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By Richard A. Epstein

Today, the momentum is growing for fundamentally restructuring the national residential mortgage market in the wake of the earlier collapse of the Federal National Mortgage Association (FNMA, or "Fannie Mae") and Federal Home Loan Mortgage Corporation (FHLMC, or "Freddie Mac). These two government-sponsored enterprises (GSEs)--so-called in recognition of their hybrid public/private nature--have long written large chunks of the residential home mortgage market, to the tune of trillions of dollars. The current legislative fixes now on the table include a bipartisan proposal from Tim Johnson and Mike Crapo, coupled with an earlier entry by Maxine Waters. The Johnson-Crapo proposal follows on earlier entries from Jeb Hensarling on the House side and Bob Corker on the Senate side. Each of these proposals seeks simultaneously to unwind the past and to redefine the future. To evaluate them requires understanding the historical linkage between past events and future prospects.

To begin, some background. In response to the brewing subprime mortgage crisis in 2008, Congress in late July of that year passed the Housing and Economic Recovery Act (HERA). That legislation, inter alia, created a new Federal Housing Finance Agency (FHFA), which on September 7, 2008 placed into a conservatorship both GSEs. These conservatorships were intended to keep both entities alive in order to facilitate their return to the private market. They were not receiverships whose object is the orderly liquidation of the two businesses. The basic plan called for an infusion of up to $200 billion in fresh cash into Fannie Mae and Freddie Mac under a Senior Preferred Stock Purchase Agreement (SPSPA) that gave the government warrants, exercisable at a nominal price, to acquire a 79.9 percent ownership stake in each enterprise. In exchange for that advance the senior preferred stock carried a 10 percent annual dividend payment, which went up to 12 percent if the GSEs delayed their dividend payments on the senior preferred.

The terms of that deal were radically altered in August 2012, when the United States, acting through the Treasury Department, imposed, through the Third Amendment to the 2008 SPSPA, a "net worth sweep" that entitled the government to 100 percent dividends on future earnings. That one bold stroke effectively made it impossible for the GSEs to repay their loans and rebuild their capital stock. Both the junior preferred stockholders and the common shareholders could under this agreement never receive a dime from either GSE, even after the entities returned to profitability. Assessing this gambit requires understanding two things: first, the relationship between the Third Amendment and the original 2008 SPSPA; and second, the relationship between the Third Amendment and efforts to revitalize the housing market. Both relationships are widely misunderstood today.

Prior Writings In July, 2013, I attacked the Third Amendment for its refusal to allow for any pay down of the $188 billion in advances made under the 2008 SPSPA. The government did so on the dubious ground that it could repudiate its obligations in the name of "taxpayer protection." At that time, the Third Amendment meant that some $59 billion in designated dividends should have been recharacterized first as a payment of accrued interest, and afterwards as a return of capital, which necessarily would reduce the interest payments going forward, and speed the path toward reprivatizing Fannie and Freddie. As I wrote then, "even if the 2008 transaction stands, the 2012 transaction should be nullified, and the private and common shares restored."

Thereafter in November, 2013, I attacked the position that the government took in its litigation with Washington Federal, where it sought by a variety of procedural devices to prevent the case from being heard. There is no question that many legal and factual obstacles stand in the path of any suit under the 2008 SPSPA, especially in comparison with the Third Amendment. But it hardly follows that those plaintiffs do not deserve their day in court, as the government has claimed by insisting that they do not have standing to bring this lawsuit.

Finally, in March of this year, I attacked the government position in the strongest possible terms in light of the recent revelations by Gretchen Morgenson's New York Times article, "The Untouchable Profits of Fannie Mae and Freddie Mac." As Morgenson revealed, the Treasury and FHFA had decided as early as December 2010 to block Fannie and Freddie shareholders from sharing in the profits of the newly revived entities.

The current attacks on the Fannie and Freddie shareholders have not in my view come to grips with the key implications of the 2008 SPSPA and its August 2012 Third Amendment. Hence this further commentary on the topic.

The 2008 SPSPA In 2008, the government explicitly decided to keep both Fannie and Freddie alive in a conservatorship, which it was allowed to do under HERA. That decision may well have made sense for a whole variety of reasons. Forcing both companies into premature liquidation could have further roiled the financial markets. Even if it did not, there was an ongoing dispute--a dispute that remains, and on which I take no position--as to whether the stock of Fannie and Freddie was totally worthless or whether the liquid assets of both companies would have allowed them to ride out the storm without going bankrupt. Indeed, even in liquidation, shareholders have the right to claim their residual equity in their shares, thus opening the door to extensive evidence on valuation--evidence that could be highly sensitive to the time that is chosen for liquidation.

Avoiding these issues made perfectly good sense, but the conservatorship itself presented a new round of issues on just how to value the contribution to equity made under the SPSPA. On this point, Senator Bob Corker thinks that Fannie and Freddie and their shareholders have no beef at all stating, "While I'm always glad when taxpayers see a return on investment, we can't forget that Fannie and Freddie wouldn't be earning one penny today without the government guaranteeing their transactions."

To this argument there are two replies. The first is that Fannie and Freddie may never had gotten into the mess if the United States had not insisted that it make high-risk loans to low- and moderate-income housing, first under the Housing and Community Development Act of 1992 (HCDA), as amended in 2007. In 1992, 30 percent of GSE loans were devoted to these programs. By 2007, that target had been raised to 55 percent. The conditions attached to the 1992 Act could be satisfied only in some financial Nirvana, for the legislation announced that Freddie and Freddie "have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return . . . ." No one can do both simultaneously. It is a financial impossibility to increase the number of high-risk loans, without courting disaster in the event of a market downturn. Yet nothing in the Corker calculations takes this heavy obligation into account. Instead, he focuses exclusively on the government's implicit guarantee of Fannie and Freddie, later made explicit, which kept them afloat.

The deep danger in his approach is that it makes it impossible to determine the relationship between the heavy costs under the HCDA against the implicit government guarantee. But it is assuredly a wrong answer to count the implicit guarantee while ignoring the correlative duties that Congress imposed. In my view, a first-best world removes both of these requirements so that market-based housing becomes the norm. It might be said in response that without government intervention, the number of Americans that will own their own homes will decline. But that proposition is not the same as saying that the number of Americans with a roof over their head will decline. Instead it will lead to an increase in rental housing, which reduces radically the risk of major financial dislocations. Landlords run businesses and in general will not engage in the kind of borrowing and leasing that are likely to cause a financial disaster.

The second response in this instance is that the 2008 agreement is water over the dam. Before that agreement was entered into, the government had the option under HERA for the FHFA to close down Fannie and Freddie. But legal consequences follow once it takes the decision to go the other route. It is critical to remember that the shares of both companies traded in the market after the 2008 date marking the onset of the conservatorship, and the share prices in those transactions rested on the assumption that the Fannie and Freddie could not be stripped of future profits by government fiat. One cannot defend the Third Amendment in 2012 by announcing after the fact--and following and in the midst of active trading--that the 2008 SPSPA was, well, a mistake. That brazen approach gives the government two bites at the apple, and a free option to switch from one system to another with the benefit of hindsight after events have played themselves out. One might as well let gamblers place their bets in a horse race after the race has been run, and not before.

The Third Amendment The previous discussion sets up the analysis of the Third Amendment. In dealing with this issue, the government in its briefing in a shareholder lawsuit challenging the government's move took the strong position that the value of the government commitment in 2008 was "incalculably large," so that Fannie and Freddie shareholders had no expectation of being repaid. In and of itself, that statement is odd because in a financial situation it should always be possible to calculate the size of a bet, whether it be large or small.

In response, I wrote, "the level of the Treasury commitment was not 'incalculably large': it was $188 billion, all of which will shortly be repaid." A detailed criticism of this statement was prepared by Larry Wall, of the Center for Financial Innovation and Stability of the Federal Reserve Bank of Atlanta. He graciously amended his account in response to some comments that I sent to him, so I shall examine the criticisms of my position only in his revised version.

Wall's first argument is that the $188 billion was not the only financial commitment; there was also the interest. I agree of course with that point, and thought that it was too obvious to say in that context. As should be evident from the discussion above, the government is entitled to recover that interest in full. The government surely took a larger risk at the earlier date. But by the time of the Third Amendment, which was the focus of my writing, the principal was on the road to being repaid, and all interest obligations were current.

Wall's second and more serious point relates to the obligations, if any, to absorb further losses in the portfolio, which could be a large sum, albeit one that was limited by the ability of the government not to make further advances if it chose not to. But however these residual risks of 2008 are calculated, they are not beyond calculation. Indeed, the applicable limits on how much the Treasury had to commit to this venture were twice raised. By the time the Third Amendment came about, no additional commitments would be needed, so that these contingent liabilities were not a serious factor in figuring out whether the Third Amendment was fair to the shareholders--which given its wholly one-sided nature it was not.

(Correction 4/21: Initially, it was stated that the applicable limits on how much the Federal Reserve had to commit were twice raised. It was in fact the U.S. Treasury not the Federal Reserve that guaranteed the obligations)

Wall's third point relates to the decision of the Treasury to take for nominal consideration an option to purchase 79.9 percent of the common stock. That option today would be worth billions of dollars if the Third Amendment had not been adopted. At this point two questions arise. The first is how we value that particular option as of 2008. Wall assigns to it a modest value, which is again disputable. To be sure, the odds that it would come into the money may have been low, but if the housing market did recover, as it did, chances are that it would be worth a substantial sum. The high rate of return is thus in tension with the low probability of its occurrence. Working out these numbers does not lead to the conclusion that the warrants should have been ignored in calculating the value of the government's stake.

More critically, once it is settled that the action is over the Third Amendment, all of Wall's calculations, as noted, are irrelevant. The proper time to evaluate the fairness of the Third Amendment is when it is made, not sooner. Indeed, ironically, the Third Amendment, if allowed to stand, wipes out the value of the government option to buy 79.9 of the common because Fannie and Freddie shareholders will never receive any payments either by way of dividend or liquidation ever. No analysis of the 2008 deal gives any insight into the Third Amendment.

Going Forward My last point is brief, but critical. There are all sorts of ways in which to reform the housing market, in order to avoid the mistakes of earlier periods. To do that, any workable reform, critically, would involve removing the deadly combination of an implicit government guarantee coupled with a mandate to make high-risk loans with small down-payments to low- and middle-income individuals who lack sufficient capacity to repay.

Unfortunately, the major reform proposals advanced to date, including most recently the Johnson-Crapo proposal, essentially double down on the old, failed model. The Johnson-Crapo bill is, I think, highly flawed. Its dangerous willingness to have the federal government guarantee about $5.2 trillion of mortgage debt is well-exposed in a recent Cato Institute Working Paper by Ike Brannon. Its dangerous similarity to recent health care reform is the centerpiece of James Glassman's pieces in the Weekly Standard, which characterizes the bill as the Obamacare of real estate. Here is not the place to go examine the Johnson-Crapo bill's complex structure and perverse incentives. Quite simply, the new bill repeats most of the old mistakes with Fannie and Freddie in the form of a new Federal Mortgage Insurance Corporation that has the same cross-subsidy to high-risk borrowers, now called "equitable access." Because the political pressures to service low- and middle-income groups will be as great now as they have ever been, it is an open question, at best, whether the new reforms will be able to prevent a slow decline in underwriting standards under the proposed new regime.

Complicating the uncertain prospects for Crapo-Johnson, and all future proposals, is the aftermath of the government's extraordinary actions under the Third Amendment. There is a tight connection between the past obligations to Fannie and Freddie and the creation of any new facility in which private parties are asked to risk capital, given the very real risk that private capital will stay away from facilities that are empowered to make foolish loans under federal oversight that will, almost inevitably, cave with time. The short answer is that if the Third Amendment holds up in court, private parties will in fact stay away in the future. There are just too many possibilities to wipe out private investment if the government has the power that it claims here and everywhere else. (If the executive branch can rewrite the ObamaCare legislation repeatedly, it can rewrite any legislation including regulation for the residential mortgage market.) Indeed, the situation is worse: even if the shareholder suits against the various government agencies prevail, private investors would rightly perceive an ongoing risk that they could be tied up for years in litigation brought to enforce their contractual rights. That grim prospect will certainly deter private participation in any new mortgage-loan facilities being contemplated.

What is clear is that the "protection of taxpayers" motif is bipartisan. Both parties see every reason to ignore contractual and constitutional obligations to Fannie and Freddie shareholders. What reason is there in this political climate to think that the Congressional leopard will lose its spots anytime soon? On all these issues, any defense of the Third Amendment, such as that offered by Larry Wall, only makes matters going forward worse.

Richard A. Epstein is the Laurence A. Tisch Professor of Law at the New York University School of Law the Peter and Kirsten Bedford Senior Fellow at Stanford University's Hoover Institution, and a Visiting Scholar with the Manhattan Institute's Center for Legal Policy. Professor Epstein works as an advisor to several hedge funds that have financial interests in the issues covered in this essay.

By Richard A. Epstein

On Thursday, July 18, Texas Republican Congressman Jeb Hensarling will hold hearings on his "Protecting American Taxpayers & Homeowners Act." The PATH Act contains many forward looking proposals, on which I have no comment. But on this occasion, I want to focus on one key feature of the Act, which is only obliquely revealed by the statutory title. Mr. Hensarling shows great solicitude for American taxpayers and homeowners. But in a telling omission, he gives the back-of-the-hand treatment to the preferred and common shareholders of Fannie Mae and Freddie Mac, (commonly called Government Sponsored Entities or GSEs). In the interest of full disclosure, let me state for the record that I have advised several hedge funds on the merits of the PATH Act, and on the parallel bipartisan legislation that Tennessee Republican Senator Bob Corker called the Housing Finance Reform and Taxpayer Protection Act of 2013, both of which are designed to wind down the operations of Fannie and Freddie.

Liquidating Fannie and Freddie The source of my concern with Mr. Hensarling's proposed legislation involve sections 103 and 104 of the Act, which, according to its legislative summary provides for "Termination of Conservatorship," such that "Five years following the date of enactment mandates the appointment of the Federal Housing Finance Agency (FHFA) director to act as receiver for each Enterprise (i.e. Fannie Mae and Freddie Mac) and carry out receivership authority." Section 104 then provides for declining maximum amounts that GSEs shall be entitled to own over the five-year transitional period before these entities are liquidated.

In one sense, the demise of Fannie and Freddie should not be lamented, after the long and sorry history of massive government intervention in their internal affairs that created serious dislocations in the marketplace in 2008, including, most notably, the Congressional insistence in 2007 that Fannie and Freddie issue some $40 billion in subprime loans. As a result of these actions, both GSEs suffered major losses during the early part of 2008, not unlike those suffered by other private companies. The nature of these actions are outlined in a complaint attacking the various government actions filed in Washington Federal v. U.S. in June 2013.

Therein hangs the following tale, which leads to the Hensarling hearings. Although not widely known, both GSEs are as organized as corporations whose shares are privately owned and publicly traded. The independence of these corporations was effectively ended in July 2008 when Congress passed the Housing and Economic Recovery Act of 2008 (HERA), which forced both companies, while still solvent and flush with liquid assets that could be either sold or mortgaged, into a conservatorship that was overseen by an agent of the United States, FHFA. I have described much of the early operations of HERA in my Defining Ideas column Grand Theft Treasury. The title summarizes my deeply critical attitude toward this problem.

In September 2008, the FHFA, as conservator of these GSEs, entered into a deal with the United States Treasury to organize a bailout of these still solvent entities. First, FHFA issued to the Treasury a new 10 percent perpetual senior preferred stock for which Fannie and Freddie over time received in exchange about $187 billion in fresh capital. As part of the deal, the Treasury received warrants to purchase 79.9 percent of the common stock at a nominal price of $0.00001, effectively wiping out most of its value. The now junior preferred stock remained on the books but had sharply diminished value. Clearly, the net benefits from this initial bailout were set by the Treasury, which exercised its power to buy into these GSEs at prices highly favorable to itself. At no point did the former directors of either GSE have any say on the terms of the deal. Essentially, the United States was on both sides of the transaction in a clear breach of the standard rule that all self-dealing transactions must be scrutinized to determine whether the shareholders' conservator provide them with fair value.

The Dubious 2012 Amendments to the 2008 Agreement Fast forward now to August 2012, at the start of the housing market recovery. At this time, FHFA and the Treasury entered into their Third Amendment to the 2008 Agreement which provided that "all positive net income each quarter will be swept to the Treasury." It is important to understand the unprecedented magnitude of this Amendment. At the time, Fannie and Freddie had returned to profitability and were thus able to pay both the interest on the Treasury's senior preferred stock and return some of the $187 billion that the Treasury had contributed to the both GSEs. This Third Amendment in effect stripped all the cash out of these companies and gave it to the United States as a "dividend" on its investment, with no reduction in principal.

Any sensible person would instantly realize that the unilateral variation in terms was not done to aid the private shareholders of Fannie and Freddie, but was intended to transfer all their wealth to the government whose crude contractual "amendment" violates the first principle of contract law: A and B may never enter into a contract that binds C without C's consent. What is truly amazing is the spin that Mr. Hensarling puts on this so-called Amendment in a document described blandly as PATH Act Questions & Answers:

Some are arguing that Fannie and Freddie have begun paying a financial benefit to taxpayers. While it's true that both companies had positive net income for the last three quarters of 2012 and have made $65.2 billion in dividend payments, these statistics don't give a complete picture of their financial situation. It is important to note that under the GSEs' contact with the federal government, these dividend payments cannot be used to offset prior Treasury draw, so that regardless of how much is paid out in dividends, the GSEs still owe taxpayers $187 billion in bailout funds borrowed And since their contracts with the federal government state that all positive net income each quarter will be swept into the Treasury as a dividend payment, in their current state the GSEs will never be able to repay that debt to the taxpayers.
His "complete picture" of the financial deal is replete with half truths. It would help if Mr. Hensarling noted that he was speaking of the August 2012 Third Amended Agreement, which was signed only by two government operatives, then acting director Edward J. DeMarco of FHFA and Timothy Geithner, then Treasury Secretary. "Their contracts" with the federal government are not "their" contracts. They are just "contracts" that the government has entered into itself. The simple point here is that neither government agency represented the GSEs's shareholders who assets were stripped bare by government actions. Of course, the companies cannot pay back the debt because the government has seized all the assets that would allow that result to happen.

The Four Lawsuits It is no surprise that this highhanded action has attracted four major lawsuits in recent weeks. In addition to the Washington Mutual case, plaintiffs filed suits in Fairholme Funds, Inc. v. FHFA, (with Charles Cooper as lead counsel), Perry v. Lew(with Ted Olson as lead counsel) and Cacciapelle v. U.S., (with David Boies as lead counsel), attacking these sweetheart agreements and administrative shortcuts.Taken as a unit, these four lawsuits highlight three fatal flaws of the corrupt government deal of August 2012.

The first involves the blatant breach of the FHFA's duty of loyalty to the GSE shareholders, for whose sole benefit this arrangement was imposed. No fiduciary, government or private, may engage in collusive self-dealing that results in a huge one-sided giveaway of all corporate assets. FHFA is not exempt from this bedrock rule. Second, the Treasury's major abuse involves its conscious disregard of the explicit protections for GSEs built into Section 1117 of HERA. For starters, that section gives the Treasury only "temporary authority to purchase obligations and securities" up to December 31, 2009. That authority certainly did not allow the Treasury to engineer its one-sided 2012 sweep, except on the absurd premise that the statutory authorization to "buy" before 2010 implicitly authorizes outright government expropriation of GSE assets after 2009.

To be sure, the Treasury's temporary authority instructs it to "protect the taxpayer," and so it should be. But the phrase must be read in context. This instruction is meant to prevent the GSEs from ripping off the U.S. with one-sided deals. By no stretch of the imagination does that phrase authorize the U.S., in the name of taxpayers, to rip off GSE shareholders. Explicitly, HERA's statutory mandate only invites the Treasury to determine such financial matters as the maturity and risk of these notes, with the eye to making deals that allow for "the orderly resumption of private market funding or capital market access." However, the Treasury has not uttered a single syllable to explain why it's necessary to wipe out GSE shareholders by sleight of hand when ample funds are available to repay, with interest, the full $187 billion advance to these GSEs. Its brief public comment to date has echoed the point that it advanced $187 billion to Fannie, as it were, to maintain the solvency of both GSEs and protect the broader economy. The Treasury's email said "We fully believe our actions have been lawful and appropriate," without of course referring to the details of the Third Amended agreement. The normal tradition of judicial deference to administrative decision only applies to cases where there was reasoned elaboration before the government. It does not attach to imperial actions that are taken without public notice or comment or reasoned explanations.

Third, by stripping the GSEs of their assets by these verbal machinations, the Treasury and FHFA have taken the property of the shareholders--the corporate assets--without paying a dime in constitutionally required compensation. Remember, both Fannie and Freddie were solvent at the time of the August 2008 takeover, notwithstanding their previous run of losses. If the United States is allowed by fiat to throw solvent firms into government receivership, the Treasury's tortured logic would routinely allow the government to force any profitable corporation into receivership, thereafter to force a one-sided renegotiation of contracts that offers it huge dividends on nonexistent investments.

This logic holds even on the dubious assumption that that the GSEs got fair value for their perpetual 10 percent preferred stock. If so, proper accounting procedure requires the Treasury to first credit distributions to its 10 percent interest on the unpaid balance, using the remainder to pay down principal. By rough calculations, about $50 billion of the money paid to the Treasury should have paid down the debt, which would then decline from about $187 billion to approximately $137 billion. In effect, the desired remedy only requires courts to take the unexceptional position that the government cannot escape all of its fiduciary, statutory and constitutional obligations by re-labeling a return of capital as a dividend.

Ominous Long Term Implications The availability of a simple account fix to government overreaching lays bare the inexcusable workings of the Treasury's one-sided deals. Ironically, Mr. Hensarling's conscious effort to undermine property rights works at cross-purposes with his larger, laudable objective of trying to rid housing markets of their past, massive irregularities in order to encourage more private investment. What private fund will invest in projects when their cash can be siphoned off by dubious contractual liberties and administrative shortcuts that make a mockery of the rule of law? Why force hedge fund investors to bear losses created by a government money grab that wipes out all of the shareholders' legitimate anticipated returns? Prompt action is needed to stop Mr. Hensarling before his populist express gives us a rerun of the Chrysler and General Motors political bankruptcies about which I have written elsewhere. But if courts don't invalidate the government's contractual gimmicks and administrative shortcuts, this is exactly what will happen.

Richard A. Epstein is a professor of law at NYU Law School, a Senior Fellow at the Hoover Institution, a Senior Lecturer at the University of Chicago and a visiting scholar with the Manhattan Institute's Center for Legal Policy. His forthcoming book is "The Classical Liberal Constitution," from Harvard University Press in 2013. He has consulted for several hedge funds not involved in the ongoing litigation on the issues discussed in this Op-Ed.

Jim Copland

Published on 01/18/12

By now, others have well documented the extraordinary nature of President Obama's appointments to fill the National Labor Relations Board and head the new Consumer Financial Protection Bureau -- purportedly exercising authority under the Constitution's Recess Appointments Clause, but almost certainly acting outside the constitutional provision's scope.

But beyond the constitutional issues, the political and policy implications of the president's action has drawn insufficient attention. The president has, in an election year and without congressional oversight, assumed sweeping and virtually unilateral authority to make policy that will generate windfalls for his two most financially crucial campaign constituencies -- organized labor and the plaintiffs' bar. Just how important are trial lawyers and labor unions to the president's election? In the 2008 election, lawyers and law firms funneled over $45 million into Obama's campaign, more than twice as much as any other industry.

The Service Employees International Union spent over $31 million in independent expenditures to aid the president's campaign -- again, more than twice as much as any other outside group.

The organized plaintiffs' bar and various labor unions constituted a staggering 19 of the top 20 political-action committees' spending on behalf of Democrats in the 2008 campaign, doling out between $1.7 million and $3.2 million each.

Since assuming office, Obama has worked to repay these campaign benefactors. The auto-company bailouts propped up unions by undercutting the clear legal rights of secured debt holders, and much of the "stimulus" spending was designed to protect public-sector unions by shielding them from budget cuts made by strapped state and local governments.

Trial lawyers avoided any serious tort reform in Obamacare, and they got legislation that gutted statutes of limitation for employment-discrimination lawsuits and expanded the scope of private litigation against government contractors.

That said, Congress has frustrated the president's most ambitious plans to help labor and lawyers. Even with large majorities in both houses of Congress, Obama was unable to muster support for the Employee Free Choice Act -- the deceptively labeled "card check" bill that would have allowed unions to form without secret-ballot elections and empowered federal bureaucrats to make sweeping changes to private labor contracts.

Similarly, the most sweeping reform bills on the tort bar's wish list also never came to pass, including legislation designed to make it easier to file baseless claims in federal court; a bill to expand securities litigation by allowing lawyers to sue customers and suppliers for companies' alleged frauds; and a trial-lawyer tax break that would have allowed plaintiffs' lawyers to treat contingency-fee loans as immediate expenses.

With his recess appointments, however, Obama is now in a position to avoid such congressional obstacles and help unions and lawyers through fiat. With three of the five NLRB members slipped into power in the dead of night -- and two of these three were nominated only two days before the Senate's Christmas break, hardly stalled by congressional inaction -- the president's labor-friendly cronies will be well-positioned to make rulings advantageous to unions.

Expect to see more along the lines of the Obama NLRB's extraordinary effort to thwart a Boeing plant's construction in right-to-work South Carolina. As CFPB director, Cordray will be positioned to green-light state tort litigation previously blocked by federal regulation and to "delegate" enforcement to state attorneys general, who in turn will farm out lawsuits to the plaintiffs' bar.

Cordray himself leveraged the Ohio state attorney general's office into a powerful campaign fundraising mechanism, when his election pulled in over $800,000 from out-of-state plaintiffs' law firms and he then hired many of those same firms to sue on the state's behalf.

The president's NLRB and CFPB appointments should be understood not only as an affront to the Constitution's system of checks and balances, but also as an aggressive move to energize his deepest-pocket electoral supporters. Sadly, American law and policy will be the likely casualty of this Chicago-style campaign gambit.

Ted Frank

Published on 01/25/12

Last week, several Internet sites protested against two bills, the Stop Online Piracy Act and Protect IP Act, that would take a heavy-handed approach to preventing copyright infringement.

Though the movement was led by left-leaning technology sites, the SOPA/PIPA kerfuffle has the potential to demonstrate why conservative principles are important.

The problem with SOPA and PIPA was their broad scope. The bills went beyond primary infringers to impose criminal penalties on search engines and service providers that linked to infringing domain names.

The threatened censorship of the Internet -- hundreds of innocent sites could be blocked because of alleged infringement by a single blog -- led many sites to go "dark" for a day to protest SOPA's drastic consequences.

It was certainly amusing to watch thousands of teenagers take to Twitter to complain, profanely, that in the absence of Wikipedia and other sites, they had no place to go to plagiarize their homework assignments.

But, more importantly, several senators and representatives, including a number of former supporters of the legislation, announced their opposition.

Hollywood, which has predicted catastrophic consequences from piracy since the now-obsolete VCR became commonplace decades ago, is outraged and continues to support the legislation -- but it now seems clear that SOPA and PIPA will not become law without substantial modifications.

In the meantime, some observations:

First, we should be thankful: Legislative "gridlock" is a feature, not a bug, of our constitutional system. We often see parties in power complain how hard it is to get legislation passed, but the number of bottlenecks in the system means that legislation is considerably less likely to pass without consensus.

Without these bottlenecks, special interests would find it far easier to ram through bad legislation like SOPA. The deliberate pace of legislation gave time for Internet opponents to mobilize.

Second, both bills demonstrate the problem of overcriminalization. All too often, a special interest asks Congress to "fix" a problem by threatening to send more people to prison.

When criminal law goes beyond punishing intentional, violent and fraudulent behavior to ensnare innocent business people guilty only of running afoul of complex and technical regulations, the chilling effect on free enterprise and job creation can be tremendous.

Bloggers had fun pointing out the number of instances where SOPA supporters were violating the proposed law, but millions of Americans already unknowingly violate hundreds of other laws on the books.

When everyone is a criminal, federal prosecutors have the awesome power to pick and choose who will have their lives ruined. The possibility of politically motivated prosecutions is a severe danger to liberty.

Third, Congress passes bills all the time without knowing what's in them, each time with dramatic unintended consequences. Bloggers were outraged at a congressional hearing where committee members had no clue about the damage SOPA was going to do to the Internet.

Further, they seemed to care very little about the effect of their ignorance. But this ignorance extends far beyond the Internet. Limited-government conservatives oppose bad legislation like Dodd-Frank and Obamacare because of the unintended consequences and adverse effects of government meddling in the market.

Finally, the successful opposition to SOPA demonstrates the importance of corporate free speech. It has become trendy on the left to assert after Citizens United that corporations are not people, and thus have no free-speech rights; there's even a constitutional amendment to that effect pending.

One wonders how far that argument goes: Do corporations have no Third Amendment rights, either, allowing the government to quarter troops at the Ritz? Corporate free speech made a decisive difference in the SOPA/PIPA debate. The media, generally SOPA supporters, were unwilling to cover the issue until corporations like Google and Wikipedia forced them to pay attention. The Left should re-evaluate its attempt to limit political speech.

The near-catastrophic passage of SOPA demonstrates the power of limited-government principles. Conservatives should use it as a teaching moment.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.