When Is A Raisin Like An Investment Return? When The Government Takes It Away

Tara Helfman Associate Professor, Syracuse University College of Law
Font Size:

It’s an unsettling fact: The government can help itself to your property. If your home stands in the way of a new sports arena, the government can bulldoze it; and if your farm stands in the path of a new highway, the government can pave it. However, the Constitution places clear limits on such takings. The Fifth Amendment prohibits the government from taking private property without due process of law. It also requires that the government pay owners just compensation whenever it takes their property for a public purpose.

But what if, instead of taking your home or your farm, the government decides to help itself to all the future profits of your investments? Does it still owe you compensation? According to a group of investors in Fannie Mae and Freddie Mac, the answer is an unequivocal yes. And it appears that the law is on their side now more than ever.

Fannie Mae and Freddie Mac are two of the largest financial institutions in the United States. Together, they hold more than 60 percent of the new mortgages in the nation. Long hailed as sound investments, pension funds, mutual funds, and insurance companies have staked their clients’ financial futures on Fannie and Freddie’s prospects.

But during the financial crisis of 2008, the federal government took what it insisted was temporary control of the companies. In the interest of stabilizing the national housing market, the Department of Treasury opened lines of credit to Fannie and Freddie in exchange for $1 billion in preferred interest-bearing shares. The federal government became the biggest shareholder in the companies, holding nearly 80 percent of the common stock.

By mid-2012, Fannie and Freddie had reached record-breaking profitability and were paying substantial dividends to Uncle Sam. It was at this point that the government unilaterally decided to make its temporary conservatorship of the companies permanent. In an unprecedented move, the Department of Treasury announced a “profit sweep” of the companies. From that moment on, the federal government would help itself to 100 percent of the companies’ current and future profits. All other investors would receive nothing.

The short-term implications of this measure are sobering. The Treasury, with the stroke of a pen, has taken the legitimate property interests of an entire class of investors without compensating them. This was no forfeiture; Fannie and Freddie do not owe the government a penny under the original 2008 agreement. (In fact, as of this week, the companies have paid the Treasury nearly $50 billion more than it was initially owed.) Rather, the Treasury seems to have undertaken the profit sweep for the sole reason that it wants money and the private investors have it.

This makes the long-term implications of the Treasury’s move nothing short of staggering. For if the federal government can unilaterally rewrite its agreements with private entities – if it can help itself to private property for the sake of padding its own coffers – then some of the Constitution’s key safeguards will be completely eviscerated.

This is essentially the argument being made by a group of investors in Fairholme Funds, Inc. v. United States, a case that is presently underway in federal court. The claimants, who include investment funds and insurance companies, are challenging the constitutionality of the profit sweep under the Fifth Amendment. Their basic argument is that the government cannot seize a corporation’s stock for a public purpose without compensation any more than it can seize a corporation’s tangible assets. This June, the Supreme Court added fire to Fairholme’s arsenal through its ruling in Horne v. Department of Agriculture, a case that was (improbably) about raisins.

The case turned on the power of the Department of Agriculture to confiscate a certain percentage of the national raisin crop from American farmers in the interest of stabilizing the national market for agricultural products. The government would then sell, donate, or dispose of the confiscated raisins in order to control market supply and stabilize prices. In the meantime, the farmers who grew the raisins did not get a penny in return.

But in 2004, Marvin and Laura Horne decided they had had enough. The California farmers refused to hand over either their raisins or the nearly $700,000 in fines and penalties that the Department of Agriculture demanded. Instead, they challenged the constitutionality of the measures under the Fifth Amendment – and won. In an 8-1 decision, the Supreme Court found for the Hornes, requiring the government to pay for what it takes from raisin farmers.

So what do raisins have to do with shares in a corporation? A lot, actually. The Hornes’ case marked a major breakthrough in the Court’s Fifth Amendment takings jurisprudence. Until then, most takings cases dealt with government expropriations of real property: houses, apartment buildings, beaches, farms, etc. And in those cases, the Supreme Court developed a complex body of law protecting private property rights from arbitrary government encroachments.

In Horne, the Supreme Court unequivocally held that the personal property enjoys the same level of constitutional protection against physical appropriation as real property. The government cannot take your raisins or your car without just compensation any more than it can take your house or your vineyards… or as Fairholme will determine, your shares of corporate stock.

With the legal battle over discovery well underway between the Fairholme plaintiffs and the federal government, it is only a matter of time before the shareholders have their day in court. And when they do, the fate of property rights in America will hang in the balance. A victory for the Treasury in this case is not a precedent that America can afford; nor is it one that the rule of law can long survive.

Tara Helfman