In Fannie (OTCQB:FNMA) And Freddie (OTCQB:FMCC): The Litigation Thesis Remains Viable After Perry, I argued that the litigation thesis supporting a speculative investment in FNMA and FMCC ("GSEs") was still alive and well.
This thesis suffered an unexpected setback when the DC Circuit Court of Appeals majority opinion in Perry held that the Housing and Economic Recovery Act of 2008 ("HERA") did not impose a duty on FHFA to conserve and preserve the assets and rehabilitate the GSEs when acting as conservator. This permitted FHFA as conservator to nationalize the GSEs by administrative fiat when it entered into the Net Worth Sweep ("NWS").
In that article I focused on three strands of legal attack that remain viable after the Perry majority opinion, in order of strength of argument:
i) the Hindes/Jacobs case, arguing that HERA states that FHFA succeeds to the GSE directors' powers. This endows FHFA as conservator with powers that the GSE directors had under state law immediately prior to conservatorship. As FHFA selected Delaware law to apply to corporate governance, Delaware General Corporation Law Section 151 controls the permissible terms that may be set forth in preferred stock by FNMA, both by GSE directors immediately before conservatorship and by FHFA after conservatorship. The NWS contains terms that are not authorized by DGCL Section 151, and there is nothing in HERA that expands upon or preempts DGCL Section 151 when FHFA causes FNMA to issue preferred stock. Therefore, the NWS is illegal and void;
ii) the Collins case, which argues that FHFA is an unconstitutionally structured executive agency with a single director not removable by POTUS at will, so that the NWS is void as an act of an illegal agency and, at a minimum, must be readopted by a constitutionally constituted FHFA in order to be valid, and
iii) arguments in Collins and other cases that the Perry dissent was right as a matter of proper statutory construction, and that FHFA does have statutory limits upon its conservatorship authority that were violated by the NWS.
In this article, I consider the possibility of a Perry plaintiff appeal to SCOTUS of the Perry majority opinion and how that appeal might be argued, and now add a fourth strand of legal attack.
This fourth line of legal attack against the NWS argues that if the Perry majority opinion's statutory interpretation of HERA is correct, then HERA is unconstitutional under the nondelegation doctrine.
If the Perry majority is correct, then HERA contains, for practical purposes, no legislatively imposed limits upon the exercise of FHFA's powers as conservator. Congress has granted FHFA legislative authority to nationalize the GSEs under the guise of acting as a conservator; and this grant of unbridled legislative discretion has been made to (ii) an unconstitutionally structured executive agency, with a single director not removable at will by POTUS. The executive branch is unable to ensure that the unbridled lawmaking discretion that Congress delegated to FHFA is faithfully executed.
As the DC Circuit Court of Appeals recently held in PHH v CFPB, It is unconstitutional to structure an executive agency with a single director not removable at will by POTUS (PHH was vacated for en banc review to determine whether it was necessary for the appeals court to reach the constitutional question; however, its reasoning is strong and correct). This impermissibly insulates the executive agency from the constitutional mandate that POTUS shall take care that the laws are faithfully executed.
If it is unconstitutional for an executive agency like CFPB to exercise executive authority with a single director not subject to removable by POTUS at will, then it is quite another thing that only compounds this constitutional infirmity for Congress to endow a similarly constituted FHFA director with unconditional legislative discretion in connection with the exercise of its executive authority. This is doubly unconstitutional.
Under the Perry majority opinion, FHFA is, in effect, a legislative and executive mashup, exercising legislative discretion under the guise of executive authority but not subject to POTUS direction, in violation of the separation of powers doctrine. In other words, FHFA Director Watt is bloody King George!
Unconstitutional Delegation of Legislative Authority to An Unconstitutionally Structured Executive Agency
Perry should appeal to SCOTUS for writ of certiorari review (which SCOTUS need not grant), and argue in the alternative that:
i) the Perry dissent was right as a matter of statutory construction, and a fair reading of HERA leads one to conclude that it did not authorize FHFA as conservator to nationalize the GSEs (or that it is necessary for the trial court to establish a full administrative record to determine that FHFA did not abuse its discretion in this regard), or
ii) if the Perry majority is right, then HERA unconstitutionally delegated to FHFA the legislative authority to nationalize the GSEs when acting as conservator, and the reason why this delegation of discretion is unconstitutional in this circumstance is because the executive branch cannot ensure that FHFA's unbridled legislative discretion is faithfully executed by a single director not removable at will by POTUS.
The constitutional doctrine of nondelegation is almost 200 years old, but it has come to be observed in the breach as the administrative state has grown in strength over the last 80 years. The nondelegation doctrine is firmly situated in the US Constitution's commands in Article I, § 1, which vests "all legislative Powers herein granted … in a Congress of the United States" and in Article II, § 1, which states "the executive Power shall be vested in a President of the United States of America." Therefore, as a constitutional matter, there is a separation between the lawmaking and executive functions, which is the genius of the US Constitution's separation of powers. Congress is the principal and POTUS is the agent, with Congress enacting the law and POTUS executing the law.
Now, it can be readily seen, and courts have held, that POTUS as agent must exercise some discretion in connection with the execution of the laws, as it would not be possible for Congress to anticipate in advance all questions that arise in connection with POTUS's execution of enacted law. As well, it would not be practicable for POTUS to refer all questions regarding the specific application of enacted law to the details of any particular situation back to Congress for specific direction. Government would grind to a halt and would not benefit from executive expertise developed from agency practice if no Congressional delegation of discretion is permitted by the nondelegation doctrine.
In its modern form then, the nondelegation doctrine provides that there is no impermissible delegation of legislative power from Congress to POTUS so long as Congress provides POTUS an "intelligible principle" to guide the executive agency in its execution of the law. In other words, if Congress sets forth some kind of a guiding principle, even a general standard that the executive agency should regulate "in the public interest," then courts have found that executive agency action to be constitutionally exercising an "executive" rather than "legislative" function.
Now, there is always a crucial assumption that underlies this modern form of the nondelegation doctrine that, I argue, is not satisfied in the Perry case. Courts are willing to defer to Congress's legislative delegation of even a vast amount of discretion to the executive branch when the executive agency is constitutionally constituted. This is not the case with HERA and FHFA.
I am aware of no case in which the nondelegation doctrine has been invoked in the situation where the executive agency alleged to have impermissibly exercised legislative power is not itself constitutionally constituted as an executive agency. That case is Perry, and the Perry plaintiffs should make that argument on appeal to SCOTUS in appealing the Perry majority opinion.
The prototypical nondelegation problem presented by the Perry majority opinion relates to whether HERA contains an "intelligible principle" to guide FHFA in connection with the exercise of its duties as conservator.
Under the Perry dissent's version of statutory interpretation, the answer is clearly yes, that when Congress chose the word "conservator" as FHFA's role under the statute, Congress was incorporating into HERA decades of prior statutory and common law understanding of what conservators do, and how they should do it. To be sure, HERA also contains specific grants of conservator authority, but there is no statutory statement that these specific grants exclude all the foregoing interpretive history regarding conservatorships, and as the Perry dissent pointedly stated, where HERA says that the conservator "may" exercise certain powers as conservator, this can readily be understood as a common sense acknowledgement that FHFA's exercise of conservator may not be successful.
Indeed, imagine if HERA stated that FHFA "shall" rehabilitate the GSEs. If FHFA proved unsuccessful and FHFA moved on to its other permissible role as receiver, would all homeowners have had an implied right of action against FHFA when their mortgage rates rise as a result of a failed GSE conservatorship? Use of the word "may" rather than "shall" makes explicit common sense.
But, if the Perry majority is right and there is no historical conservatorship jurisprudence incorporated into HERA to guide FHFA, and if there are no statutory limits upon FHFA as conservator contained in HERA because FHFA "may" do what it wants in the exercise of its conservator powers, even nationalize the GSEs representing some 20% of US domestic GDP if it so elects, then has Congress supplied FHFA an "intelligible principle" upon which to act as conservator?
So, an appeal of the Perry majority opinion would argue, along the lines of the third litigation theory above, that the Perry dissent was right, that there are limits upon FHFA conservator power, in order to avoid raising the question whether HERA violates the nondelegation doctrine.
But this appeal would also incorporate the argument contained in the second litigation theory above, that FHFA's unconstitutional structure prevents POTUS from faithfully executing the laws, and it is this unconstitutional structure that exacerbates the nondelegation doctrine analysis.
The strength of a Perry appeal along the lines discussed in this article is that while SCOTUS allows Congress a great deal of legislative leeway under the nondelegation doctrine to draft laws in an open-ended manner and thereby give POTUS a great deal of executive leeway in executing these open-ended laws, leading SCOTUS to find an "intelligible principle" in the most general of legislative commands, this leeway assumes that POTUS is in fact exercising its executive power through an executive agency in a constitutional manner. Where the executive agency is unconstitutionally structured, the deferential premise underlying the normally permissive nondelegation doctrine is absent.
Let me illustrate this by the following thought experiment: suppose Congress enacted HERA containing all of its current terms and provisions but with one difference, that Congress named Joe the Plumber as GSE conservator (and POTUS signed this statute into law). Other than this exception with Joe the Plumber acting as conservator, this HERA 2.0 would be exactly the same as HERA. Assume also that when Congress named Joe the Plumber as conservator, Congress authorized that Joe the Plumber would have sufficient resources to rely upon a full complement of housing finance experts to advise him in connection with his exercise of conservator power. To paraphrase the Perry majority opinion, this is indeed not your grandfather's Joe the Plumber.
How would the Perry majority rule in this circumstance? Would the Perry majority discover limits to Joe the Plumber's conservatorship power under this HERA 2.0 that it did not find in HERA? Let's assume that the Perry majority is intellectually consistent and finds that the statutory provisions of HERA 2.0 should be interpreted in the same manner as HERA.
Would the Perry majority rule that has granted too much discretion, putting aside for a moment to whom, in violation of the nondelegation doctrine? Would the Perry majority rule that it was an impermissible delegation of legislative authority to grant a single individual, putting aside for a moment whether that single individual is Joe the Plumber or the FHFA director, the power to determine whether to nationalize the GSEs? Perry plaintiffs did not argue this to the DC Circuit Court of Appeals, but the answer logically should be no, since if HERA 2.0 contains an excessive delegation of discretion, so must HERA.
The answer of course is that the Perry majority would find that HERA 2.0 violates the nondelegation doctrine because Congress delegated unbridled discretion to Joe the Plumber, rather than POTUS, to exercise the authority to nationalize the GSEs. Joe the Plumber is not subject to POTUS's removal so that POTUS can ensure that the power to nationalize the GSEs is faithfully executed, as is constitutionally required of the executive branch.
But then, neither is the FHFA director.
My argument here is that when courts engage in what is essentially a meaningless game of semantics distinguishing between "legislative" and "executive" power, and courts find that Congress has not unconstitutionally delegated the power to enact laws to the executive branch, and that the executive branch is merely executing laws that Congress has enacted under the guidance of an "intelligible principle," there is a more basic structural principle at work based upon the separation of powers doctrine that underlies the nondelegation principle.
This structural principle is that the executive branch is executing the law by means of a constitutionally structured agency, such that POTUS can faithfully execute the laws, even laws whose legislative guidance is found only in an "intelligible principle". If that agency is controlled by a single director not removable at will by POTUS, then the executive branch is not faithfully executing the legislative discretion that Congress has delegated to the executive, and the underlying presumption that normally inhibits courts from invoking the nondelegation doctrine is absent.
I believe that a Perry appeal to SCOTUS based upon the nondelegation doctrine, argued in the context of an unconstitutionally structured FHFA, has merit and if heard by SCOTUS upon writ of certiorari, would invalidate the NWS.
This would invalidate the NWS and result in a vindication, at long last, of the litigation thesis underlying a speculative investment in FNMA and FMCC.
Disclosure: I am/we are long FNMA, FNMAS.
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.
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