WASHINGTON D.C. — When the government took over mortgage giants
Fannie Mae and Freddie Mac, taxpayers inherited more than just bad
debts. They’re also potentially on the hook for tens of millions of
dollars in legal fees for the executives at the center of the housing
market’s collapse.
With the Justice Department investigating
companies involved in the mortgage and financial meltdown, executives
around the country are hiring defense lawyers. Like many large
companies, Fannie and Freddie had contracts promising to cover legal
bills for their executives.
When the Treasury Department
delivered a $200 billion bailout to Fannie and Freddie, that obligation
passed to the government, which may find itself paying for the lawyers
defending the executives against the government’s own prosecutors.
"Who’d
have thought we might be on the hook for paying the defense costs when
we’re also paying the prosecution costs?" said Doug Heller, executive
director of Consumer Watchdog, a Santa Monica, Calif.-based group that
has been critical of the financial bailout packages. "To defend the
economy from the havoc that’s been created, we’re going to defend the
havoc creators?"
The Bush administration is working to avoid it.
The Federal Housing Finance Agency, which controls Fannie and Freddie,
said in regulatory filings that it soon will issue regulations spelling
out exactly how such legal fees may be dolled out. The agency could
prohibit some fees, but a broad prohibition almost certainly would lead
to a costly court fight over who’s responsible for the bills when the
Justice Department comes knocking.
Fannie’s and Freddie’s
contracts also cover legal fees from shareholder lawsuits. Taxpayers
could be forced to pay those legal bills, too. If the shareholders win
— if they can prove the companies were mismanaged — the government
could be liable for millions of dollars to make up for the executives’
failures.
It wouldn’t be the first time federal money intended to
prop up the financial industry was used for unintended purposes. Days
after it received an $85 billion federal bailout loan, the huge insurer
American International Group Inc. spent $440,000 on an executive
retreat with spa treatments, banquets and golf outings.
Both
Fannie Mae and Freddie Mac have been subpoenaed as part of the
wide-ranging Justice Department investigation into the companies’
accounting, disclosure and governance practices. The two companies are
key to the U.S. mortgage industry. After banks make loans to home
buyers, Fannie and Freddie buy the mortgages from the banks so bankers
can have cash on hand to make more loans and keep the economy humming.
Fannie and Freddie then bundle those loans and sell them as
mortgage-backed securities. The proceeds of those sales help buy more
mortgages.
In recent years, however, the companies purchased more
risky, subprime mortgages. When the housing bubble burst and the
subprime industry imploded, investors feared the risk of buying Fannie
and Freddie’s mortgage-backed securities, making it harder for the
companies to raise money.
Combined, Fannie and Freddie own or
guarantee nearly half of all U.S. mortgages. The Treasury Department
stepped in to keep the companies from collapsing and taking the
mortgage industry with them.
Neither Fannie nor Freddie has said
whether they already have advanced any legal fees to former executives.
The companies are required to make general disclosures about such
payments but only on quarterly corporate filings.
When the
government took over, Fannie Mae chief executive Daniel H. Mudd,
Freddie Mac chief executive Richard F. Syron and the rest of the
companies’ leadership was dismissed. All those executives would be
entitled to have their legal fees covered.
The obligations could
easily stretch into millions of dollars. Both companies have promised
to pay legal fees for all current and former board members, executives
and employees charged or investigated in connection with their
employment.
Legal fees can add up quickly. After Freddie Mac
restated its earnings in 2003, it became embroiled in several
investigations and lawsuits. By the middle of 2005, the company had
paid $16.8 million in legal fees for its executives and employees.
Executives
who are convicted of wrongdoing are required to give the money back.
Those who are acquitted, who are merely witnesses or who are
investigated but never charged do not need to reimburse the company.
It’s
impossible to determine how much money might be at stake. In taking
over the two mortgage giants, the government pledged to spend up to
$200 billion to keep both companies afloat. The amount the government
actually will spend depends on how well the companies perform in a
changing mortgage industry.
With so much money at stake, defense
attorneys are watching closely to see how broadly housing regulators
restrict any future legal payments. The Fannie and Freddie contracts
give the executives the right to sue to force the companies to pay
their legal fees. If the executives win, the cost of those lawsuits
gets passed to Fannie and Freddie, and potentially to the taxpayers.
