The Federal Housing Finance Agency believes California Attorney General Kamala Harris is pestering Fannie Mae with stupid questions. Whether that opinion is enough justification for the government-sponsored enterprise to ignore her queries is to be determined.

On Tuesday, Harris filed suit in San Francisco Superior Court, seeking to force Fannie to respond to a lengthy list of questions about defaulted loans it guarantees in the state and other matters. Appended to the filing is a letter from Arnold & Porter attorneys representing the FHFA, who argue that the agency's authority over Fannie shield it from California's questions.

"No state Attorney General has the authority to issue an administrative subpoena or investigative interrogatories to [Fannie Mae], and no court may compel a response to such interrogatories," the Arnold & Porter letter declares, arguing that federal oversight of the mortgage giants preempts state control. Harris' questions are "frequently vague and ambitious," it says.

The California Attorney General's questions were initially sent to both Fannie and Freddie Mac, but the Arnold & Porter letter specifically refers to Fannie.

The spat raises a number of unusual legal questions. Among them are whether banking preemption laws apply to the FHFA's oversight of the GSEs, whether the GSEs are functionally an arm of the government, and whether Harris's initial inquiries are a "visitorial" action that exceeds her office's power. The Supreme Court has held that states are on stronger legal footing when they seek to enforce state laws than in instances where they are merely conducting a "visitorial" investigation of a regulated entity's conduct.

Richard Gottlieb, director of the financial industry group at the Dykema law firm, calls the lawsuit "a stretch," saying the Federal Housing Finance Agency stands on "pretty solid ground" in arguing that Harris' questions infringe on its oversight of Fannie and Freddie.

"It's a question of whether the California Attorney General has any authority to investigate these agencies, and the answer should be no," he says. "They can sue, they just can't audit or investigate."

Gottlieb and several other lawyers cited the Supreme Court's Cuomo v. Clearing House case, which determined that the Office of the Comptroller of the Currency was the sole regulator of national banks but that it could not preempt state law enforcement agencies from enforcing their own laws.

Not everyone is so sure. Because Fannie and Freddie are not banks, the case does not fall into a classic mold for preemption, other lawyers say. Experts on preemption say the FHFA would likely try to remove the case to federal court, because of the perception that a state judge would be more sympathetic to Harris' cause.

Fred Smith, a constitutional law professor at the University of California Berkeley's Law School, says that the dispute over California's authority lands in a murky corner of preemption.

If a court accepts the FHFA's contention that Congress gave it express preemption authority, the regulatory agency would have a strong case that California lacks the authority to interrogate the GSEs. But Smith notes that the Housing Economic Recovery Act, which placed the GSEs in conservatorship, only said that states would have no authority over the FHFA — not the GSEs.

"If you look at the language, the FHFA's position that states don't have any authority over Fannie Mae and Freddie Mac is a bit of a jump," he says.

If the FHFA is unable to make an express preemption argument, it will have to rely on a weaker form, in which regulators argue it was Congress's intent to give them full authority even if the authorization was never explicitly stated.

"I think at this point, and especially because of the last few years, predicting what a court is going to do on a preemption question, absent express preemption, is very hard," Smith says. "Sometimes, the judge's policy preferences seem to drive the result."

The suit could also bring the awkward question of the FHFA's relationship with the GSEs to the fore. Part of the dispute between Harris and the FHFA is whether the GSEs are independent private companies that happen to be under conservatorship or if they are effectively arms of the federal government.

In other contexts, such as Freedom of Information Act litigation, the FHFA has emphatically taken California's current position that the GSEs are private companies. That position is integral to the FHFA's contention that GSEs are immune from public records requests.

"[The GSEs] did not cease to be private legal entities when they were placed into conservatorship, nor did they become part of FHFA," DeMarco told Congress in May.

California's lawsuit against Fannie and Freddie — and the FHFA's attempts to rebuff it — also raise questions about the ability of states and local municipalities to enforce local property maintenance codes and to collect taxes on properties held by the GSEs.

On the one hand, Fannie and Freddie's servicer guidelines specifically state that companies contracted to do property maintenance have to comply with all state and local laws. But the FHFA, in spurning Harris' questions, appears to be arguing that that responsibility does not extend to the contracting entity.

Foreclosures have become such a blight on neighborhoods that several cities, most notably Chicago, have passed ordinances requiring that trustees assume liability within 30 days of a property becoming vacant, even before it goes into foreclosure. The FHFA sued Chicago earlier this month, claiming that the city's ordinance was preempted by federal law and would increase the cost of managing Fannie and Freddie in conservatorship.

As a government agency, the FHFA would be loathe to allow 50 different states to conduct their own investigations of Fannie and Freddie, lawyers say. State attorneys general normally work closely with regulators on investigations and the FHFA is doing so with New York's Eric Schneiderman on the issue of mortgage-backed securities sold by banks. Because the GSEs bought substantial quantities of those securities, their interests are aligned with the private investors that Schneiderman seeks to champion.

Separate from the legal questions is the unusual nature of some of the California Attorney General's questions themselves.

In her formal questions, Harris peppers Fannie and Freddie with queries about wrongful foreclosures, blight from abandoned homes, and whether the GSEs have paid taxes on foreclosed properties.

Many of these matters are under the direct authority of mortgage servicers hired by Fannie Mae to handle the administration of mortgage loans, though Fannie has some ability to direct the servicers' actions. As the FHFA attorneys' letter noted, Harris' office is asking questions in keeping with a global investigation of Fannie's role in the housing market.

Some of the questions appear to display a misunderstanding of the GSEs' role in housing finance. The suit and related questions declare that the GSEs "issued numerous securities" which "are now virtually worthless." But Fannie and Freddie do not issue securities — they guarantee them. And unlike private mortgage-backed securities, which are backed only by the collateral in securitization trusts, GSE-guaranteed securities are backed by the U.S. government, making credit losses virtually impossible.

Some of the defense attorneys that spoke with American Banker said they were unsurprised by the broad scope of California's investigation, given Harris' decision to pull out of a unified settlement effort by state attorney generals. At the time, banks and regulators fretted that the splintering of the coalition would produce highly aggressive actions from states acting on their own.

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