The Federal National Mortgage Association (OTCBB: OTCQB:FNMA) and the Federal Home Loan Mortgage Corporation (OTCBB: OTCQB:FMCC) provide assistance to the secondary market for residential mortgages. They are often referred to as Fannie Mae and Freddie Mac and/or the GSEs for short.
These enterprises were established and chartered by the Federal Government for public policy purposes. They are not included in the Federal Budget because they are private companies, and their securities are not backed by the full faith and credit of the Federal Government. However, because of their public purpose, detailed statements of financial condition are presented in the Budget of the United States Government, to the extent such information is available, on a basis that is as consistent as practicable with the basis for the budget data of Government agencies.
The Federal National Mortgage Association (Fannie Mae) is a Government-sponsored enterprise (NYSE:GSE) in the housing finance market. As a housing GSE, Fannie Mae is a federally chartered, shareholder-owned, private company with a public mission 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 and in underserved areas. Fannie Mae engages primarily in two forms of business: guaranteeing residential mortgage securities and investing in portfolios of residential mortgages.
Fannie Mae was established in 1938 to assist private markets in providing a steady supply of funds for housing. Fannie Mae was originally a subsidiary of the Reconstruction Finance Corporation and was permitted to purchase only loans insured by the Federal Housing Administration (FHA). In 1954, Fannie Mae was restructured as a mixed ownership (part government, part private) corporation. Legislation directed the sale of the Government's remaining interest in Fannie Mae in 1968 and completed the transformation to private shareholder ownership in 1970.
The instant an emergency is proclaimed, the rest of a hijacking occurs in an instant before we even have a chance to glimpse fully what is happening, let alone decide if it is a good idea. The hallmark of such a hijack is that once the moment passes, those so possessed have the sense of not knowing what came over them. These hijacks are by no means isolated, horrific accidents that lead to brutal crimes...
See what I did there? Above's an excerpt from Emotional Intelligence. There recently have been baseless claims regarding the GSE Jumpstart Bill that I think would be rescinded if the authors of which were made aware of the Congressional Record:
The nomenclature behind the GSE Jumpstart Bill should serve as a lesson for future doublespeak masterminds to go along with George Orwell's classic 1984. Regardless, the GSEs are in conservatorship which is different from receivership. Since conservatorship started, FHFA has taken over $100B out of affordable housing by engaging in a series of agreements and targeted accounting actions wholly designed to victimize the GSEs by making them look unprofitable. On top of that, government plans reveal that they are forecasting more of the same:
What's not surprising about this is that on balance investors expect the GSEs to make around $15B a year or more. What appears to have happened here is that since conservatorship has begun, the government has taken everything and their plans suggest more of the same. As such, an investment in the equity securities of Fannie Mae and Freddie Mac is a vote of confidence for private property rights and a vote against the government doing what it's been doing for seven years and running.
This Conservatorship Evolves To Evade Private Equity Shareholders
Such inchoate mistakes are based on feeling prior to thought. The one thing that differentiates this conservatorship from any in history is this conservatorships ability to evolve. This is best introduced by Judge Sweeney's exchange with Mr. Schwind:
THE COURT: Well, then, if you don't know what it is, then you're just making it up as you go along.
MR. SCHWIND: We're definitely not, Your Honor. And -
THE COURT: Well, of course you are. You're saying you don't know what they've asked for, you don't know what's been produced. Oh, by the way, but it simply goes to merits, and it can't possibly help them with respect to their jurisdictional defenses or their jurisdictional allegations.
Earlier, Judge Sweeney questioned the Government's defense for its actions as schizophrenic:
THE COURT: And so far, I haven't gotten - I haven't received a good answer from the Government. Counsel is very able. But counsel has expressed concern of what could happen if certain documents are released, which I do not want to see happen, but counsel didn't answer to my satisfaction the discrepancy between sort of using the deliberative process as sword and shield. On one hand, FHFA is a government entity, you know, for purposes of booting the Plaintiffs out of court and not part of the Government, but for purposes of forwarding discovery, all of a sudden deliberative process is appropriate because they are part of the Government. So, it's a schizophrenic approach and I'm just waiting to hear a reasonable explanation.
While we wait, the Federal Housing Finance Agency continues to manage the affairs of Fannie Mae and Freddie Mac. These private companies have operationally been effectively repatriated to the United States Government since they are presently being run by the United States Government and all of their money is being taken by the United States Government.
2008 - When Conservatorship Began
On September 6, 2008, the Federal Housing Finance Agency used the board consent clause to force the GSEs into conservatorship. At the time the GSEs entered conservatorship, their capital positions were at all-time highs. Treasury and the Federal Housing Finance Agency entered into an agreement called the Senior Preferred Securities Purchase Agreement (SPSPA) that the Federal Housing Finance Agency's Director Melvin L. Watt puts it best:
I think the law got trumped when they went into conservatorship...
Director Melvin L. Watt continues to operate FHFA under this inherited agreement that trumps the law that was arranged before he started at FHFA. This particular exchange between Watt and Mulvaney specifically relates to an order of payments issue whereby the point of contention is whether or not the GSEs can serve their public mandates of funding affordable housing while in a conservatorship where an agreement was made to prevent the end of conservatorship as outlined in HERA by the U.S. Treasury. Subsequently, as part of an Omnibus bill, GSE jumpstart reform measures as championed by Senator Bob Corker continue to take a vacation from the legal process which David H Stevens correctly assesses:
"rule of law" is old and tired.
Treasury and FHFA have been successfully evading legal scrutiny since conservatorship began in 2008. Judge Royce Lamberth last year threw out lawsuits related to Treasury's and FHFA's third amendment net worth sweep.
Assets Have An Owner
An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. At the beginning of conservatorship, Treasury and FHFA struck a deal whereby at FHFA's accounting discretion Fannie and Freddie's net assets available to private shareholders could be dissolved by making arrangements for the two of them to:
- Dissolve their net asset base.
- Prevent private earnings from becoming private assets.
This year, three (1, 2, 3) forensic audits have been produced that proactively question the legality of step 1. The forensic audits suggest that FHFA engaged in related party transactions. So far there are no pending lawsuits suing Deloitte and PwC, the auditors of Fannie Mae and Freddie Mac, who would likely be liable for signing off on FHFA's asset impairments causing draws against the SPSPA. There is, however, the Washington Federal complaint that fights the original SPSPA, but it fights the government. In my opinion, the easier targets for accounting fraud are the auditors because they aren't directly benefiting from the $15B+/annum of funding that they can use to pay law firms to defend their ongoing actions.
The legality of step 2 is the big one that everyone is contesting in courts around America, not limited to but including Delaware, Kentucky, and the Federal Court of Claims. The most difficult thing about suing the government when they are taking all of your money is that they can use your money to pay lawyers to come up with all sorts of arguments why it isn't your money anymore. Legal arguments put forth by the government are not limited to but include:
- Sovereign Immunity: Sovereign immunity bars plaintiffs' claims against Treasury
- No Conflict of Interest: There Is No "Conflict-of-Interest" Exception to HERA
So, as you can see, the government's defense isn't in the business of justifying the reasonableness of its actions as much as it is in the business of proving that because it is the government it gets to make it up as it goes along and that might seem fair because that's what's been happening so far.
The Common Securitization Platform & Omnibus
According to the most recent 8-K filed by Fannie Mae (The 2016 Conservatorship Scorecard)
Build a New Single-Family Infrastructure for Use by the Enterprises and Adaptable for Use by Other Participants in the Secondary Market in the Future. (30%)
The Enterprises are to:
Common Securitization Platform and Single Security:
The Common Securitization Platform (NYSE:CSP) and Single Security are significant, multiyear initiatives, and FHFA expects these inter-related projects to remain ongoing conservatorship priorities. FHFA expects the Enterprises and Common Securitization Solutions, LLC (CSS) to implement these initiatives on the following timeline:
i. Release 1: In 2016, implement the CSP for Freddie Mac's existing single-class securities; and
ii. Release 2: In 2018, implement the Single Security on the CSP for both Fannie Mae and Freddie Mac.
The Omnibus bill also winds up around 2018. Also, the enterprises are set to have $0 capital by 2018. At this point the GSEs could be put into receivership, the common securitization platform could be taken away from them at this point in time preventing private shareholders from participating in the upside. This is the plan actively being pursued by the current administration. With this plan in mind, the intrinsic value under this scenario for all GSE equity securities is distinctly $0.
Even Warren Buffett Weighed In
Warren Buffett has suggested that the junior preferred shares that I own are a terrible form of security as they are non-cumulative. I agree. If they were cumulative they'd be in arrears. Buffett's argument puts more points on the scoreboard in this case than usual because Congress sets capital requirements for the GSEs and they could raise capital requirements making it so that even if the third amendment is voided it would take a decade or more for the preferreds to pay a dividend. How could this take so long you might find yourself asking?
Well, so far FHFA has forced the GSEs to take $132.2B and has paid out over $239B and says that the GSEs still owe $187.5B of liquidation preference to the U.S. Treasury. Seeing as how FHFA is running things this way I don't think it's unreasonable to say that they couldn't come up with an alternative solution that prevents private ownership of private profits for at least a while longer. Because the junior preferreds are a weak form of security the longer we are deprived of dividends that are instead nationalized, the lower the shares should trade today. Some might call that risk but I'd call it opportunity, especially in the context of the legal dynamite that appears to be stacking up.
Legal Dynamite - Susan McFarland
Susan McFarland was the CFO of Fannie Mae before, during and after the net worth sweep. She has been deposed and apparently has revealed facts that demonstrate the government "was determined to keep Fannie and Freddie under government control and to ensure that shareholders other than Treasury would be wiped out."
Susan McFarland appears to completely discredit the government's defense that the purpose of the net worth sweep was to save Fannie and Freddie from being forced to make cash payments in excess of their earnings. One might be able to imagine the reasoning she might have proposed. Could it be that dividend payments were optional? Could it be that the 12% was PIK and not a penalty as Lamberth seemed to presume? Could it be that dividends are not obligations and preferred equity securities are not debt? Could it be that the DTAs were obviously a looming threat to the sustained obliteration of private shareholders? Could it be that she would have been fired if she didn't go along with it because FHFA was in charge?
The reality is that we don't know. It very well could be that the government is telling the truth. If you believe that I have some water front real estate on the moon that I'd like to sell you or better yet why don't you just give me your money for nothing. If that sounds too crazy to actually happen that's just what Treasury & FHFA did to Fannie and Freddie according to plaintiffs. In fact, Independent Community Bankers of America, the Association for Mortgage Investors and William M. Isaac propose a more down to earth metaphor:
Legal Dynamite - Show Us What You Really Did
The best part as a equity shareholder of Fannie Mae and Freddie Mac is that it's not like the evidence is impossible to find. The evidence is just being withheld from plaintiffs as if it is a matter of national security:
Even more revealing to people who are more familiar with the discovery process are documents that have somehow gone missing. As a former Director of Financial Planning and Analysis of an eDiscovery firm, I would normally find the following omission alarming:
What's even more interesting is how the plaintiffs caught this. Around the time the lead government lawyer Greg Schwind left, court documents reveal that plaintiffs were ordered to destroy as part of an expedited discovery process documents that were provided to them that should not have been provided to them but instead were intended to be marked as privileged. The fact that these documents were not included in the document production or the privilege log seems to suggest that the documents never were supposed to exist in the first place. Regarding why things are taking so long, plaintiffs seem to suggest that the Defendant might be proactively withholding responsive documents.
This matters because there are many lawsuits running in parallel and Judge Sweeney is allowing Fairholme to file discovery materials in other court rooms where plaintiffs are fighting the government's actions during conservatorship. For example, in the Perry Capital appeal, these timing issues may negatively have affected their ability to appropriately respond to the government's motions or amend their complaint to reveal pertinent discovered facts. As the saying goes, delayed justice is injustice. The good news is that the discovery is spreading:
Judge Sweeney above says that the discovery process paid for by Fairholme will be made available to all plaintiffs in all courtrooms as it may provide grounds to amend the complaints. That's big time folks. Prepare to see amended complaints, probably redacted at least at first to reflect facts from depositions and discovered documents. The lid of government secrecy is blowing off like a Pringles can thanks to Judge Sweeney in the Court of Federal Claims.
The Ultimate Price of Fannie Mae and Freddie Mac
If you understand and can value other people's time you can afford to tell them what to do for as long as you're right. Private capital is what enables a country's citizenry to make the best things that country has to offer possible. Part of being able to value other people's time is the expectation that when you're doing good work to make the country a better place you have the right to earn money for the work that you do if someone will pay you for it. This is why we have labor laws, to ensure that people are paid for the work they do.
Whenever an employer is able to find a resource that they can put to better use than the person who is using it the employer has the opportunity to make an offer that the person may choose to accept or not. This is free trade. As part of free trade, the government taxes the net profits on both sides of the trade at certain rates. In the case of Fannie and Freddie the government has decided with itself that the value of the two companies is $0. Painting itself as a hero, the government says that it came in and gave Fannie and Freddie much needed access to capital and painted Fannie and Freddie as the root of all housing problems. In this backdrop, the government is not unlike the Wizard in the Wizard of Oz.
Since you're wondering my view is that the government came in and painted Fannie and Freddie like they were the biggest money pits in the world while it has meanwhile taken over $100B ($239-$132.2B) out of the business like no one was paying close enough attention to notice what was going on or at least wasn't going to be able to stop them because of Statutes of Limitations being too late. The money doesn't lie. The government's claims that Fannie and Freddie are broke when the government has been draining $15B/year out of them is the biggest laugh in financial history. An additional excerpt from Emotional Intelligence reads:
Not all hijackings are distressing. When a joke strikes someone as so uproarious that their laughter is almost explosive, that, too, is a limbic response.
My version of what really happened is Treasury and FHFA took my shiny toy and put up billboards in their front yard saying how broke it was and how much of a disaster it has been trying to bring my toy back to life but every single day I peek through their backyard fence and there they are racing my toy race car around their dirt track having a blast. In fact, FHFA is having so much fun it is planning to hire more people to increase its examinations. I'd ask you to guess who is paying for it, but you guessed it: Fannie Mae and Freddie Mac.
The two taxpayers Fannie Mae and Freddie Mac have been run by tax collectors as if they are tax collectors even though they are classified by the government as private taxpayers. Not unlike the Delaware lawsuit which claims a preferred security is a security that pays dividends at a rate or in preference to another security, a taxpayer is a person or business that pays taxes at a rate or in preference to the profits that it keeps. If Fannie and Freddie are not taxpayers, they are tax collectors. Fannie and Freddie cannot have it both ways meaning that they can't be in two places at the same time and can't do the following at the same time:
- They can't keep a portion of their money and not be taxpayers and
- They can't give all the money to the government and not be tax collectors.
That is to say:
- If you are public, your money is government money, you are a part of the government and you belong on the government's balance sheet.
- If you are private, pay a portion of your money to the government (taxes) and keep the rest and you do not belong on the government's balance sheet.
Meanwhile, Fannie Mae and Freddie Mac are currently being forced to pay all their money to the government and are private companies that don't have an explicit government guarantee. Per terms unprecedented in the history of conservatorships Fannie and Freddie were outright abducted and have been forced into a "debt slavery" situation by coercion, deception, fraud, intimidation, and isolation. According to estimates, slavery is a $35B/annum industry not including the $15B/annum of Fannie and Freddie. In the case of Fannie Mae and Freddie Mac, not even the employees there can stand up against the government because they risk joining the unemployed.
Whose Money Is It?
Although it is seductive for government officials to think that a system called conservatorship can be used to milk taxpayers for all they are worth, other systems exist to prevent this from happening and the judicial branch carries a bigger stick than the executive branch and while executives can run around revolving doors into out of and between government agencies the justice system comes with bars that people are put behind when they take things that aren't theirs, lie about it, and cover it up. It's either that or a settlement and I'm betting on a settlement. If the GSEs were never put into conservatorship they'd have over $100B+ more capital than they do today. They never would have run out of money according to forensic audit reports, and that's without even having to borrow a dime.
That's primarily why this is so interesting. Through a series of steps the government has been able to at the very least temporarily nationalize two massively profitable Fortune 50 companies by unilaterally deciding to treat the private companies as if they are public agencies. Actions like these not only do not prevent a crisis but they cause them to begin with by magnifying investor uncertainty during times when capital structures and established order of payments solvency principles is supposed to determine whose money is it. What's particularly crazy about this scenario is that Fannie Mae and Freddie Mac were never in the dire financial straights that they were painted to be in and the money they were forced to take was part of the plan to ensure existing shareholders would no longer have access to the $15B/annum of combined profits that would have been theirs since conservatorship started that has instead been reclassified as top secret government revenue. Further, the government argues in court that by law FHFA and Treasury can do whatever they want with that money. My view is that there is no reason to put so much effort into covering up what FHFA and Treasury have been up to if in fact as they say the law actually permits their actions as conservator thus far.
David Fiderer has written a book that you should read called The Plot To Destroy Fannie Mae: Anatomy Of A Power Grab. All of Fiderer's research comes from publicly available documents, which is pleasing because his work is easily verifiable. (Reportedly, he wore out two library cards at the NYC public library branch in Greenwich Village.)
Summary And Conclusion
At present I have more than 4x my net worth (65,000 shares of $25 par value and $175,000 of debt) invested in the preferred shares because it is my understanding that the court system will catch up with FHFA before 2018. It wasn't always this way but as you can see lately the share price of the preferreds I have my largest position in have been sliding:
At this rate, we'll be at $0 within the next quarter. I don't expect this to continue. I could be wrong but fundamentally I do not think that it is legal for the government to outrun the law forever. While they are outrunning the law for now and the courts may look tired and old to some of the leading GSE detractors, there is no legal defense against blatant expropriation of private property rights and unless there is an Amendment to the Fifth Amendment to the Constitution of the United States of America to make for limited exceptions I will eventually have over a million dollars worth of Fannie Mae and Freddie Mac preferred shares.
As a private citizen of the United States of America and owner of Fannie and Freddie securities, we have the high ground and will prevail. I have accepted that the way that this conservatorship is being run by FHFA is evasive to private shareholders and as such have decided to own the preferreds instead of commons for the time being because when the people running the business appear to be trying to financially run it for the government I am not sure how much I can count on the law to defend me when FHFA is in a position to pursue a scorched earth exit policy on behalf of shareholders that effectively hands the keys to the mortgage market to the banks with an explicit government guarantee that doesn't exist today.
While I'm not going to deny that that's where we are headed and that I think it's about time that organizations like the AAMA adopt resolutions to promote home ownership, the question remains: Are we as Americans too late to save Fannie and Freddie from the government? Either way, it does appear that 2018 is the impending deadline.
My opinion is that the CSS/CSP could be taken from Fannie and Freddie bankrupting the shareholders much like the FHFA has taken over $100B out of the twins since conservatorship began. Affordable housing has suffered and this in my opinion is the primary culprit for why the recovery since 2008 has not been felt as widely as it should have been as African Americans and Hispanics have disproportionately missed out. Fannie and Freddie have been forced to cut back on their business to minorities because the capital that normally backs their business is being taken by the U.S. Government. The status quo therefore unsurprisingly benefits the U.S. Government at the expense of Affordable Housing.
Going back in time, the reason Fannie Mae and Freddie Mac were created in the first place was to inhibit segregation and to promote equal opportunity home ownership. As recently as yesterday the CEO of Fannie Mae Timothy Mayopoulos suggested that Fannie Mae has had tremendous success with reforming the business and making it safer, stronger and better for future generations of Americans. If I'm right and eventually Fannie and Freddie are released and become recapitalized, eventually my preferred shares FNMAS and FMCKJ will be worth at least $25. That's how I am going to make my second first million. That's not bad considering my net worth right now is under $40,000.
Happy Birthday Mark Bradford
My father wants to have a serious sit down conversation with my mother around the end of this year regarding what to do about his shares of Fannie Mae and Freddie Mac (common and preferred but mostly preferred). He thinks that part of my investment hypothesis is that it is possible for me to lose everything and that will be okay for me and that investment thesis does not sit well with him, understandably so. This article is for you Mark, maybe through this article you will understand that from where I sit a bottom dollar is a bottom dollar.
If the U.S. Government can effectively void U.S. Dollars owned by you or me without judicial review then the $5,000,000,000,000 of assets owned by Fannie Mae and Freddie Mac were never anyone's to begin with in the first place and that's just affordable housing these days. In the past when I've lost large sums of money due to fraud, the fraud was people unsustainable taking what was not theirs in the first place and this is no different except I'm on the other side this time. The government isn't even fighting over fairness, they are just saying that we can't stop them. And better yet, we're winning! I basically just spent a year wandering around Miami Beach, the question for me remains how much more of this wandering around Miami Beach I have to do before this is resolved? I'm not sure but I'm not worried either, it's just sad that waiting doesn't pay in this case meaning that I'm not going to get anymore since these things aren't cumulative. The government sure has the cumulative aspect of it all going in its favor. That's their lower hand while we shareholders remain entrenched in the upper.
Disclosure: I am/we are long 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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