Freddie and Fannie: closer to Ackman’s proposed reform

Three of our Legends have exposure to the common and/or preferred shares of U.S. mortgage giants Freddie Mac and Fannie Mae (‘GSEs’). The election of Donald Trump gave a big boost to the companies’ share prices with the common shares rallying a dazzling 170%. Treasury secretary pick Steve Mnuchin addressed the GSEs upon his appointment, saying that getting them out of government control was a top 10 priority for the new administration. His language mimicked the 2014 proposal of Bill Ackman.

Fannie and Freddie were placed under government control when they required $185 billion in taxpayer bailouts during the financial crisis. As part of the deal, Fannie and Freddie issued preferred shares of stock to the U.S. government that pay annual dividends. In 2012, the Treasury amended the terms of the bailout agreement and declared a “net-worth sweep” that would sweep all of Fannie and Freddie’s profits into the government’s pocket until the entities were completely wound down.

It’s now been eight years since the bailout and between Freddie and Fannie, U.S. taxpayers have made more than $63bln in profits after recovering the $185 billion bailout. The government bailouts of Fannie and Freddie are by far the most profitable bailouts of the financial crisis and are the primary reason why the financial crisis bailouts have generated an overall net taxpayer profit.

The net-worth sweep has been contested in several court cases by investors such as Bruce Berkowitz’ Fairholme Capital, Richard Perry’s Perry Capital (which has closed, but has held on to the GSE positions) and our Legend Bill Ackman’s Pershing Square. These and other investors claim that the sweep was an illegal action that should be reversed by the courts. Per Pershing Square, the net-worth sweep:

• Amounts to an unconstitutional taking without just compensation
• Exceeded the scope of the FHFA’s authority as conservator, and
• Exceeded Treasury’s investment authorization

Apart from the court cases, Ackman believes a restructuring of Freddie and Fannie is the (only) way forward. On the 2014 Ira Sohn conference he pitched his restructuring proposal to the investment public. The presentation can be found below. In his proposal the reformed GSEs would be worth $23 to $47 a share (versus a current valuation of approximately $4.00) and would create a windfall for the U.S. taxpayers, who own warrants in the GSEs, of between $165bn and $342bln.

Donald Trump’s Treasury Secretary’s pick Steve Mnuchin discussed a restructuring of Freddie and Fannie right after his appointment was announced. And his language was very much in line with what Ackman has been saying since his 2014 proposal:
“We have to get Fannie Mae and Freddie Mac out of government ownership. It makes no sense that these are owned and control by the government.” And, he added: “We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again.”

Most important perhaps to GSE shareholders, Mnuchin hasn’t mimicked Republicans who have said that Fannie Mae and Freddie Mac should be wound down or eliminated. What he did say was that unlike the Obama administration, reform of the GSEs are a top 10 priority for the new administration and that they will get it done reasonably fast.