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By Saul Griffith

The decision paves the way for a court case on the 'takings' plea by Fairholme Capital against FHFA.

Last week, Federal Judge Margaret Sweeney cleared the way for a court case that will determine whether the government's 'takings' of profits generated by GSEs Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCQB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCQB:FMCC), under the stewardship of the FHFA, was illegal and to the detriment of the companies' shareholders.

Fannie Mae, Freddie Mac vs FHFA: Jurisdiction

The judge ruled in no uncertain terms in her Discovery Order that her court had the authority to consider the merits of the lawsuit.

"With respect to the defendant's claim that the court lacks the authority to affect the exercise of the FHFA's powers or functions, the court agrees with the case law of the United States Court of Appeals for the Ninth Circuit which states that the 'FHFA cannot evade judicial review… simply by invoking its authority as conservator'," she said.

"Thus, rather than turning a blind eye to a case and immediately dismissing it from its docket merely because the case concerns the FHFA, the proper approach is for a court to examine the factual underpinnings and legal contentions presented by the complaint, in order to determine whether the exercise of its jurisdiction is proper," she clarified. "In essence, defendant asserts that the court should merely take its word that the documents - some of which the defendant, itself, has not reviewed-are privileged. This suggestion is contrary to law."

Fannie Mae, Freddie Mac: Discovery of Documents

The Judge also addressed the issue of the period for discovery of documents pertaining to Fairholme's claim. (Discovery is a pre-trial phase in a lawsuit in which each party, through the law of civil procedure, can obtain evidence from the opposing party by way of requests of production of documents and relevant information).

The court ordered the FHFA to submit to discovery requirements for Privileged Material (from April 1, 2008 to December 31, 2008, and June 1, 2012 to August 17, 2012) and for Non-Privileged Material (from August 18, 2012 to September 30, 2012).

Significantly, the Judge allowed expanded discovery periods even beyond what the FHFA argued for: September through December 2008 and January through August 2012.

Boost for Fannie Mae and Freddie Mac shareholders

Richard X Bove, renowned banking analyst and Vice President Equity Research at Rafferty Capital Markets, commented that the orders of the court mean that the plaintiff's (Fairholme Capital) case is bolstered because of the availability of discovery information, and that the lawsuit will now progress further.

"If so, I continue to believe that the government will lose and its taking of the monetary claims of the plaintiffs will be reversed," he said. "This would be very positive for the stockholders of the GSEs."

Fairholme Capital on Fannie Mae and Freddie Mac reform

In November 2013 Fairholme Capital proposed to acquire the mortgage insurance businesses of Fannie Mae / Federal National Mortgage Assctn Fnni Me and Freddie Mac / Federal Home Loan Mortgage Corp and convert them to private insurance companies subject to State regulation.

"The new companies could be cornerstone participants in a reinsurance program along the lines contemplated by proposals under discussion in the Senate, if that is the result of the legislative process now underway," Fairholme had said in its press release at the time. "Alternatively, the new companies could serve as cornerstone participants in a new, competitive market with less Federal involvement, such as proposals being contemplated in the House, putting their private capital at risk to achieve the best possible pricing and availability for mortgage borrowers under those parameters."

The proposal did not cut much ice with the Obama administration, and housing reform, in the form of various bills by different legislators, is still stuck in Washington.

By current reckoning, nothing substantial is likely to be achieved until 2015.

Housing numbers receive a jolt

Meanwhile sales of new homes in the US during June were unexpectedly below expectations, falling 8.1% compared to the previous month.

Richard Bove attributed the downward trend in new home sales after June 2013 to declining money supply rather than falling demand for homes.

(click to enlarge)

He observed that historically, home sales tended to rise when housing prices and interest rates were rising because the possibility of investment gains was a crucial element in a decision to purchase a new home.

Why then were new home sales tending to fall in an environment of rising home prices?

Money supply 'drying up'

"No one has considered the fact that money supply is drying up for this industry as the reason that new housing sales have been in a downward trend for the past 12 months," he says.

The factors responsible, according to Bove, are the Federal taper of mortgage purchases, banks losing billions of dollars to litigation claims from government as well as the private sector regarding mortgage issues, increasing delays in the mortgage processing system and declining profitability on mortgages as a financial product.

"No one wants to put up the money, relatively speaking," he says. "It is time that analysis of the housing sector was broadened from conventional, and misleading, clichés to a broader look at the key factors driving the business."

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Disclosure: None.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Source: Fairholme Win 'Very Positive' For Fannie Shareholders: Bove