Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) have on a net basis since conservatorship produced and transferred over $100B of cash dollars to Treasury on a net basis. Treasury now claims that it is owed over $187B in a liquidation in additon to draining the net worth of the companies through a quarterly dividend. To top it all off, it has 79.9% warrant coverage. White House forecasts reveal hundreds of billions more across the next decade. In case it isn't self-evident: the conservatorship, the accounting manipulations overseen by FHFA during said conservatorship, and the net worth sweep have been designed around villipending the economic interests of publicly traded preferred and common shareholders.
Investment Thesis: Investing in Fannie Mae and Freddie Mac is basically betting that the American judiciary system will interpret the law favorably for plaintiffs before it is too late. Fannie and Freddie are being run as an off-balance sheet government agency even though they are private companies. Shareholders have sued. Combined the GSEs make $15B/annum and investor William Ackman suggests they are worth upwards of $20/share and this valuation is echoed by Richard X. Bove.
The Government's Winning Streak Heavily Relies On Perry
The United States government has won three cases against plaintiffs so far, and by won I mean that none of the three have made it past the government's motion to dismiss. The judges in Perry, Pratt and Pagliara have ruled in favor of the government in ways that make your average person question their sanity.
The government got Perry dismissed which got Pratt dismissed which got Pagliara dismissed. The Pratt dismissal is effectively a copy-paste of the Perry dismissal but the Pagliara one took things to a new level, basically ruling that all rights means all rights even though the respective statutory language that HERA was modeled after has a history of not being interpreted to mean all rights. Even still the Pagliara ruling relied heavily on Perry. The government decided to notice Perry Appeals regarding Pagliara.
My interpretation of a pro-government legal ruling in 2014 suggests that a lot of this chicanery was simply unnecessary as far as implementing the net worth sweep is concerned because the facts were said to not matter. That being said, if the government would have implemented the net worth sweep before writing down all of the assets then in a liquidation the shareholders might retain some economic value because there wouldn't have been that build up of liquidation preference. One judge presiding over the appeal thinks that the class plaintiff's breach of implied covenant of good faith is fully adequate for relief:
All eyes on Perry. The question is whether or not they can legally take it. If they can, then they will have to pay for it in the Court of Claims. The government's arguments lately look pro-nationalization.
Pagliara's Freddie Ruling May Be Avenged With Fannie
Pagliara filed two suits, one for Fannie and one for Freddie. Even though the Freddie suit got dismissed the Fannie one is alive and well:
Where no authority is cited:
I don't think it gets better than this:
Since the Freddie Mac dismissal heavily relied on Lamberth's ruling it will be interesting to see how the Fannie Mae one goes especially if the Perry Capital Appeals court remands or reverses beforehand.
Summary & Conclusion
Doublespeak is the name of the game in GSE land. The government says they're broken but has had to confiscate over $100B of their cash to break them as well as all their net-worth in perpetuity. Meanwhile shareholders get nothing. Maybe this is simply a situation where people saw the opportunity to step in and take the GSE business model away from the GSEs.
The reality is that the nomenclature 'bailout' applied to the GSEs is less applicable than 'stick-up.' The government injected itself like poison into their capital structure, engaged in highly technical accounting manipulation designed to separate the companies from their prior owners for zero compensation, and has been covering it all up and is saying that no one can stop them. Some judges have agreed with the government's arguments. In fact, because Lamberth issued his opinion dismissing the Perry Capital complaint, the Pratt complaint was copy and paste dismissed. Dismissing the Pagliara one took a turn for the worse and now those arguments are being supplemented into other lawsuits contesting the government's conservatorship actions. Just when things look like they can't get any worse it's worth pointing out that Saxton, Robinson, Perry Appeals, Fairholme's Motion To Compel and possibly Hindes are fully briefed. Let the good times roll.
Disclosure: I am/we are long FMCCH, FMCCP, FMCCT, FMCKI, FMCKO, FMCKP, 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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