Most stories about the financial crisis of 2008, the darkest chapter in American economic history since the Great Depression, come to an end by 2012. That’s when ours begins.

After the housing market bottomed out in 2011 and began its upward trajectory, the nightmare seemed to end. For business it was morning in America again. Most of the too-big-to-fail institutions had either paid back their federal bailout money or were on track to do so. Stocks climbed and stockholders rejoiced.

That was the basic story arc for such titans as J.P. Morgan Chase JPM and Wells Fargo WFC (recipients of $25 billion each in taxpayer largesse), for instance, and for Citigroup C and Bank of America BAC ($45 billion each), and even for the derivative-plagued insurance giant AIG AIG ($182 billion).

Shareholders of Fannie Mae FNMA and Freddie Mac FMCC , the housing-finance behemoths at ground zero of the crisis, thought it would be their story line too. Fannie and Freddie, shorthand for the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., are known as government-sponsored enterprises, or GSEs, because of their unique structure: federally chartered yet privately owned.

Charles J. Cooper, lead attorney for proponents of Proposition 8, argues in front of the California State Supreme Court hearing in San Francisco, Tuesday, Sept. 6, 2011. On Tuesday, the California Supreme Court will be considering whether the sponsors of Proposition 8 have a legal right to appeal the federal court ruling that overturned the same-sex marriage ban, since the governor and attorney general refused to bring such an appeal. The 9th US District Court of Appeals, which has main responsibility for the case on appeal, asked the state court to weigh in on the question it deals with the stateís ballot initiative process. (AP Photo/Paul Sakuma) Powerhouse Republican attorney Chuck Cooper represents Fairholme Funds in its battle with the government.PHOTOGRAPH BY PAUL SAKUMA—AP PHOTO

The government had injected $187.5 billion into the GSEs after placing them in conservatorship in September 2008. But both seemed to be recovering on schedule, ending the first quarter of 2012 in the black and posting a whopping combined $8 billion profit for the second.

Yet on Aug. 17, 2012—about 10 days after the terrific second-quarter results were announced—something singular happened. For reasons that remain shrouded in secrecy to this day, the Treasury Department and the companies’ conservator, the Federal Housing Finance Agency (FHFA)—two arms of the same government—agreed to radically change the terms of what the GSEs would owe in exchange for the moneys they had already received.

Instead of a 10% annual dividend on all the bailout funds drawn—a dividend that came to $4.7 billion per quarter—the dividend was now to be set at 100% of each GSE’s net worth. One hundred percent. That is to say, any and all profit they posted. And this would be so in perpetuity. For all practical purposes, the GSEs’ shareholders were wiped out. The two firms, on their way back to health, were effectively nationalized.

The sudden change was called the “third amendment,” an innocuous-sounding designation that belies its momentous consequences. Just how momentous became clear almost as soon as the third amendment took effect, in January 2013. For within months the GSEs began posting the highest profits in their history. And when they did, all those billions were spirited off to the Treasury.

USA - Washignton DC - The Fannie Mae Building, The Fannie Mae Building, Washington, DC. Photograph by Tony Savino — Corbis

To date, the third amendment has swept into government coffers $129 billion more than the original 10% dividends would have. As a result, the GSEs have now paid the Treasury about $240 billion in recompense for the $187.5 billion extended to them (or actually $189.5 billion, counting fees that were part of the original deal). While that’s not yet a complete “repayment” of principal and interest at 10%, it’s getting close.

Or, rather, would be getting close if any of those payments counted as redeeming even a penny of the $189.5 billion principal—but they don’t. They’re just dividends. The government left no mechanism for Fannie and Freddie to pay back the principal, which is never reduced. So if the GSEs are ever dissolved, the government will still take the first $189.5 billion recovered from liquidation, stepping ahead of the companies’ preferred shareholders, who would have otherwise collectively held at least $33 billion in liquidation rights.

If this strikes you as, well, un-American, you’re not alone.

“I just don’t think there’s any precedent for the government nationalizing two privately owned companies the way it has.”

“I just don’t think there’s any precedent for the government nationalizing two privately owned companies in the way that it has,” says Chuck Cooper, an attorney representing the Fairholme mutual fund family and a group of insurance companies that own millions of preferred shares of Fannie Mae and Freddie Mac.

So Fairholme is suing the government, as are several other funds, insurance companies, and tens of thousands of individuals in a dozen or so suits now pending in at least five federal courts across the country. The cases allege that the U.S. government illegally or unconstitutionally took, without just compensation, Fannie and Freddie—two Fortune 50 companies. (They rank 17 and 42, respectively, on the 2015 Fortune 500 list.) The money at stake here—$33 billion worth of preferred shares and almost $130 billion in diverted dividend payments—places these cases among the highest-valued lawsuits in history.

“A conservator has one constant accepted responsibility,” says Cooper, of Cooper & Kirk in Washington, D.C., who is handling two of the cases and advising on a third. “That is to rehabilitate the entity under conservatorship. Rehabilitate it. Not to hold it in perpetual captivity to harvest its profits for the benefit of the conservator itself. That’s the very antithesis of a conservator.”

The government’s alleged nationalization of two enormous corporations raises potentially landmark constitutional issues—comparable to President Harry Truman’s attempt to nationalize steel mills during the Korean War. Asked to cite an earlier dispute against the government with comparable stakes, Cooper can only come up with the gold-clause cases of the 1930s, when President Franklin Roosevelt and Congress, coping with the exigencies of the Great Depression, abrogated all contractual provisions that permitted redemption of debts in gold. (The Supreme Court largely upheld the action.)

The corporate logo for Freddie Mac is seen at its headquarters building in McLean Photograph by Larry Downing — Reuters

Yet the contest over the third amendment is not just a weighty legal dispute over a sacrosanct constitutional principle—though it is that. It’s also a battle royal being waged between fabulously wealthy, opportunistic fund managers and Uncle Sam. That battle, in turn, is spilling over into the political arena, recasting the debate over housing-finance reform—and, as we’ll see in a bit, driving a sharp wedge between factions of the conservative base.

The fund managers have become key because, for better or for worse, the third amendment is more than just a colossal legal misstep; it’s a colossal investment opportunity. It had the effect of slashing the GSEs’ stock valuations to nearly nothing. Judging the amendment to be legally dubious, investors spied an opportunity to vacuum up GSE securities cheap, strike down the amendment in court, and then make a huge profit when the stock rebounded.

So, like sharks to blood, speculators rushed in, complaining about an alleged taking that, in many cases, occurred before they even got there. Cooper’s client Fairholme, founded by Bruce Berkowitz, began buying in May 2013, amassing about 120 million shares of Fannie and Freddie preferred—with a par value of $3.4 billion—for roughly $700 million. Bill Ackman’s Pershing Square Capital Management hedge fund bought up 10% of both GSEs’ common shares in late 2013. Billionaires Carl Icahn and John Paulson are among other marquee hedgies with skin in the game.

The activist fund managers are now trying to drive the policymaking debate in the direction of recapitalizing and restoring Fannie and Freddie to something like their prior positions—“recap and release,” they call it—which would, not incidentally, maximize the value of their shares. Their arguments—voiced on CNBC, Bloomberg TV, Charlie Rose, op-ed pages, and elsewhere—are plausible, but their conflicts are breathtaking. Under a recap and release scenario, Ackman’s projections show, his stake in Fannie and Freddie common stock—acquired for about $400 million—could in five years top $8 billion in value.

A host of public interest groups have also sprung up to support recap and release. While many of these are doubtless independent of the fund managers—Ralph Nader leads one—the opaque disclosure rules relating to nonprofits make it impossible to tell. According to the Wall Street Journal, one conservative seniors group, called 60 Plus, came up with $1.6 million in the spring of 2014 to mount a TV ad campaign to defeat senators supporting a bipartisan reform bill that would have dismantled Fannie and Freddie, terming it “Obamacare for the mortgage industry.”

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Finally, the third amendment is having one additional weird, unintended impact on the political environment: It’s splitting the conservative camp, which had once seemed solidly bent on driving a stake through Fannie’s and Freddie’s hearts at whatever cost. Cooper himself is emblematic of the anomaly. He’s a well-known Republican who has frequently pursued conservative legal causes, from defending bans on same-sex marriage to protecting gun rights. (Senator Ted Cruz, the Texas Republican now running for President, was once an associate in Cooper’s office.)

He’s also a good friend of Peter Wallison, perhaps the single harshest GSE critic in the nation and the one who has most tirelessly championed the view that Fannie and Freddie were the primary causes of the financial crisis of 2008, not mere enablers of more culpable private-sector banks. During the Reagan Administration, Cooper headed the Justice Department’s Office of Legal Counsel—acting, as he puts it, as Reagan’s chief constitutional lawyer—while Wallison served as Treasury and, later, White House counsel.

But while many conservatives still want Fannie and Freddie put to sleep as quickly as possible—the Wall Street Journal editorial board, for instance, has consistently denigrated the third-amendment litigation as frivolous—the front is no longer united. It seems that if there’s anything a dyed-in-the-wool conservative hates more than a GSE, it’s a government taking of a GSE.

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The stakes of the housing-finance policy debate are even greater than those of the lawsuits. Historically, Fannie and Freddie have played a central role in promoting homeownership in this country, the traditional gateway to the middle class. They have promoted liquidity and affordability in the mortgage market by buying mortgages, bundling them into securities, and selling them around the globe with an implicit (now explicit) government guarantee. They have been widely credited with having made possible the 30-year fixed, prepayable mortgage—the foundation of the American mortgage market and a rarity beyond our borders.

The Obama Administration has supported ambitious but complex bipartisan bills, known as Johnson-Crapo and Corker-Warner, that are intended to fix what many saw as inherent failings in the GSEs’ hybrid structure—one that privatized gains but socialized losses. The bills would, their sponsors claim, end the GSEs’ “duopoly” over the secondary-mortgage market and replace their implicit government guarantees with more limited, explicit ones. But the bills have stalled.

Seven years into their conservatorship, the GSEs remain adrift, with shrinking capital reserves and no exit plan—a dormant, festering crisis.

As a policy matter, Bethany McLean, a former Fortune writer whose recent book, Shaky Ground, sounds the alarm over Fannie and Freddie’s neglected plight, comes down on the side of the fund managers. “One of the investors gave me the analogy that Corker-Warner was like taking the existing highway structure in the U.S., tearing it up, and building a new one right next to it, with no guarantees that the new one was going to work,” she says.

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The point is a good one. But what a strange way we’ve hit upon to make policy in our country. Fund managers identify an investment opportunity, then retroactively construct self-serving arguments for why the nation will be a better place if their bets are allowed to hit the jackpot.

With Congress locked in partisan stalemate, however, it may just be how the sausage gets made.


The government justification for the third amendment hinges on something it calls the “death spiral.” That’s the term U.S. officials have used in affidavits defending the litigation in court. (Justice Department lawyers and spokespeople for FHFA and the Treasury declined to comment for this article.) In a letter last April to Sen. Charles Grassley, an Iowa Republican, Randall DeValk, an official at Treasury, explained that the GSEs themselves projected that “for the foreseeable future, they would be unable to pay the 10% dividends without taking additional draws.” Those new draws would cause them to approach their funding caps, DeValk continued, triggering a new insolvency crisis.

But how could their projections have been so far off, given that Fannie and Freddie were actually about to post their largest profits ever? Those profits, after all, came from one-time accounting adjustments, which should have been foreseeable. By 2013 (and probably earlier than that) it had become obvious that many of the losses the GSEs had incurred during the crisis—the impetus for their having drawn so much money from Treasury in the first place—had been losses on paper only. They had resulted from accountants’ overly pessimistic projections, which, under GAAP, became eligible for reversal when the economic picture brightened. It was these reversals that enabled Fannie, for instance, to book $59 billion in profits for the first quarter of 2013.

Pershing Square Capital Management LP Founder And Chief Executive Officer William "Bill" Ackman William “Bill” Ackman, founder and chief executive officer of Pershing Square Capital Management LP, poses for a photograph following a Bloomberg Television interview in LondonPhotograph by Chris Ratcliffe — Bloomberg via Getty Images

FHFA didn’t know that—or so said an agency official in an affidavit submitted in late 2013 in a suit brought by hedge fund Perry Capital.

Cooper doesn’t believe FHFA’s claim. Documents and depositions from officials at Treasury and FHFA, obtained in discovery in a suit brought by Fairholme Funds, show that the government’s story is “highly misleading” in some respects and “outright false” in others, plaintiffs lawyers allege in court briefs.

Instead of a 10% dividend on the bailout funds drawn, the dividends would be set at 100%of each GSE’s entire net worth.

The lawyers can’t tell the media (or even their clients) specifically what the documents and depositions show, however. That’s because Court of Federal Claims Judge Margaret Sweeney has ordered those materials sealed from public view, at the government’s behest. Bewilderingly, the Justice Department has persuaded her that disclosure of that information—concerning a now three- to eight-year-old decision-making process of tremendous public interest—might cause “dire harm” and “place this nation’s financial markets in jeopardy.” But the lawyers have won Sweeney’s permission to send their discovery finds (still under seal) to all the judges handling related cases, which they’ve done.

In any case, the government also stresses that it’s fundamentally wrong to imagine that the GSEs are anywhere near “paying back” the bailout moneys—or that they ever will be. “Treasury did not make a simple ‘loan’ to Fannie and Freddie,” DeValk argued to Grassley. “It made available hundreds of billions of dollars of funding capacity to ensure market confidence in the continued stability of the enterprises at a time when that stability was very much in doubt … Treasury and the taxpayers continue to be on the hook for future losses those enterprises may incur. Any private lender would demand substantial compensation for providing that kind of ongoing funding commitment.”

In September 2014 the government won an early round in the litigation. U.S. District Court Judge Royce Lamberth, of Washington, D.C., threw out Perry Capital’s case and four others, concluding that the conservator had acted within the broad powers given to him by Congress; that the GSEs were so heavily regulated that their stock wasn’t the sort of property that was capable of being “taken” in constitutional terms; and that the conservatorship had already “extinguished” the plaintiffs’ property rights in any event.

The suit is now in the U.S. Court of Appeals for the District of Columbia. But with other cases still playing out in the federal court of claims and in federal district courts in Iowa and Kentucky, the litigation seems certain to last for years and destined to reach the Supreme Court.


In March 2008, when the plummeting housing market caused investment bank Bear Stearns to fail, James Lockhart, Fannie and Freddie’s chief regulator, was sending out broad signals of optimism. He eased certain regulatory burdens on the GSEs, enabling them to issue new shares to the public. “The actions we’re taking today,” Lockhart declared at the time, “make the idea of a bailout nonsense in my mind. The companies are safe and sound, and they will continue to be safe and sound.”

Two months later Fannie issued $7.4 billion in preferred stock. About $65,000 worth was purchased by Jim and Pandora Vreeland of Loudon, Tenn.  Jim, then 61, had been an officer with the Montville (N.J.) Township Police Department before retirement. In 2008, when his mother died and left him a small inheritance, he went to his Wachovia broker seeking advice, he recounts.

It seems if there’s anything a dyed-in-the-wool conservative hates more than a GSE, it’s a government taking of a GSE.

“ ‘I’m looking for something to produce good interest, pretty assured,’ ” he recalls telling the broker. “ ‘Oh, what you want is preferred shares of Fannie Mae,’ ” he was told. (At that point Fannie hadn’t had an unprofitable year since 1985, and Freddie had never had one.)

Vreeland bought $40,000 worth, at about $25 per share. At the same time his wife, Pandora, acting as the trustee for her father, who had Alzheimer’s, bought $25,000 worth for his trust, banking on the income stream to pay for his nursing-home care.

It wasn’t just mom-and-pop investors who were buying Fannie preferred, even at this late stage. GSE securities had long been favored instruments for community banks and insurance companies. They were safe enough to satisfy regulators, explains Chris Cole, a spokesman for the Independent Community Bank Association, and were considered “a good way to diversify and to improve yield.”

In July 2008, as the economy continued to deteriorate, Treasury Secretary Hank Paulson asked Congress to give regulators beefed-up bailout powers for Fannie and Freddie. That same month Congress passed the Housing and Economic Recovery Act, creating the Federal Housing Finance Agency to oversee the GSEs. Lockhart, who was appointed to head the new agency, got the power to place Fannie and Freddie into either receivership or conservatorship. The roles differ substantially: Receivers liquidate troubled companies; conservators attempt to nurse them back to health and restore them to independence.

Two months later, the week before Lehman Brothers fell, Lockhart put both housing giants into conservatorship. As Lockhart explained that day in a press statement, that statutory process was “designed to stabilize a troubled institution with the objective of returning the entities to normal business operations.”

The following day, Sept. 7, 2008, FHFA and Treasury signed deals with the GSEs setting out the terms of the bailout. Each GSE would issue senior preferred stock to the Treasury, and each could then draw cash as needed to avoid insolvency. In exchange, each would owe a 10% dividend on the money drawn, payable quarterly. To further protect the taxpayer, Treasury also got warrants to buy 79.9% of each GSE’s common stock at a nominal price—$0.00001 per share. (The percentage was kept below 80%, it has been widely reported, to avoid having to move the GSEs’ $5 trillion in assets and liabilities onto the government budget, which would have noticeably increased the national debt.)

The shareholders’ lawyers would later argue that the warrants provision gave private shareholders further reason to believe that the government aimed to eventually recap and release the GSEs. It aligned the interests of private shareholders and taxpayers by giving both a stake in the reinvigorated GSEs. Indeed, if the GSEs returned to health, nobody would benefit more than Uncle Sam. All of this made the third amendment superfluous, if not downright bizarre. “If the government wanted a dividend larger than the 10%,” says Hamish Hume, a partner at Boies Schiller & Flexner and a lead lawyer for a class of preferred and common shareholders, “the original deal made it clear what the government should do: exercise its right to acquire 80% of the common.” Why steal the cow when you can get the milk for free?

During the conservatorship, the GSEs’ shares were allowed to keep trading. Stockholders retained “all rights in the stock’s financial worth,” according to an FHFA fact sheet, though other powers of stockholders were “suspended” and dividends were “eliminated.”

The trading price of the Vreelands’ preferred stock had begun falling in July, when Paulson asked for legislation. The first trading day after conservatorship, it tumbled further, from $14 a share to less than $3.50, and by December it was under a dollar. Fannie’s dividends—the whole point of the Vreelands’ investments—were cut off. Having bought just four months earlier, they received just one dividend before the seizure.

“It was a big loss to a small guy,” says Jim in an interview. “That was the money I was supposed to live on.”

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Vanity Fair Contributing Editor and author of Shaky Ground Bethany McLean speaks onstage Kimberly White Getty Images for Vanity Fair

Still, Jim held out hope. “I was led to believe the government would back this up,” he says. “It was a quasi-government agency.” If the companies started making money again, he says, he assumed “they’d come back and take care of the people that had invested in this thing.”

He wasn’t alone. “I read all the documents,” says Tim Pagliara, the CEO of CapWealth Advisors in Franklin, Tenn.  “I felt like the government’s reaction was overblown,” he recounts, and that the companies would eventually get back on their feet. The GSEs’ preferred stocks—like nearly all bank stocks at the time—were then cheap, so he bought some for himself, he says, and put 276 of his clients into it as well. Eventually some super-sophisticated investors, like Perry Capital, began buying the stock too.

For a couple of years the GSEs booked huge losses. In December 2010, Pandora Vreeland gave up on her father’s Fannie preferred, selling it for 56¢ a share, salvaging $520 from a $24,874 investment. But her husband, Jim, held on to his.

In August, FHFA and Treasury lowered the boom, announcing the third amendment. Jim Vreeland’s shares dropped 55%, from $2.35 to $1.05, and a day later they were worth 86¢.

“I thought it was a typo,” Bruce Berkowitz, the founder and chief investment officer of the Fairholme mutual funds, told journalist McLean of the moment when he first read the third amendment. “This can’t be right,” he continued, as recounted in Shaky Ground. “It’s like I took 80% of your house in the financial crisis, because you couldn’t pay, and then you somehow crawled your way back, and instead of saying, ‘Wow, you made it!’ I say, ‘Now I’m going to take 100%.’ ”

Seeing a golden opportunity, Berkowitz started buying these dirt-cheap Fannie and Freddie preferred shares in May 2013. Other funds were gorging on them too, pushing up the value of the shares. (Thanks to these speculators, Vreeland was able to unload his shares in March 2014 for between $10.40 and $12.70 per share, recovering nearly $18,000 of his $40,000 principal. Of course, his dividends were lost forever.)

Berkowitz then retained Chuck Cooper to try to get the third amendment struck down. In July 2013, he filed two cases for Fairholme, one in federal district court in Washington, D.C., and one in the federal court of claims.

Cooper was the obvious go-to guy for this assignment. His 13-lawyer boutique, based in a stately New Hampshire Avenue townhouse near Dupont Circle, specializes in suing the government, including “takings” cases. (Takings cases are those predicated on the clause of the Fifth Amendment that reads: “nor shall private property be taken for public use, without just compensation.”)

Cooper, who speaks with a soft Alabama accent and sometimes whips himself into fervors worthy of a jury summation, cut his chops in this realm by winning United States v. Winstar before the U.S. Supreme Court in 1996. In that case, which arose from the savings-and-loan crisis of the 1980s, healthy thrift institutions had been induced to buy sickly ones with the lure of certain regulatory accounting breaks, only to see those benefits abolished by Congress a few years later.

The legal challenges in the Fannie and Freddie suits come in two main flavors. The true “takings” cases, claiming that Uncle Sam stole billions of dollars from shareholders, seek damages from the U.S. government. The other suits instead seek court orders invalidating the third amendment and reversing its effects. They argue, for instance, that FHFA acted beyond its powers under the Housing and Economic Recovery Act.

Although the takings concept seems to best capture the injustice the plaintiffs feel, those cases may be harder for many to win or be less lucrative. There’s some question about whether plaintiffs who bought shares after the third amendment was announced (like Fairholme and Pershing Square) even have the legal right to seek damages for a taking. Also, since GSE shares were already quite cheap by the time of the third amendment—Fannie common was just 30¢ on Aug. 16, 2012, and fell only 6¢ after it was announced—a court might value a taking stingily, even if persuaded that one occurred.

If the plaintiffs succeed in invalidating the third amendment as beyond FHFA’s statutory power, on the other hand, many of their lawyers hope to win an order that would force the Treasury to count the nearly $130 billion paid in excess of the 10% dividend as a paydown of bailout principal. That would enable the GSEs to begin to rebuild capital and resume normal business, which would ultimately restore value to their shares.


In Congress, the struggle over whether and how to replace the GSEs continues. In mid-October top Obama administration officials reiterated their opposition to recap and release, squelching rumors—spread by activist investors, they suggested—that they might be undergoing a change of heart.

In an interview, Sen. Bob Corker, the Tennessee Republican, insists that while he opposes returning Fannie and Freddie to independence as a policy matter, he has nothing against the GSE shareholders. “Those individuals have rights, and nothing we’ve done has had anything to do with interfering with those rights,” he claims. “They’ll have their day in court. At the same time, this is just a fact: These entities would not be generating one penny of income if the federal government wasn’t standing behind them.”

Journalist McLean doesn’t second-guess the government’s decision to put the GSEs into conservatorship in the first place. “I have a hard time arguing with things done in the fog of war,” she explains. “But morally, the third amendment was done in a calm and happy time. It was calculated. The reason that has been articulated for it does not make sense, and it’s pretty clearly not true. That’s incredibly unpleasant for anybody that cares about the abuse of government power.”

She’s right. And the law isn’t as legalistic as cynics sometimes think. Gut checks count.

The spectacle of a conservator wiping out shareholders just as the companies he’s supervising are about to have their best years in history simply doesn’t smell right. It’s hard to picture the Supreme Court letting it stand.

A version of this article appears in the December 1, 2015 issue of Fortune with the headline “Uncle Sam’s $130 Billion Money Grab.”