Abductive Reasoning: The Government Theft Of Fannie Mae And Freddie Mac

| About: Fannie Mae (FNMA)

Summary

The government was in charge of GSE accounting during the time period where the government issued itself $180B+ of par value preferred and dividended itself $245B+ and counting.

The government says it hasn't been paid back, and according to their accounting formulas and net worth sweep agreement with themselves, technically it is correct.

The spirit of the law is fairness and the $100B+ of cash that has been transferred by the government to the government from the GSEs disproves the death spiral narrative.

Abductive reasoning is determining plausibility based on a set of evidence. Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two private companies in a government managed conservatorship. If committing accounting fraud to force companies you're in charge of to take a poison pill in an attempt to run their shareholders interests into the ground is illegal, then perhaps the equity shares of these two companies that are owned by non-governmental shareholders have value. As long as the status quo remains, whereby the government is in control and Judges rule in its favor, the publicly traded equity shares are worthless. The companies themselves, however, are not worthless as they produce $15B/annum by some estimates. Bill Ackman and Richard X. Bove have suggested that valuations of the common shares could start at $20 if the net worth sweep is declared illegal. The government itself has taken $100B of capital that otherwise would have belonged to Fannie and Freddie away from them through agreements that the government forced upon them. On top of that previous 10-year government forecasts are more of the same, demonstrating that the GSEs are cash cows.

If the net worth sweep is legal, corporate raiders of public companies could undermine capital structures of publicly traded companies by issuing themselves or companies they own preferred stock that represents the estimated future earnings of the company and subsequently amending their contracts with themselves to take everything. The implication is that the value of publicly traded companies would be tied to the investment community's belief that the management team would not take similar actions to enrich themselves. If this becomes settled law, however, taking everything from public companies for nothing would now have a best practice known as the net worth sweep. Note that Representative Mike Capuano around the 18 minute mark of this video says:

Fannie and Freddie are basically being used as a piggy bank by the Treasury, and at some point they will lose the lawsuits being brought on by investors and owe someone an awful lot of money

If you're only interested in the snippet, click here. Elsewhere in the video David H Stevens notes that they make $12B/annum and that the government is counting on that money.

The stated rationale in defense of the third amendment net worth sweep takes a narrow view that somehow paying dividends in cash is the only option. This flies in the face of my corporate finance experience where dividends are discretionary. Not only that, but since when is it legal to pay dividends to the stakeholder controlling the conservatorship, depleting the capital of the companies in conservatorship at the direct expense of minority stakeholders? I'll tell you what, minority stakeholders have rights too. Those rights not only deserve to be protected but have protections from numerous laws, thanks to multiple state, federal, and court of claims courts. According to a recent Forbes article which was published but I can't find a link to anything except somewhere on a blog, there are three potential outcomes for that lawsuit, from increasing order of likeness starting at nil: affirmation, remand, and reverse. The reason the Forbes columnist suggests that affirmation is the least likely remains unclear to me. As such, I thought I'd write about my thoughts on the topic to clear things up for those of you who haven't invested their life savings and everything they can borrow totaling hundreds of thousands of dollars.

I Fought The Law And The Law Won

And to those of you that don't think that is very much, I can't say I disagree, but the points I am about to make are based on my non-lawyer interpretation of what seems to be the relevant parts of the relevant Statutes that make deciding this case with a remand to be the second most likely in my professional opinion. The net worth sweep guarantees insolvency where assets do not exceed liabilities. As such, HERA reads in solvency as conservator and therefore makes the net worth sweep amendment illegal according to Federal Law. According to state law, FHFA stepping into Fannie Mae and Freddie Mac to force them to issuing cash dividends lowering the net capital lower than the liquidation preference of the preferreds (currently not being sued for as far as I can tell), writing down assets to issue the government securities effectively to itself (from it's perspective), and a SPSPA and conservatorship in general that started when their capital was at the highest level in their history and had no need for cash money.

The best part of all of this is that they were at their highest capital levels when it all started. The worst part of all of this is that right now they pretty much are winding down their capital levels from negligible to nothing across the next year or so. This next quarter may show some evidence about how reliable they are at making cash money for those of us who can tell the difference between cash money and accounting fluctuations. For those of us who can't, it's the secret sauce to understanding exactly how the government set this whole thing up to begin with, with a concept that they could write down a private company's assets and subsequently transfer them to the government. It begins by taking control and entering into an agreement where cutting the value of their assets issues yourself stock and writing down as much of the assets as you need to in order to justify that they are worthless to everyone else and then change the terms of you stock so that you take all the net assets after which you re-value all the assets as your own.

I must say, that's a pretty genius idea if you ignore how illegal it is since it breaks accounting laws to scapegoat companies by misrepresenting financials to the investing public by making them look sickly and dying when they're simply on life support because you put them there and are keeping them there against their will in some sort of coma leading to decisions like bloodletting where their board of directors issues dividends in cash when they are conserving and preserving their net capital. That's not the preservation. That's the liquidation. Money has been flowing away from the GSEs like a toilet bowl flush. First it started flowing in dividends at a slow rate but the rate increased when they sealed the deal to everything based on the logic that the dividends that they issued to themselves were greater than the estimated earnings of the company going into the future.

Imagine Filling A Glass Full of Liquids

When considering exactly how to invest into the GSEs, what the government attempted to do is divide and conquer. By injecting itself between the equity and the debt and destroying the intrinsic value of the outstanding public equity while making the debt whole, the government has undermined the laws by picking winners and losers. The notion of favoring creditors over owners is the sort of thing that Fannie and Freddie were put into existence to compete against in the first place. Fannie and Freddie have provided a clear path to home ownership for generations before me.

As you pour net capital into the business of Fannie and Freddie, the money first accrues to preferred shareholders and then if they are paid in full money would then flow to common shareholders. As such, it can be said that preferred shares have preference. Because the government has drained the net capital of Fannie Mae and Freddie Mac, the first shares to benefit from the end of the sweep would be the preferred shares because capital would have to be set aside for them before dividends can be paid on common shares.

This is sourced from a pale perspective of justice. True justice would come in the form of reversing all of FHFA's actions taken against the GSEs including but not limited to the warrants, the accounting fraud, and any and all net cash transfers not related to taxes going to the government to be reclassified as government revenue. Unfortunately I do not pretend to know if our legal system is advanced enough to figure out how to achieve that, but one can dream. In that scenario the companies have over $100B in capital out of the gate and the big winner is the common shareholders. Given litigation timelines and my perception that Perry Capital is up first, I think that the first part of what will eventually be the solution is the death of the third amendment.

From there, it would seem that FHFA would attempt to let the GSEs build capital or put them into receivership. It will be interesting to see how earnings play out this quarter and if either of the GSEs is forced by the government to take a draw per the accounting terms of the agreement that the government forced on the GSEs. If you recall, the government benefits by writing down GSE assets because those writedowns result in issuances of securities to itself.

The mathematics behind this conservatorship have been to take all of the equity for nothing and as such, I prefer to own preferred shares instead of common shares and part of me hopes that I am wrong because I'd love nothing more to see true justice served but bet on it I shall not. That's the difference between investing and speculating in my opinion, which is why I am speculating that it is a possibility with a kicker position in the common shares.

A New To Me Lawsuit That's Kind Of A Neat Thing

This lawsuit was emailed to me. It is an interesting argument that the government foreclosing is an unjust enrichment of where that money goes directly to without even having to pass go. Although it doesn't directly relate to GSE shareholders I do think that rulings on these types of cases will provide more clarity on whether or not FHFA is the government or not. Remember, the FDIC filed saying that sometimes the FDIC is:

Click to enlarge

That's all I really have to say about that one. I'm not sure it really means anything to shareholders or potential shareholders except it could show that money going to the government from Fannie Mae and Freddie Mac counts as taking of private property for public use if it's not paid for. Sounds close enough to me.

Summary and Conclusion

That's just something you don't do, taking other people's money. When it happens, thank those who came before us for teaching society to establish courts to preside over disputes where one party defrauded another and stole money from their homes. The taxpayers is just what we all are, each and every one. As such, it's completely nuts for us to take from ourselves unless we are so rich we don't need a mortgage to buy our homes. And there you have it. Stealing money from Fannie Mae and Freddie Mac decreases their ability to make equal opportunity affordable mortgages nationwide. Not having capital makes modeling risk, how do you say it, impossible? Running implicitly government guaranteed companies with all their capital being stripped to the government may cost taxpayers dearly in another housing crisis if the government lets them fail because the government decided to screw them on purpose by taking all their money. Tax collectors stripping taxpayers of private property in the name of taxpayers might sound like a notion that would never get any lift but that's precisely what's been happening here since 2008 and the tax collectors have been doing it by making taxpayers look like they are worthless when they started out as capitalized Fortune 50 Companies that made billions in profit throughout the cash stripping process known as FHFA's conservatorship. Covering up the cash transfers with accounting fraud and public lies is being uncovered by Judge Sweeney's discovery which is being sent to any court where the third amendment net worth sweep is being fought.

I take great deep breaths and buy more shares in two Fortune 50 companies equity, especially when it's been raided by the government and billionaire investors have come to the rescue to file lawsuits to fight for the right to party in your home that you own in America through a Freddie Mac and Fannie Mae fixed-rate thirty year mortgage. My generation hasn't been able to buy homes because mortgages just haven't been made available to a lot of us who are more than deserving and good for it because since we have gotten to the time when we normally might be able to do that the rug got pulled out from under the two main companies that would help us do that by people who already have their big fancy homes and don't want us to get our first starter homes. It sucks, I'd like to have a home. I'm 29 and I don't live with my parents but they wish I would at times I'm sure because it is so awesome to have family in your life if you can. This is about letting Fannie Mae and Freddie Mac keep their money so that they can help my generation afford our first homes.

I have instead spent 90% of my life savings on preferred shares of Fannie Mae and Freddie Mac along with 10% of my life savings on common equity shares of Fannie Mae. I think that people seeing the light at the end of this tunnel will right now look at what sort of gift or trojan horse this is and see that I'm not going to jab it in the mouth. I love Fannie Mae and Freddie Mac and the only thing that they did wrong is that none of their friends came to save them when the government began forcing them to commit accounting fraud and therefore their own demise as soon as conservatorship started. The government paid their salaries by not firing them and the same goes for their auditors who also have lawsuits asking for a restatement of their work as accountants figuring out the net losses reported by Fannie Mae and Freddie Mac or why they simply did as FHFA instructed when that wasn't the right thing to do.

It is what it is. This is an investment opportunity for some of you. For me, I'm all in, crossing my fingers and does and reading 100% of everything I can.

Disclosure: I am/we are long FNMFN, FNMA, FMCCP, FNNMFO, FMCKO, FMCKP, FMCCT, FMCCH.

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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