Did the US shortchange investors $27 billion?

Elon Musk’s bid to get out of buying Twitter Inc for about $44 billion goes to trial October 17 in Delaware. The same day, another multibillion-dollar lawsuit that zeroes in on good faith when parties sign contracts will be heard in US District Court in Washington. The investment firm Fairholme Funds Inc is leading a group that claims US government agencies shortchanged them $27 billion in the financial engineering that has its roots in the 2008 mortgage meltdown.
Two weeks before the collapse of Lehman Brothers, authorities agreed to bail out Fannie Mae and Freddie Mac, government-sponsored enterprises (GSEs) that greased the nation’s housing market. But the government couldn’t afford to take their liabilities onto its own balance sheet in a full-blown nationalisation, so then-Treasury Secretary Henry Paulson proposed a conservatorship instead. The US Treasury Department offered each of them up to $200 billion of capital support in exchange for warrants over 79.9% of common stock together with some preferred stock. Initially, the support carried a 10% cash dividend.
The situation was meant to be temporary. The press release accompanying the move said that it was “designed to stabilise a troubled institution with the objective of returning the entities to normal business operations.” That all changed in August 2012, when the government amended the terms of the bailout. The 10% dividend was canceled, and the companies were now required to hand over all their profits to the Treasury in a so-called “net worth sweep.”
With the companies stripped of the right to retain earnings, any value left in their legacy junior preferred stock evaporated. Shareholders were not happy.
Fairholme and a number of other investors sued. The government claimed that Fannie and Freddie were in a “death spiral” — their profits were so weak they required support from the Treasury simply to make their payouts.
In a 2014 decision, Judge Royce Lamberth of the US District Court for the District of Columbia sided with the government. “It was Congress, after all, that parted the legal seas so that FHFA [the body overseeing the housing companies] and Treasury could effectively do whatever they thought was needed to stabilise and, if necessary, liquidate, the GSEs.”
But a separate hearing entitled Fairholme to conduct fact discovery and it soon transpired that not all was as it seemed.

—Bloomberg