"Bullshit," writes Princeton Philosophy Professor Harry Frankfurt in his best-selling book, "is a greater enemy of the truth than lies are." No one can dispute the pervasiveness of BS, which Prof. Frankfurt defines as a statement that is, “short of lying” but is still a deliberate misrepresentation, told by someone who "is trying to get away with something...[H]e is attempting to lead us away from a correct apprehension of reality."
Which brings us to the arguments against allowing a regulated financial institution to build balance sheet equity. To me, the idea of repudiating balance sheet equity, for the GSEs or any other company that assumes credit risk, is pure poppycock.
And yet, some individuals make that argument with forceful virtuosity. As 2016 winds down, I'm reminded of the argument against balance sheet equity made by Howard Cayne, counsel for FHFA, before the D.C. Circuit Court, (pages 69 - 90 of the hearing transcript). In a nutshell, Mr. Cayne says that when FHFA director James Lockhart placed the GSEs in conservatorship in September 2008, he permanently ushered in a "new capital paradigm" for the GSEs, which means that, going forward into perpetuity, GSE equity can remain close to zero so long as the government commits to supplementing GSE equity if it ever fell below zero.
Some might say FHFA was, "attempting to lead us away from a correct apprehension of reality." Take a look at an excerpt and decide for yourself. You don't need to finish the text, or follow what he's saying, to get what it's all about. It's a deep, deep well of doublespeak.
MR. CAYNE: Plaintiffs essentially allege that the FHFA is violating all sorts of rules, laws, regulations, safe and sound banking practices by allowing these institutions to operate with as little as zero capital, that is the point that this statute gets to, Your Honor, because as you Court will know from the statute, it says that the, if the Agency as regulator, and again, Your Honor, when we filed out papers we were focusing on the conservatorship allegations in the complaints, but when the Agency is regulator, reclassifies or changes capital classification, that might be challenge, but beyond that anything relating to a changed capital classification according to the statute is not subject, it may not be affected in any way by an order of any court.
So, what we have here at the outset in 2008 at the time the institutions were put into conservatorship, a new capital paradigm was established, and that capital paradigm said as long, by the Director of the Agency as regulator, and that capital paradigm said as long as these institutions are not forced into mandatory receivership they may operate. And the new paradigm was rather than requiring them to maintain eight percent, five percent, six percent capital, whatever the standard was as a normal banking institution, it was determined that as long as the Treasury commitment was out there ready to come in to cure any insolvency, which as the Court knows if the institutions were insolvent for more than 60 days the Agency would have been forced to place them into mandatory receivership, so the new paradigm was we'll have the 100, 200, eventually Treasury committed to 467 billion, nearly a half a trillion dollars to support these enterprises, and the regulator made the regulatory decision that we will, the Agency will allow that to satisfy capital standards.
So, again, this, it was not challenged at the time, and so what the statute says is that this action by the Agency as regulator to establish a new capital paradigm for the duration of the conservatorships may not be affected by injunction or otherwise in any manner, it's similar to the banking cite in here, and the banking cite is 12 U.S.C. 1818(i), no court may effect by injunction or otherwise a cease and desist order that has been issued.
What was happening there, and there's case law on this, this provision essentially parrots what are called on the banking landscape capital directives. Capital directives were first enacted by Congress in 1983 pursuant to the International Lending Supervision Act of 1983. And what a capital directives -- and it was issued, Your Honors, in response to a Fifth Circuit decision, the Fifth Circuit back in 1983 in a case called Comptroller Currency v. First National Bank of Bel Aire ruled that the Comptroller's cease and desist order requiring the bank to increase its capital was not supported by substantial evidence. And to overrule that decision the Congress enacted what are called capital directives, and capital directives provide that the agencies, the comptroller, the FDIC, the Fed, the NCUA, I believe, can require institutions to maintain whatever capital level they deem appropriate under the circumstances, and this was the key point, those determinations are subject to no judicial review. In 1990 that point that they were subject to no judicial review was challenged in the Fifth Circuit in a case called FDIC v. Bank of Coushatta, reported at 930 F.2d 1122, and on a three-judge Fifth Circuit panel including the esteemed Judge John Minor Wisdom, the Court ruled that the statute comported with due process.
There's a lengthy analysis, and the statute, the capital directive statute at issue there that provided no judicial review to banks, when the agencies changed, increased, decreased their capital guidelines was not subject to judicial review. Your Honors, that is precisely what is implicated by the statute that the Court has referenced.
JUDGE MILLETT: And so your view here is that they're challenging this what you call capital paradigm of, that was created here of, in the Third Amendment getting rid of obligations that the GSEs had under the prior amendments, and the PSPAs and replacing them with this just pay us whatever you can each month, that's a new capital paradigm decision by the Director?
MR. CAYNE: No, what I'm referring to, Your Honor, is the, it's throughout their briefs, it came up in my esteemed colleague Mr. Olson's presentation many times that we, the Agency is driving these institutions out of business. It's allegedly not allowing them to grow capital, it's keeping them at zero, how can that be? Well, the reason that can be is the paradigm, the new capital program that never has been challenged that was established in 2008 sets precisely that, an action was taken by the Director at that time, in September, 2008, that said going forward the normal capital classifications, whatever the percentage was, I don't recall, three, four, five, six, seven, eight percent no longer applied. Instead, we're going to have this new paradigm, and the new paradigm is, and we all have to understand, much of the presentation by my colleagues, it's like we're dealing with this fabulously successful financial institution, and the shareholders are being stripped of their rights. Well, what we're dealing with are institutions which we all recall that in 2008 were on the verge of insolvency, and they were threatened with receivership, which would have had massively adverse consequences on the national mortgage markets, so Congress passed special legislation, and this legislation, getting, and I apologize for just skipping a bit, but this legislation is with respect to the matters that we hear about, conflicts. This legislation was actually included in the charter acts, the charter act of Fannie Mae, the charter act of Freddie Mac, so this is both federal law, and this is in the governing corporate instruments of these institutions, this ability, authority of Treasury to infuse massive amounts of tax payer dollars, and so what we have in this -...
That was the, the agreement, Your Honor, was executed between the enterprises, so it was, the enterprises and Treasury, so it was authorized by the Federal Housing Finance Agency in its capacity as conservator. And getting back to Judge Ginsburg's question, that's why our briefs rely on the withdrawal of jurisdiction that would apply or bar a court from effecting the operations of a conservator. With respect to the Court's inquiry to Counsel this morning, the reason I'm referring to the FHFA as regulator is it was the FHFA as regulator that made the regulatory decision that going forward the capital tests that previously had applied to these enterprises were off the boards for the indefinite future, for the duration of the conservatorship. Instead, as I said, the Agency as regulator in that capacity authorized this new capital paradigm, which is Treasury, the conservator on behalf of the enterprises will enter into an agreement with the Department of Treasury pursuant to which the Department will we have to avoid, we can to, whatever we have to do to avoid receivership, is that --
Instead, as I said, the Agency as regulator in that capacity authorized this new capital paradigm, which is Treasury, the conservator on behalf of the enterprises will enter into an agreement with the Department of Treasury pursuant to which the Department will commit literally hundreds of billions of tax dollars to the infusion and to the support of these enterprises, and that will satisfy any capital requirement we as regulators believe is necessary. And my points simply with respect to the Court's inquiry is the whole range of relief being sought by Plaintiffs here were granted, but directly contradict, undermine, effectively set aside that regulatory decision by the Agency. What, just one specific, what my esteemed colleague Mr. Olson is asking for is that the Court issue some type of relief to force these enterprises to increase their capital to some arbitrary level. Well, again, that may happen or not, but it's not consistent with the action taken by the Director which focuses on keeping these entities in business, and the Court had, there was much back and forth in the context of fiduciary powers, fiduciary interest relating to the statutory provision that the Agency as conservator now can take action in the best interests of the enterprises, or in the best interests of the Agency.
If I may submit, what that means is these are very unique creatures, they are, as the Court has noted, massive financial institutions, but these are not comparable to standalone banks, or standalone savings and loans, because Congress had a more fundamental purpose, Congress' purpose in enacting and authorizing these financial institutions wasn't just to have two more banks, it was to provide support to facilitate the operation of the national mortgage markets, that was a policy decision by Congress. Congress considered it absolutely essential that those markets operate, and they operate efficiently, and that was the purpose for these enterprises.So, under circumstances such as 2008, now, whenever, the conservator may well determine well, I have a particular choice to make, I can run things to try to make this a profitable, more profitable, or I can run things to maximize the ability of the enterprise to facilitate the operation of those markets. Congress made the policy judgment to allow the conservator without interference by shareholders, with all respect, without interference by the judiciary to make that decision. And what we have here, getting back to what's being challenged, again, we have to look everything in the context, what is -- we have here are the shareholders are effectively asking this Court to override the conservator's judgment, and this is judgment Congress decided this is the agency, this is the expert, we want to rely on the agency, and the agency is conservator.
The net effect of what is being asked of this Court is to second guess the decisions made by the conservator on how it will handle, marshal, administer this nearly half a trillion dollars of tax payer funds. And again, the record is clear, and I'll refer to the statute in a moment, Congress put that money in clearly not to benefit shareholders of an institution that months later became insolvent, they put it in because the bottom had fallen out of the world, and the United States' national economy, and Congress believed, this is their, in their judgment that if the national mortgage market fails, becomes non-operational, that will just make a horrible situation so much worse...