Why Fannie and Freddie Shareholders Challenge "Just" Compensation for U.S. Seizure

In the comedy film “Dumb and Dumber,” the two main characters, played brilliantly by Jim Carrey and Jeff Daniels, trek across the country to return a briefcase they believe was mistakenly left at an airport by a beautiful woman. On the way, they discover that the briefcase is full of cash, and agree that it is important they return the money. Unbeknownst to them, the money was a ransom for the return of a kidnapping victim and, in the climax of the film, Carrey's and Daniels’ characters are forced at gunpoint to open the briefcase by the kidnappers.

Out of the briefcase tumbles hundreds of slips of paper, marked simply “IOU.” “What is this? Where’s all the money?” asks one of the criminals. “That’s as good as money, sir. Those are IOUs,” replies Carrey and Daniels, who obviously spent the money and thought that the paper slips were just compensation.

While funny, this scene speaks to a broader point of justice. If you are going to take someone else’s money, you ought to be prepared to pay it back. This is the point enshrined in the Takings and Due Process Clause of the Fifth Amendment of the U.S. Constitution, which declares, “…nor shall private property be taken for public use, without just compensation.”

In other words, if the government needs to confiscate property for an important public purpose, it must compensate the owner for the loss. In “Dumb and Dumber,” the characters did not have a particularly persuasive reason to spend the money, but the U.S. government has faced a number of pressing public challenges that have required the confiscation of private property.

For instance, during World War II, the government acquired more than 20 million acres of land to build defense plants and other essential war facilities. After the war, the government knew that both as a matter of economic necessity and of national security, the U.S. needed to build an interstate highway system connecting the country, coastto- coast. To facilitate the mammoth undertaking it engaged in more than 750,000 separate takings of private property. Other examples of the federal government taking property abound. Even NASA benefited from government takings of private land; the Cape Canaveral launch site was originally taken from private ownership in order to help the space race.

In each of these cases, the government’s actions were an understandable response to an urgent public need, and the individuals whose land was taken were compensated. While every property owner was not perfectly satisfied, the government generally made a good-faith effort to pay owners a fair market value for their property in cold hard cash, rather than vague IOUs.

This stands in stark contrast to public takings throughout history. Roman emperors, feudal lords, even the British monarchy in colonial America could take property without just compensation. It was in part due to these experiences that the Fifth Amendment was added to the Bill of Rights. The principle established by the Takings Clause is clear; sometimes property must be taken for an important national need, but owners must be fairly compensated for their losses. In the midst of the financial crisis of 2008, such a need was made apparent; without quick action, the national economy could collapse. The government took a number of emergency actions, including the now-infamous bailouts of some of the largest financial institutions in the country. But we allege it also engaged in massive public takings under the Fifth Amendment.

Specifically, the government effectively nationalized, we argue, Fannie Mae and Freddie Mac, two previously private shareholder-owned companies.

In quite possibly the most lopsided loan arrangement of all time, the government would be given senior preferred shares in both companies and the right to purchase up to 80 percent ownership at a price of $.00001 per share. These actions, while perhaps necessary as part of a broader plan to save the global economy, made the common stock held by shareholders effectively worthless overnight. We have now filed a lawsuit, on behalf of Freddie and Fannie shareholders, against the U.S. government, seeking compensation for investors who suffered losses when the government took conservatorship of Fannie Mae and Freddie Mac.

Before the financial crisis, Fannie and Freddie fulfilled a crucial need in the market for mortgages in the U.S., buying mortgages and mortgage-backed securities from other financial institutions and guaranteeing them for investors. The companies had originally been established by the government, but had since been privatized, raising capital and issuing stock like any other publicly traded company.

Unlike many other financial institutions, Fannie and Freddie had largely avoided the riskiest subprime loans and mortgage-backed securities built on that debt. However, beginning in 2001, Congress and regulators took steps that encouraged the companies to take on more and more questionable assets, including subprime loans.

Despite these actions, both companies had less exposure to toxic assets than did other financial institutions, even as the government took control of them. We argue that, as a result of the takeover, investors’ existing stake in the companies lost significant value. Yet, in choosing to take over Freddie and Fannie to prop up the banks, the U.S. government did not compensate investors for their actual losses.

The government’s actions were effectively a “taking” under the Fifth Amendment. Instead of taking land or physical goods for the public good, the government sought to pick, and create, winners and losers in the financial crisis. During the crisis the government chose to act first, and put off thinking about the consequences until later. Now, with the financial crisis over and Fannie and Freddie pumping out billions of profits, we think it is time for a proper review of “just compensation” for the shareholders. Since such cases have to be filed in the Court of Claims, which has special procedures for class actions, former shareholders of Freddie and Fannie will have to affirmatively opt into the class action in order to participate. Still, at least there is now an opportunity to be heard and hope for “due process of law” to occur.