Fannie Mae (OTCBB: OTCQB:FNMA) and Freddie Mac (OTCBB: OTCQB:FMCC) are two Government Sponsored Enterprises that are often referred to as the GSEs. Between the two of them, they make over $20B/year on a normalized basis and have 9B fully diluted shares outstanding and operate in the housing finance market by guaranteeing residential mortgage securities and investing in portfolios of residential mortgages.
Together, they control over $5T of assets. As a housing GSE, both Fannie and Freddie are federally chartered, shareholder-owned, private companies with public missions to provide stability in and to increase the liquidity of the residential mortgage market and to help increase the availability of mortgage credit to low- and moderate-income families in underserved areas.
Treasury Secretary Confirms GSEs Paid Back Every Penny That They Have Borrowed At Full Committee Hearing
On June 17, The Honorable Jacob J. Lew, Secretary, U.S. Department of the Treasury was brought to bear witness for the Full Committee Hearing entitled "The Annual Report of the Financial Stability Oversight Council." According to Treasury Secretary's testimony, Fannie Mae and Freddie Mac have paid back every penny that they have borrowed from the American Taxpayer. He goes on:
I think what they have not done is they have not removed from the Federal Government, the Federal Taxpayer, the risk that goes with those institutions having the backing of the federal backstop.
Treasury Secretary also commented that now is not the time to talk about ending the conservatorship and paying dividends, well not yet anyway. I thought that was interesting, but I would probably take that view as well if I was him. If you get to pick the topics of conversation, you might also think that it would not make sense to talk about how all the dividends go to the General Fund of the Treasury which ensures that he gets paid, first.
As long as Treasury is taking everything, Fannie and Freddie common shares are worthless. The fact that they are freely trading at a non-zero value implies that there are those among us, myself included, that see the Treasury taking everything coming to an end at a theatre near you. Until then we're kind of left wondering what sort of risk Lew is talking about because the Financial Crisis Inquiry Report confirms that the GSE mortgage securities weren't the problem.
Treasury Secretary's Stance On The Federal Backstop Trumps Administration Official Stance Takes On Federal Budget
Unlike most private companies, the GSEs have their own section in the Appendix of the Fiscal Year 2016 Budget of the United States Government. What's interesting to me is that the Budget is explicit in its terminology regarding whether Fannie and Freddie have a federal backstop or not. The budget reads:
It makes one wonder if Treasury Secretary Jack Lew is right or if the White House Budget is right. Treasury Secretary says that they are backed and the White House Budget says that they are not backed, so when the Treasury Secretary says that they haven't removed the risk that goes along with having a federal backstop I couldn't agree more because it is impossible to remove what you don't have.
Fannie and Freddie are not backed and as such it's particularly amusing that they get slammed politically for not removing risk from a backing that they don't have. Nevertheless, derisking is taking place concurrently and that is drawing attention as of late.
GSEs Are Already Doing Credit Risk Transfers, Bipartisan Group Of Senators Seeks To Maximize Credit Risk Transfers
Exactly one week earlier on June 10, a bipartisan group of Senate Banking Committee members including U.S. Sens. Mark R. Warner (D-VA), Bob Corker (R-TN), Heidi Heitkamp (D-ND), Mike Crapo (R-ID), Jon Tester (D-MT) and Dean Heller (R-NV) urged the Federal Housing Finance Agency (FHFA) to expand and better define the development of the Credit Risk Transfer programs, which shift credit risk from the Fannie Mae and Freddie Mac to the private sector.
According to Debbie Hoffman at DSNews, since 2013 Fannie and Freddie have intensified their efforts to transfer risk from taxpayers to the private market:
CRT transactions are comprised of securities that are designed to allow the GSEs to share the credit risk on a portion of their strongest performing business. These types of transactions provide for a layer of defense against loss to taxpayers and Fannie Mae and Freddie Mac, while also reducing the GSEs participation in the mortgage market and increasing private investor participation. Fannie Mae and Freddie Mac launched their first CRTs in 2013.
The success that Fannie and Freddie have had so far transferring credit risk appears to be attracting the attention of Senators who so far seem to be encouraging more of the same in the name of taxpayers.
Recent Lawsuit Updates
1. June 17, Fairholme filed motion to stay. The introduction reads as follows:
The following part of Fairholme's motion is the most interesting to me because the Government is deciding to now file new motions based on facts that have been known for over a year to dismiss plaintiffs that the Government just finished ridiculing this same month for not responding to an unnannounced delivery within 18 minutes.
Nevertheless, the most important part of Fairholme's motion suggests that there's something in the bag:
After discovery closes, Plaintiffs intend to move for leave to amend their complaint and include facts gleaned from discovery.
2. June 18, Fairholme filed sealed motion to remove the "Protected Information" Designation from Certain Grant Thornton Documents. Cacciapalle also replied in support of their motion for a partial Lift of Stay And For Limited Discovery. In this reply, there is one quote to rule them all so to speak:
The Government quotes only the first sentence of the Order, and ignores the second.
The rest of the reply is more of the same, demonstrating that the Government's attempt to prevent them from participating in the depositions is unwarranted and unwelcome.
Financial Times Confirms Ugoletti Deposed
In addition to confirming that Mario Ugoletti has been deposed, the Financial Times pulled some great quotes from Fairholme's Bruce Berkowitz:
Any notion of a 'death spiral' was fiction. Fannie Mae and Freddie Mac performed as promised, had mountains of cash and generated cash during the financial crisis. Reported losses were the result of decisions by a handful of government officials to reflect a doomsday scenario that did not and could not occur.
As previously outlined, Ugoletti swore in written testamony that at the time of the third amendment net worth sweep there had been no discussion regarding the recognition of value of the enterprises deferred tax assets.
With the Ugoletti deposition completion confirmed, no one other than the lawyers and Mario Ugoletti is allowed to know what he said during his deposition. The plaintiffs have filed to make this depositon public. One of the plaintiffs commented on the AIG (NYSE:AIG) ruling as it relates to their legal arguments against the Government:
I think it says: do not underestimate that the Treasury department will do whatever the heck it wants to do, whether it's legal or illegal.
Whether or not that carries over to the court cases involving Fannie and Freddie remains to be seen, but the Treasury disagrees with the Court's conclusion regarding the Federal Reserve's legal authority and continues to believe that the government acted well within legal bounds.
Updated Investor Calendar
June 29: Government reply due regarding the removal of protected information designation from at least one deposition (Ugoletti).
June 30: Perry capital briefs for the appeal are due.
July 6: Government response to Sealed Motion to Remove the "Protected Information" Designation from Certain Grant Thornton Documents due.
July 28: Government's response to Saxton Complaint due.
September 4: Plaintiff reply briefs for Perry Capital due.
Q4: Perry Capital Appeal.
For GSE equity investors, these are some of the most exciting times. In short order we will begin to see whether or not Ugoletti's deposition is brought to the public and odds are that the plaintiffs wouldn't have filed to make it public if it didn't include some gotchas.
For the time being, the U.S. Treasury is continuing the practice of taking everything from Fannie and Freddie into the General Revenue Fund that the head of Treasury is directly paid out of. The current operating agreement might seem to suggest that this status quo can continue in perpetuity and if that is the case the companies common shares might be worthless as the companies might as well be nationalized.
There are, however, rulings like Pennsylvania Coal Co. v. Mahon that support the notion that just because U.S. Treasury wants to wind down the GSEs doesn't mean that they can do so in an unconstitutional way:
We are in danger of forgetting that a strong public desire to improve the public condition is not enough to warrant achieving the desire by a shorter cut than the constitutional way of paying for the change.
The recent admission that the GSEs have paid back by Secretary Lew is a big one. His reservations regarding what they have not done seem to be line items that the two companies are resolving on an ongoing basis with great success. As such, it appears that there is indeed light at the end of the tunnel for common shareholders, where the upside could be from anywhere from $20 to over $100 depending on the legality of the warrants.
Disclosure: I am/we are long FNMA.
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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