U.S. Treasury Flunks Finance 101 In GSE Litigation

by: Rule of Law Guy


The US Treasury asserted in its most recent filing in the Perry appeal that the Net Worth Sweep has generated a 7.5% annual return.

This is patently and unambiguously false. I calculate on a conservative basis that the NWS has provided Treasury with a 17% annual return.

Treasury has lost all credibility, given its false "death spiral" narrative as the cause for adopting the NWS, and now this false representation regarding the return the NWS has generated.

In its most recent filing with the DC Circuit Court of Appeals in the Perry case, the US Treasury asserted that it has derived a 7.5% per annum return from the Net Worth Sweep (NWS). This is patently and unambiguously false.

While this is a disturbing misrepresentation taken in isolation, this is just another in a series of false representations and fictitious narratives that Treasury has made in the Perry litigation. Treasury has lost what little credibility it had.

In the filing, Treasury states:

"Between 2008 and 2011, Treasury invested $187.5 billion in the GSEs…Through the first quarter of 2016, Treasury has received $245.6 billion in dividends, which equates to an annual rate of return of around 7.5%."

Treasury goes on to note that this mere 7.5% annual investment return is inferior to the 12% annual investment return that Fairholme, one of the plaintiffs, has obtained in the past. So, in other words, what's the big deal about the NWS? Why are the plaintiffs complaining?

Of course, this is nonsense. In making this assertion, Treasury has assigned no value to its outstanding $188 billion preference amount of preferred stock. By doing so, Treasury under-reports the amount of its investment return by the value of the preferred stock it still holds...a $188 billion error.

Under the NWS, the preferred stock is entitled to the dividend of all future profits of the GSEs, equal in annual amount to about $15 billion. Does Treasury renounce any interest in its preferred stock going forward? Of course not. Then how can Treasury purport to represent to the Perry federal appeals court that its investment return doesn't include the present value of its preferred stock, calculated based upon anticipated future returns?

This is an unimaginable financial misrepresentation coming from the governmental agency responsible for federal finance!

Using a quick calculation that assumes that Treasury invested all of its funds in 2008 and ignores that Treasury reaped its largest dividends during the early years of its holding period (both conservative assumptions), Treasury's total $245 billion in dividends divided by its $188 billion investment yields a total return of 130%, which when divided by its holding period of 7.75 years, results in a 17% simple annual return. This is a return on its $188 billion of preferred stock which, unless the NWS is invalidated, is deemed to remain outstanding.

What is the value of this outstanding preferred stock? Unless the NWS is invalidated, the preferred stock is entitled to all of the GSEs' net cash flow in perpetuity, which is approximately $15 billion per year in perpetuity. In an interest rate environment in which the Treasury's 10 year note yields less than 1.8% per annum, this cash flow stream certainly results in a valuation for Treasury's preferred stock (again, assuming the NWS is not invalidated) equal to at least par, or $188 billion.

Why does this blatant financial misrepresentation by Treasury matter?

Litigation has been called a liar's game when counsel try to stretch their presentation of facts when the truth doesn't fall comfortably on their side. Judges rely on counsel as officers of the court to make representations to the court in good faith. Judges are able to gauge the credibility of counsel's legal arguments by referring to the case law, but during the motion stage of a legal proceeding before any trial testimony is produced for the judge or jury to observe and assess for themselves, judges must rely on counsel's presentation of the facts as being made in good faith.

Treasury has abused the DC Circuit Court of Appeal's trust. Treasury should be ashamed of itself.

Disclosure: I am/we are long FNMA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.