Fannie and Freddie: Double or quits
The fight between the US Treasury and Fannie Mae and Freddie Mac preference shareholders took a bizarre turn last month. Having filed a class-action lawsuit against the Treasury in June seeking $41 billion in damages from its suspension of dividends in August 2012, some preference shareholders in the two GSEs have now offered to buy them from the government as well.
The new plan is being spearheaded by Fairholme Capital Management, which is run by Bruce Berkowitz, a fund manager who made a fortune investing in AIG after it was bailed out. The firm, which has $10.5 billion under management, is proposing a $34.6 billion capital injection into the two entities by preferred shareholders in exchange for all preferred stock outstanding. A further $17.3 billion would be raised from the preferred stockholders via a rights offering.
Under the plan, Fannie and Freddie would be liquidated and their names retired, facilitating the establishment of two new, state-regulated private insurance companies for the mortgage market. These would be monoline insurance companies that would guarantee future mortgages using a traditional bond insurance structure. The plan includes a five-year lockup whereby investors will not take any distributions or dividends for that period and pay 79.9% of any proceeds over a 10% dividend rate to the US Treasury. Fairholme Capital Management is the largest investor in the Fannie and Freddie preferred shares, holding between $3.5 billion and $4 billion of the stock at face value. Other preferred stockholders include hedge funds Perry Capital, Paulson & Co and Claren Road Asset Management. It has recently emerged that activist investor Bill Ackman of Pershing Square Capital has also built up a 10% stake on the GSE preferred stock – an interesting development given his famously successful short on mortgage insurer MBIA.
The motivation behind the plan is not hard to fathom – these shares have collapsed in value since the Preferred Stock Purchase Agreement (PSPA) that was negotiated between the Treasury and the GSEs last year stating that all earnings from the GSEs should be distributed to the Treasury as dividends in a cash sweep. Preferred shareholders are therefore very motivated to salvage their investment – the most liquid tranches of the preferred stock rallied 10% on news of the plan. But for them to now propose entering into negotiations with the government to acquire Fannie and Freddie while at the same time suing the government for $40 billion over their missed dividends in Fannie and Freddie since August 2012 seems contradictory to say the least.
The future of the GSEs is of huge political significance in Washington following their conservatorship in 2008. However, they are poised to have paid back their combined bailout of $187.5 billion and more by late 2014 and have become important moneyspinners for the government, which is very unlikely to support the preference shareholders’ plans.
Following Fairholme’s announcement, Gene Sperling, director of the National Economic Council, made a point of stating publicly that "the only credible way to end the failed business model of Fannie Mae and Freddie Mac is through comprehensive housing finance reform".