happens at a bailed out company and the cost is actually borne by the taxpayer, it is an indication that regulators do not think it is problematic to encourage such irresponsible misbehavior. As we’ll see, the head of the Federal Housing Finance Agency seems to simply think that this is how business is done.
Does the taxpayer have to write a blank check to these former executives to defend them against an SEC suit? Of course not – paying for these legal fees is simply a policy choice by FHFA Acting Chief Ed Demarco. The FHFA could have repudiated these obligations when it took the GSEs into conservatorship. FHFA officials claimed argued that canceling employment contracts would be unconstitutional and that doing so might make it difficult to attract skilled individuals to the company. I found this baffling, since the Housing and Economic Recovery Act of 2008 authorizing the conservatorship allowed the the FHFA to repudiate claims. There is the possibility Fannie and Freddie could be sued by former executives for these legal fees. It’s not clear they would win, and in the meantime, these former executives would have to pay out of pocket to defend themselves.
There’s a consistent pattern at work at the FHFA. In November, we learned that the executives at Fannie/Freddie were paid a total of $12 million in performance bonuses for 2010, which Demarco again justified as necessary for getting employees with the requisite skills.
This is nonsense. Treasury is stuffed with so-called “dollar a year” men. People will do public service at reasonable salaries, if they believe it is public service. Of course, now that the FHFA has committed to paying the legal fees of the executives that destroyed Fannie and Freddie and cost us hundreds of billions of dollars, we can see that paying for talent is not what was actually going on.
I believe Demarco, unlike many regulators in Washington, has integrity, and executes according to what he perceives of as his legal mandate. But I really don’t understand the thinking here. He overpays GSE chiefs, and unnecessarily fronts money to former GSE executives that may now actually be held accountable for misleading investors.