According to the new 2017 White House Budget, there are two private companies that are going to give the IRS's parent US Treasury all of their profits across at least the next decade after giving Treasury over $108B+ of their profits since conservatorship began in 2008. Even in 2008, it was clear that private sector loans were the problem:
What exactly is a profit anyway? Being forced to hand over all of your money to the government might sound more like a tax on equal opportunity affordable housing. The reason that it is a profit is because it needs to be a profit in order for the government to take it through a process known as conservatorship designed around accounting irregularities imposed by FHFA. If the accounting reflected more of the actual profitability as outlined in a key legal filing discussed herein filed by the 2012 CFO of the year no such nationalization would have been possible. With that in mind, Fannie and Freddie are expected to earn around $15B per annum together and that means that today their market value trades at a fraction of their annualized earnings, or takings if you're the White House Budget. That's who gets them all and that's why these securities are risky and may be worth $0.
Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) have been held hostage by the government since 2008 when the government forced itself on the twins. After forcing itself on the two, FHFA has been exerting eminent domain and Treasury has been declaring privileges after a series of accounting decisions forced the GSEs to borrow $132.2B in cash and subsequently pay back over $241B in cash taking the GSEs from their highest levels of capital in history to their lowest in history. The difference of $108B and counting has gone directly to the Treasury, who has forced the GSEs to borrow from the private market in order to pay Treasury dividends. I don't have a legal degree, but I am not sure that it takes one to understand what is going on. Treasury and FHFA public statements would lead you to believe that Fannie and Freddie are a broken business model, but so is any business model where the government can unilaterally decide to take all of your money when your regulator just said you're adequately capitalized and leave you penniless.
Fairholme Invokes White House Name In Motion To Compel
Lead plaintiff Fairholme's own Bruce Berkowitz has this to say about the motion to compel:
Today's filing challenges the latest example of foot-dragging and evasion by those attempting to defend the government's indefensible decision to enrich itself by putting Fannie and Freddie on the permanent brink of insolvency. It is outrageous that the government has unjustifiably withheld key documents at every turn, only to hand some of them over at the eleventh hour when challenged. The government's persistent obfuscation has the purpose and effect of inflicting economic harm on our tens of thousands of shareholders and other innocent investors.
First, Plaintiffs show that privilege assertions include public speeches these days:
Secondly, Fairholme suggests that "evidence shows, it is clear that many of the materials in Defendants' possession contradict the public, made-for-litigation explanation for the Net Worth Sweep".
Where is the administrative record? We are pretending that it wasn't the biggest deal between two government agencies that were willing to overlook privilege in 2012. It's time to take into consideration whether or not officials within an agency are fungible or not:
It's been two years. In February 2014, the Court of Federal Claims authorized Fairholme to receive documents from the federal government related to the Net Worth Sweep. According to Fairholme:
the Department of Justice has employed "overbroad and otherwise improper claims of privilege to withhold some of the most important documents in this case" (see relevant filing here) - particularly documents that show the government's case is based on outright falsehoods.
A decision on this matter could come from the Court at any time. Fairholme's press release says that the government is unlawfully withholding documents as Fairholme challenges the third amendment which requires the GSEs "to pay their entire net worth to the Department of Treasury every quarter in perpetuity."
On The Mootiness of FHFA Administrative Record
Most importantly, it's time to finally produce an administrative record. This is something that was problematic in the DC District Court, so it will be infinitely interesting to see where this one goes, nobody knows. The Lamberth court did not order the entire administrative record and declared it irrelevant in that decision to dismiss on 9/30/14 (page 21):
FHFA's Justifications for Executing the Third Amendment and, Consequently, the Accompanying Administrative Record, Are Irrelevant for § 4617(f) Analysis
Chief Judge Reade decided the administrative record is required for some reason that is not yet publicly available. The decision may be due to the sealed Fairholme content that was added to the amended complaint. That's what I'm betting on, but it could be moot just because an amended complaint was filed:
On February 9, 2016, Chief Judge Linda R. Reade filed an order denying the pending motions for dismissal as moot. As shown above, the document number for that order is #60 and currently there is no access to the document. The takeaway for me is that it looks like Chief Judge Linda R. Reade thinks her court has jurisdiction, in which case what was actually considered will be the only thing Reade wants to see.
Another author on Seeking Alpha has done a great job explaining the game changing nature of this ORDER above:
Assuming FHFA fails to present an administrative record, it is hard to see how FHFA will be able to support any arguments to defeat the plaintiffs' summary judgment motion, since the factual underpinnings to FHFA's defenses would have to be found in its administrative record.
It appears that Judge Lamberth affected the province (power or authority) of the judicial branch to review all laws by agreeing with anti judicial review provisions of HERA. It also appears that Judge Lamberth overlooked judicial duty to citizens to hear the cases filed in his court and review all laws in question. Nevertheless, according to a U.S. Department of Justice document, here are some guidelines for compiling an Administrative Record. The first bullet below demonstrates the difference between what worked in Lamberth's court and what an Administrative Record actually is:
Knowing very well the pending appeal on Judge Lamberth's ruling, this court wisely ignored motion to dismiss and ordered defendants to produce APA documents. Reade can't be said to have decided that she has jurisdiction, but she can be said to have decided she needs administrative records. That's not a bad start. Moving on, that brings us to the question, "What's so good about Illinois?"
New Lawsuit For The Northern District Of Illinois
The 2012 CFO of the year Thomas P. Fischer has filed a new lawsuit. Along the lines with the accounting fraud reports Adam Spittler and Mike Ciklin have produced, Mr. Fischer has included graphs of their annual profitability during 2008 through 2014. During a period in time that Fannie Mae and Freddie Mac, 2008-2001, they were massively cash profitable, Treasury and FHFA orchestrated accounting writedowns to facilitate a nationalization when, as Fischer's lawsuit shows, they were massively cash profitable:
That's not to say that Fannie Mae and Freddie Mac weren't in trouble between 2008-2012. The GSEs were in serious trouble because FHFA and Treasury effected a hostile takeover under the guise of conservatorship in 2008 and planned on preventing the twins from ever having access to their own capital by forcing them to hand it over on government orders. FHFA and Treasury put out public statements that would lead you to believe Fannie Mae and Freddie Mac were losing billions of dollars, Treasury and FHFA were here to save the day, and that depictions of profitability like the above represent a broken business model.
If the above looks like a graphic from a broken business model to you, then that's very sad because only in one year did expenses exceed revenue and this was just after a year preceding it in which the difference clearly is more than double the loss in 2010, making 2010 the exception to the rule. This was during a time at which FHFA was committing accounting fraud to write down the assets to make it look like Treasury and FHFA were the heroes coming in and saving the day! When really all they were doing was breaking in and taking all of the money out through the back, they would have led you to believe that these profit charts as pictured above represent a failed business model. Here's what they did to make it look broken:
Borrowing money to pay an enormous dividend on a non-cash profit (due to an accounting reversal) is without precedent in conservatorship, but that's what they did this time. Not only that, but the government took the dividends and they forced two taxpayers to borrow from other taxpayers in order to pay it. I couldn't make this stuff up if I tried and it's hard for me to believe that it's even true, but the facts check out when you verify them against their public reports. Just look at the Q3 2008 reason why they reserved against the DTA:
Companies aren't supposed to just make how they are accounting for their business up as they go along, but in this case FHFA was incentivized to minimize the stated value for Fannie and Freddie assets to facilitate GSE nationalization for Treasury.
The Government Forced Fannie And Freddie To Put Taxpayers At Risk To Pay Treasury Dividends
While putting taxpayers at risk to pay tax collectors, Treasury puts out public statements that their actions are to protect taxpayers and I simply am having difficulty reconciling what Treasury is saying with Fannie Mae's financial statements:
During conservatorship, tax collectors take everything and then force taxpayers to borrow from unsuspecting taxpayers? What's to keep FHFA from deciding that the GSEs don't need to pay off the people that the FHFA forced them to borrow from? I had the opportunity to discuss with 2012 CFO of the year Fischer, who had this to say:
I have owned FNMA commons since September 2008, has been a long wait for fairness. I have read Adam and Mike's analysis and just about everything else that has been written about the twins since 2008. My reasons for buying and holding the stock have never wavered. There is plenty of capital, it just has been stolen by Treasury.
That's one of the best parts about talking about Fannie Mae and writing about Freddie Mac. I've had the honor and privilege to get in touch with all sorts of high quality people who really see the world as full of opportunity. It feels like our time together is not always going to be forever and that our paths will change and I just want you to know that it has been great for me to spread the good news and I have loved bringing the truth into at least a few more heads out there.
In the meanwhile, forcing two taxpayers to borrow money from taxpayers and give all of that money to tax collectors makes for a dangerous precedent. I'm not sure how to talk about the implications of what all that means without sounding like someone forecasting the nationalization of banks and perhaps markets in general.
Understating The Value Of Private Property To Nationalize It Smells Like Accounting Fraud
It's really too bad that none of these lawsuits are against the auditors pushing for a restatement. As long as that remains the case, I'm not expecting an accounting miracle. An accounting miracle in this scenario is simply a restatement of Fannie Mae and Freddie financials because FHFA's enormous writedowns that were subsequently reversed wouldn't have accidentally triggered a nationalization.
Follow the money, it all goes to Treasury. As long as that's the case the NPV of future cash flows to GSE equity shareholders is less than or equal to $0 making the shares worthless. I figure that it could be less than in situations where the government figures out more ways to get the unsuspecting public to buy shares from it before it's all said and done.
Summary and Conclusion
If you assume that the government is going to try and settle these lawsuits and then seize 79.9% of the companies, that's really interesting because I don't know how that works. Maybe you can tell me in the comments. Again, I'm not a lawyer, but if you are and you want to help me figure that one out, that would be great. That being said, if that happens, Ackman and Bove suggest $20 is the starting point for a valuation of the common shares. Prior CFO Timothy J. Howard has this to say about their normalized profitability, if you're interested in doing your own calculations with your own assumptions:
Prior CFO Timothy J. Howard says he owns FNMA commons and FNMAN preferreds in that same post. For me personally, owning commons right now feels dangerous because FHFA is in charge and they haven't been "staying awake at night worrying about shareholders" or something to that effect if you ask Melvin L Watt, their director. Well why should anybody be awake at night? Are people awake at night? I guess that's besides the point. The point is that I don't own the commons even though they may have an incredible amount of upside simply because I am forecasting more of the same. FHFA has been effecting with Treasury a hostile takeover.
It sounds like the deal is going south, if you're into reading legal filings like I am. How does a dog spit out its food? I don't know, but I'm just afraid that if FHFA can't have them, it might try to destroy parts of what they took from us by literally giving it away for nothing at this point in the game. Technically, that's what the net worth sweep effects so this isn't really news as much as it is me forecasting more of the same sort of behavior from FHFA in the future that we've already seen regardless of if and when they may get exposed in court. 11,292 documents of evidence that they are trying to withhold from the public in mocking fashion is not the exception as much as the rules they play by.
I don't know if that's fair or not but William Ackman runs his numbers like it is, even though it still irks me. Because it irks me I have chosen to own preferreds. Maybe I'm being a big dumb idiot, but I don't want to try and be the hero here. I just want to be the first in line to get paid. Much like jugs of water fill up from the bottom when you pour water in the top, a capitalization structure fills preferreds before it fills commons (the overflow). As such, I have gone with the fill line instead of the overflow because I don't know what FHFA is going to do with the jug because who knows what a government agency won't do when they're declaring Sovereign Immunity.
Disclosure: I am/we are long FNMA, FMCC, FNMAS, FMCKJ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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