On Sept. 7, 2008, Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) were essentially nationalized when the government forced itself on the twins. Since then, the government has taken full advantage of this arrangement where it may appear at first glance that it is making it up as it goes along but that's probably not the case. Fannie and Freddie are two private taxpayers that are being managed by the government for the government. Since conservatorship commenced in 2008, the companies have been overseen by the Federal Housing Finance Agency (FHFA), who has written down their assets and then transferred them to Treasury. This has all been made possible by leveraging off-balance sheet accounting techniques that appear planned in advance. Fannie and Freddie are often referred to as the Government Sponsored Enterprises (GSEs). This is the yet to be completed story of how the government thought that by publicly disgracing Fannie Mae and Freddie Mac it could get away by outrunning statutes of limitations.
Investment Opportunity In Brief: There are lots of lawsuits in courts around the country where plaintiffs are alleging that the government broke the law somewhere between the onset of conservatorship and having an agreement that it negotiated with itself that permits it to drain the net capital of two Fortune 50 companies.
The thing about financial reporting is that accounting tricks can be used to serially understate or overstate earnings for periods of time until eventually rules force the truth to bubble to the surface. In this case, imagine the government structuring an agreement where they could push down the reported profitability of two profitable companies while simultaneously issuing itself massive amounts of equity in the two companies. Further, imagine the normalized profitability as a waterline and the government accounting manipulations pushing an inflated air balloon further underwater with every pushdown.
Eventually the air balloon bursts and the bubbles surface. During 2008-2011, the government committed accounting fraud to write down GSE assets. Per the terms of the government's agreement that it struck with itself, it simultaneously issued itself massive amounts of GSE stock. Knowing that they couldn't artificially hold down profits forever they declared that based on the fictitious losses the government was reporting that the GSEs were worthless even though all of their profits were submerged deep and were about to blow up and explode to the surface due to the insurmountable pressure of reality that you can't hide $15B/year of cash profits from the public forever. Giving up on hiding them, the government decided to follow through with the original plan of just stealing them by effecting a net worth sweep after a time during which all the profits had been hidden by declaring valuable assets were worthless.
Shareholders Will Win
The question is, which ones? Right now there are two classes of equity shareholders. The government owns senior preferred securities and warrants that it issued itself as part of the deal it struck with itself when it placed Fannie Mae and Freddie Mac under its control. Since conservatorship has begun, a series of cash transfers has taken place. First, $132.2B flowed to the GSEs. Then, $246B flowed back. Now, the government claims that courts can't stop them because 4617(f) precludes courts from intervening when the government amends its security to take the net worth of the GSEs. This is a step down from the earlier government argument that has since been debunked by evidence produced through the discovery process in the Court of Claims that has been made public in order to allow plaintiffs to use the information to argue their claims during oral arguments.
Previously, the government argued that Fannie Mae and Freddie Mac were in a death spiral and that the only way to save them was to take all of their money. This previous perspective seemed to purposefully ignore the PIK provision. In addition, the former Chief Justice of the Supreme Court of Delaware represents plaintiffs in another lawsuit that says having a preferred security take the net worth of a Delaware corporation is illegal in the state of Delaware. Further, by IRS tax law, the third amendment net worth sweep constitutes a purchase of a new security by the government's own definition. My understanding is that the accounting was designed to facilitate a slow rolling nationalization well in advance of conservatorship.
Lawsuits have been filed against Deloitte and PricewaterhouseCoopers for their role in signing off on the government's writedowns. The government's argument recently lost in an attempt to consolidate several lawsuits including ones against the accounting firms auditing the GSEs. On top of that, the government has lost in their attempt to cover everything up as discovery has been produced and passed around to any court challenging the government's actions.
Combined, the GSEs make $15B/annum at their current level of g-fees. This money belongs to shareholders. The question is which ones. Since conservatorship began and per the plans of the government, the tax collector has been getting it all leaving taxpayers out in the cold. Evidenced produced in discovery so far proves plaintiff claims that the government has been lying about everything to be correct. It's no wonder why the government has fought so fiercely to cover its actions up by asserting privilege and challenging plaintiff claims at each turn in the road as well as attempting to game the court system.
Summary & Conclusion
Given that HERA is modeled after the FDIA which governs the FDIC the same way HERA governs the FHFA, either a conservatorship enables the conservator to transfer all the net worth of the enterprise to itself or it does not. Any serious review of the statute undermines the government's defense of its actions grounded in public bamboozlement and deceit. For those unfamiliar with the purpose of laws, sometimes people do the wrong thing and laws provide for avenues to course correct when this happens.
The public hoax is that Fannie and Freddie are broken business models is undermined by the fact that on a cash basis conservatorship has stripped the GSEs of over $100 Billion dollars. Combine that with the fact that the GSEs would have been better off on every single day since conservatorship was imposed if conservatorship was never imposed in the first place. The government forced itself on the GSEs.
Disclosure: I am/we are long FMCCH,FMCCP,FMCCT,FMCKO,FMCKP,FNMA,FNMFN,FNMFO.
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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