Investors Sue Government Over Fannie, Freddie Stock

Amid newly energized trading in the stocks of mortgage giants Fannie Mae and Freddie Mac, shareholders filed suit Monday against the federal government, contesting its takeover of the two in 2008.

The City of Austin Police Retirement System in Texas and Seattle-based bank Washington Federal are seeking $41 billion in damages. They charge that the conservatorship of Fannie Mae and Freddie Mac was "unlawful and unwarranted," as is the requirement instituted this year that the two pay the Treasury all of their profits.

"The government has appropriated many billions of dollars' worth of private shareholder property, without providing any compensation for this action," according to the filing.

Fannie Mae reported record profits in the second quarter of this year and has now paid the Treasury $95 billion in dividends, nearing the $116 billion it originally drew. Shareholders believe they should be reaping some of these profits, not the federal government.

Mike Kemp | Rubberball | Getty Images

Trading among common and preferred shares of both companies has been heavy recently, as hedge funds reportedly make the bet that the government will let the two off the hook once they pay back an equal amount in dividends to what they originally drew.

That is highly unlikely, as the dividend payments do not go to pay back the draws. The government still owns $188 billion worth of senior preferred shares in the two entities.

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"What we found is that under almost all scenarios, the cash flows from the guarantee book would barely cover the principal owed to the U.S. government; as such, we believe little, if any, economic value will be given to non-government securities," according to an analysis by FBR Capital Markets.

The lawsuit, filed in U.S. Court of Federal Claims, comes just as a new bill is being drafted in Congress to reform housing finance and potentially liquidate Fannie and Freddie. Sens. Bob Corker (R-TN) and Mark Warner (D-VA) have been working on the legislation that would prevent the need for a government mortgage backstop.

"I think you've got to move away from a situation where when private shareholder gain and government taxpayer losses, and that is what this bill seeks to do, it really transforms how we doing housing finance hopefully we will be able to pass something that puts us on a better course than where we are," said Sen. Corker in an interview Tuesday on CNBC.

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Some analysts say the lawsuit could actually push Congress to act more quickly on winding down Fannie and Freddie.

"What we just a few days ago saw as only a remote possibility is now a 25 percent chance for action," wrote Jaret Seiberg of Guggenheim Partners in a note to investors. "This is because we suspect this will anger many on Capitol Hill who believe Fannie and Freddie are only alive and kicking because taxpayers put $187 billion at risk. We see the suit reinforcing the view on Capitol Hill that Fannie and Freddie included too much upside for investors and too much risk for taxpayers."

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—By CNBC's Diana Olick; Follow her on Twitter @Diana_Olick or on Facebook at

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