WASHINGTON — The question of what are appropriate checks on independent regulators continues to be a focus for courts around the country, but the issue has now extended way beyond the Consumer Financial Protection Bureau.

A three-judge panel for the U.S. Court of Appeals for the Fifth Circuit has ruled that the Federal Housing Finance Agency's leadership structure — with a single director at the top who can be fired only for cause — is unconstitutional.

The decision — which could be appealed to the full panel of Fifth Circuit judges or the Supreme Court — echoes a similar ruling in 2016 written by Judge Brett Kavanaugh, of the D.C. Circuit, that the CFPB's single-director structure was unconstitutional.

Fannie Mae building
The decision is likely to dissuade Fannie Mae and Freddie Mac investors from using further litigation to fight the Third Amended Dividend Agreement. Bloomberg News

That CFPB decision was later overturned by a full panel of the D.C. Circuit. But with Kavanaugh now nominated for a Supreme Court seat, and plaintiffs clearly still interested in using the constitutional argument to fight regulatory power, the issue could be coming to a head with big implications for both agencies.

“Existing precedent supports independent financial regulators,” said Aaron Klein, a fellow at the Brookings Institution. “The Kavanaugh philosophy may overturn precedent.”

The case was brought by shareholders of Fannie Mae and Freddie Mac who oppose the arrangement between the government-sponsored enterprises, FHFA and the Treasury Department that the mortgage giants must sweep their profits into the government under the terms of their conservatorships.

In a blow to the investors, the ruling appeared to find nothing wrong with the profit sweep.

This decision is likely to dissuade investors from using further litigation to fight the Third Amended Dividend Agreement — which requires the GSEs to hand over profits to Treasury — and will encourage shareholders to instead push either Congress to pass legislation or Treasury to take administrative action, Jaret Seiberg, an analyst for Cowen Washington Research Group, wrote in a research note.

“There’s still community banks out there that hold that stock and certainly we would like to see their rights restored,” said Ron Haynie, senior vice president of mortgage finance policy for the Independent Community Bankers of America. “It doesn’t look good because court after court has pretty much ruled the same way on that, and so I’m not sure what it means for those claims.”

Others said the continued litigation over the GSE conservatorships just bolsters the need for sustainable reforms of the housing finance system.

“This has been nothing more than a distraction from the real work that must be done by Congress and the Administration to move forward with comprehensive GSE reform in a manner that could resolve this decade old conservatorship,” said David Stevens, president and CEO of the Mortgage Bankers Association.

But the shareholders also argued that the FHFA, which was created under a 2008 law, violates the separation of powers because it is led by a single director who can be removed only for cause, which they said gives the agency too much power to impose economic hardship. (The current FHFA director, Mel Watt, was appointed by former President Barack Obama; his term ends in January.)

Indeed, in siding with the investors on that argument, the judges said the case “concern[s] the transfer of all minority shareholder economic rights to a single majority shareholder."

"In sum, while Congress may create an independent agency as a necessary and proper means to implement its enumerated powers, Congress may not insulate that agency from meaningful Executive Branch oversight," they said in the ruling.

The for-cause standard, for a president's removing a sitting FHFA director, limits an administration from any appropriate oversight, they said.

"Congress encased the FHFA in so many layers of insulation — by limiting the President’s power to remove and replace the FHFA’s leadership, exempting the Agency’s funding from the normal appropriations process, and establishing no formal mechanism for the Executive Branch to control the Agency’s activities," they said in the ruling.

But analysts said overturning that standard hands whichever party controls the White House greater power to set the course for the nation's housing finance system.

"Near-term this has limited impact; longer-term, if this decision stands, there could be even greater housing market volatility related to presidential elections," Ed Mills, a policy analyst with Raymond James, wrote in a research note.

Yet others note that the ruling may not have immediate impact on the current FHFA — Watt is expected to serve out his term without controversy — and the decision did not appear to call into question any FHFA rule or other policy.

"The important takeaway is that nothing in this decision impedes FHFA’s ability to do whatever it wants under Mel Watt or a future director, while the broader constitutional challenge question continues,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics.

“The Fifth Circuit ruled unequivocally that regardless of its views on the constitutionality of FHFA’s structure, its actions as an independent agency are proper and may continue as they did,” Petrou said. “There’s no diminution of FHFA’s rulemaking authority, period.”

But Klein said the two regulators, which were both created relatively recently, are emerging as the test subjects for a legal showdown over the bounds of independent authority for financial regulators.

It is likely that the ruling on the FHFA’s constitutionality will face a larger panel of judges in an "en banc" review if the case is appealed to the full Fifth Circuit, similar to the D.C. Circuit Court case challenging the CFPB, said Klein.

“The CFPB and the FHFA are the newest regulatory bodies in a single agency structure and have been at the forefront of this constitutional question,” he said.

The plaintiffs in the appeals court case surrounding the FHFA used the example of the structure at the CFPB to bolster their oral arguments, said Rob Zimmer, head of external affairs for the Community Mortgage Lenders of America.

However, in the Texas court’s opinion, the panel of judges acknowledged the differences between the CFPB and FHFA as independent agencies.

“Unlike CFPB, which was politicized at its birth, FHFA, which has a similar legal structure as the CFPB, was highly bipartisan,” said Klein.

The differences between the two as financial regulators in addition to more impending litigation means that this ruling doesn’t threaten the CFPB — at least yet, said Petrou.

“This is a decision about FHFA with implications for CFPB, but not a decision with direct applicability in my opinion,” she said.

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