Tearing down the wall of secrecy

A little discovery is a dangerous thing, as the government is learning in the latest round of litigation arising from the Treasury Department’s 2012 profit sweep of Fannie Mae and Freddie Mac. 

On Wednesday, Sept. 30, Judge Margaret Sweeney of the Court of Federal Claims allowed the plaintiffs in Fairholme Funds v. United States to file any and all materials designated by the government as “Protected Information” in other lawsuits challenging the government’s conduct toward Fannie Mae and Freddie Mac.  This effectively opens the floodgates for the disclosure of information that the government has long been trying to suppress.

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Fairholme Funds is one of a number of private investors who are suing the government in separate lawsuits, all of which arise from the government’s response to the 2008 financial crisis.   It was in response to that crisis that the federal government put Fannie Mae and Freddie Mac, two of the largest financial institutions in the United States, under what was supposed to be the temporary control of the Federal Housing and Finance Agency (FHFA).  The purpose of this measure was to avoid mass foreclosures on the subprime mortgage market. 

As the majority shareholder in Fannie and Freddie, the government then began moving enormous tranches of toxic debt into the two government-sponsored entities (GSEs).  In exchange, the Department of Treasury opened up billions of dollars’ worth of credit to the companies.   

By 2012, the GSEs were returning to profitability, notwithstanding the fact that the government had effectively turned them into warehouses for toxic debt.  (Indeed, as of this April they have paid $40 billion more to the government than they borrowed during the crisis.)  But as the mortgage market began to stabilize, the Treasury Department made an unprecedented move: it announced a sweep of 100 percent of Fannie and Freddie’s profits.  Since August 2012, every dollar the GSEs have made has gone directly into the government’s coffers rather than into the pockets of Fannie and Freddie’s preferred shareholders.

Not surprisingly, a number of investors have brought suit against the government for its high-handed expropriation of the GSEs’ profits.  The government’s response to these suits, however, has been surprising to say the least.  The Justice Department has invoked executive privilege to avoid the production of documents created by officials at the FHFA and Treasury during the lead-up to the profit sweep.

Executive privilege is an extraordinary power enjoyed by the president.  Through it, he can avoid the compulsory disclosure of sensitive information during litigation.  The doctrine is frequently invoked in order to protect state secrets and/or to preserve the executive’s interest in confidentiality when it comes to the delicate process of policy-making.  But in the current GSE litigation, the government assumed an entirely novel approach to executive privilege.  The Department of Justice argued that it should not be compelled to hand over sensitive documents during discovery because financial markets might be destabilized as a result.  In essence, the DOJ argued that investors simply could not handle the truth about how the government makes financial policy. 

Thankfully, Judge Sweeney has been chipping away at the government’s attempts to build a wall of secrecy around its financial decisions.  In late July of this year, she permitted Fairholme to use information that the government sought to keep secret as “protected information” in its shareholder lawsuit.  Judge Sweeney required that the information remain under seal, thereby keeping it out of the public eye, but it was certainly a step in the right direction. 

This Wednesday Judge Sweeney went one step further, granting the Fairholme plaintiffs’ request for permission to file those documents in other lawsuits against the government, as well.  And since Fairholme is filing amicus briefs in a number of suits, those documents will likely send shock waves through the litigation strong enough to shake the foundations of the government’s wall of secrecy.

In the short term, Judge Sweeney’s ruling will help throw much-needed daylight on the government’s financial policies.  In the long term, it will send a message to future administrations about transparency and accountability in a free market economy: our markets are a lot more resilient than politicans think.

Helfman is an associate professor at Syracuse University College of Law. 

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