CHICAGO (CN) – The Seventh Circuit heard arguments Monday on whether the Federal Housing Finance Agency had the authority to divert mortgage giants’ future profits to the U.S. Treasury as a condition of their $188 billion bailout during the 2008 financial crisis.

According to the government, the 2008 collapse of the housing market left the Federal National Mortgage Association, also called Fannie Mae, and the Federal Home Loan Mortgage Corp., or Freddie Mac, in danger of folding.

To avoid the economic disaster that such a collapse would create, Congress enacted the Housing and Economic Recovery Act, or HERA, authorizing the Treasury to purchase any obligations or securities issued by either company.

The Federal Housing Finance Agency, abbreviated as FHFA, placed Fannie and Freddie under conservatorship in September 2008, and committed $100 billion in funding to each corporation.

A second amendment to the bailout agreement raised the limit to $200 billion each, in exchange for a dividend worth 10 percent of the Treasury’s existing liquidation preference.

In a third amendment, the Treasury replaced the previous dividend formula and simply required that Fannie and Freddie pay the Treasury the amount by which their net worth exceeded a fixed capital buffer, a figure that shrank each quarter.

This final amendment, according to Fannie and Freddie shareholders, effectively nationalized the mortgage lenders by diverting every penny of profits to the Treasury.

“With the stroke of a pen, the agencies had nationalized the companies and taken all the value of the companies for Treasury, thereby depriving the private shareholders of all their economic rights, well in excess of the authority granted to the FHFA as conservator,” according to the shareholders’ complaint, which was filed in February 2016 in Chicago federal court.

When Fannie and Freddie agreed to this amendment in 2012, the Treasury had provided $187.5 billion to the companies with the promise of more money as needed.

Fannie and Freddie have since paid the bailout money back and are now hugely profitable, but all those profits – $186 billion since 2012 – go to the government, not to shareholders.

A federal judge ruled against the shareholders in March, granting the government’s motion to dismiss the complaint.

Representing the shareholders, attorney David Thompson with Cooper & Kirk in Washington, D.C. told the Seventh Circuit on Monday morning at oral arguments that “the net-worth sweep is unlawful” as it imposes a “mandatory zero-capital regime.”

Thompson argued that any sound business builds a capital buffer to protect itself from unfavorable turns in the market. But the amendments to the bailout plan prohibit Fannie or Freddie from building any capital reserves, ensuring that they will have to draw on Treasury funds again if they have an unprofitable quarter, he told the Chicago-based appeals court.

Judge Diane Wood expressed reluctance to second-guess decisions made by federal agencies in the middle of the 2008 economic crisis.

“I was overwhelmed when reading these briefs that you are taking an ex post facto view of these things,” Wood said. She insisted that “no one knew what would happen” when the government took conservatorship of the mortgage lenders.

Wood also said that the government’s motive for taking Fannie and Freddie’s profits is irrelevant when the question before the court is strictly whether FHFA acted within its statutory authority.

Gerard Sinzdak, representing the Treasury Department, emphasized that HERA gave the federal agency wide authority to take whatever actions necessary to save Fannie and Freddie from collapse.

“Plaintiffs’ claims are [that] this could have been done a different way,” Sinzdak said. “But this is fundamentally a business decision by the FHFA.”

Judge Frank Easterbrook, seconded by Judge Wood, asked Thompson whether this case didn’t belong in the Court of Federal Claims as a constitutional-takings claim.

Thompson informed the court that a shareholder action in that court is currently ongoing.

A similar action challenging FHFA’s bailout terms was rejected by a 2-1 decision of the D.C. Circuit in February. Other related cases are pending before the Fifth, Sixth and Eighth Circuits.

The Seventh Circuit panel, however, was not entirely unsympathetic to the shareholders’ plight.

When FHFA attorney Howard Cayne told the court that Fannie and Freddie survived the 2008 crisis “only by the grace of [Treasury’s] massive investment,” Judge Easterbrook interjected, “You must have a very low opinion of bankruptcy courts.”

Cayne laughed and denied that point, but Easterbrook was not amused.

“Your point is that when a business fails, only nationalization will save it,” Easterbrook said in a heated tone.

“Yes, don’t go there,” Wood said.

When asked how long the agency’s conservatorship of Fannie and Freddie is expected to last, Cayne said “conservatorship is temporary but indefinite,” eliciting laughter from the bench.

“What’s that for a government agency, 100 years?” Easterbrook joked.

Backtracking, Cayne emphasized that the agency acted within its authority, whether or not the court agreed with its actions.

“As long as FHFA is exercising powers authorized by Congress, we submit, that is the end of the inquiry,” he said.

Judge William Bauer rounded out the three-judge panel. He did not comment during oral arguments.

The Seventh Circuit is expected to issue a ruling in the case within three months.