In the April 13, New York Times an article discusses developments in the civil proceeding between an owner of shares in Fannie Mae and Freddie Mac and the federal government over the latter’s decision in August 2012 to revise the terms of its conservatorship of Fannie Mae and Freddie Mac. The original agreement stated that the U.S. Treasury would receive a 10 percent dividend on its 189.5 billion dollar injection of capital. The revised terms gave all positive cash flows from Fannie and Freddie to the Treasury leaving little for the firms’ shareholders. Granting a request from the government, materials produced under discovery in the case have been under seal. Responding to a request by the New York Times the judge in the case has released two depositions. In one the former chief financial officer of Fannie Mae said that she told Treasury officials before their 2012 decision that Fannie Mae would soon earn profits again and that she believes her briefing played a role in the government’s decision to alter the terms governing the conservatorship.

For some background on this issue you should read my Working Papers column in the Fall 2014 issue of Regulation in which I discuss two papers relevant to the issue. In “Stealing Fannie and Freddie,” Yale Law School professorJonathan Macey argues that the decision by the Treasury to take all of the profits now earned by Fannie and Freddie erodes the rule of law and violates shareholder rights.

In “The Fannie and Freddie Bailouts Through the Corporate Lens,” Adam Badawi, professor of law at Washington University, and Anthony Casey, assistant professor of law at the University of Chicago argue that in the third quarter of 2012, when the federal government changed the financial arrangements to take all future positive cash flows, the value of shareholder equity in Freddie alone was negative $68 billion. That is, for the shareholders to earn anything, Freddie would first have to earn $68 billion, which was more than Freddie had earned in the 19 years prior to its financial difficulties (1988–2006). But if Freddie lost only $4 billion more (which is the amount of losses per week in 2008–2009), the senior preferred Treasury shares would be worthless. The data for Fannie were even worse: it would have to earn $114 billion before common shareholders would earn anything, which is more than it had earned in the 27 years prior to the financial crisis. The authors argue that when equity’s real value is negative, the directors’ duty to maximize the value of the firm is the practical equivalent of a duty to creditors and not shareholders. The authors argue that the government’s actions are consistent with what we would expect from a private creditor and do not violate shareholder rights.

I think both papers may be relevant. As my colleague Mark Calabria has argued the Treasury may have violated the spirit if not the letter of the law. And in a commentary written at the time he argued creditors were advantaged rather than taxpayers.

But similar to the decision in the AIG case in which a judge ruled that the federal government exceeded its authority in its takeover of AIG but that the government owed no damages to shareholders, the damages to Fannie and Freddie shareholders also may be zero because at the time the firms had negative net worth and would continue to have negative net worth for the foreseeable future.