Treasury officials Lew and Weiss want to keep taking all the money from Fannie and Freddie for the Federal Government Budget Deficit raising questions regarding the purpose of capital structures.
NCRC, NAACP, LULAC say that the answer does not lie in scrapping Fannie Mae and Freddie Mac. “They can and should be recapitalized; they can and should be fixed.”.
If what Treasury and FHFA have done to equityholders sticks, bondholders and homeowners could be next.
Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) collectively referred to as the GSEs (Government Sponsored Enterprises) are currently in conservatorship run by an independent federal agency called the Federal Housing Finance Agency (FHFA) which is directing their net worth on a quarterly basis to the department of government established to managed government revenue, US Treasury.
Civil Rights Groups Fight For Return Of Fannie And Freddie
According to the National Community Reinvestment Coalition (NCRC) President and CEO John Taylor:
Fannie and Freddie, through their charters, their affordable housing goals and the products they offer, have played a critical role in creating homeownership opportunities and building the middle class in America.
The most sensible path forward for the housing finance system is to recapitalize Fannie and Freddie, take them out of conservatorship, and to build on the reforms of strong supervision and oversight of the Enterprises started in 2008 with the passage of the Housing and Economic Recovery Act.
We anticipate several others in the housing advocacy and lender community will also be expressing similar thoughts about recapitalization and the future of Fannie Mae and Freddie Mac in the coming days.
It sounds like a concerted effort to raise awareness regarding the positive value that the GSEs provide is being coordinated in response to recent statements made by the Obama Administration by Weiss, Lew and Stegman.
With all of the money going to the government, it’s no wonder that the publicly traded preferred and common shares trade as if they are distressed as the probability of them being worthless is in theory a reality. John Carney, for instance, was able to produce an analysis suggesting that the commons are worth less than they can be bought for today. Part of the push for recapitalization push by civil rights organizations is that the warrant shares are assignable:
According to the Counselor to the Secretary of the Treasury for Housing Finance Policy Michael A. Stegman, this is apparently not in line with his public interpretation of available options:
This potentially massive money grab has not been lost on the affordable housing funds:
Investors Fight For Return Of Fannie and Freddie
In the most recent legal filing for the Saxton case in Iowa, the government isn’t even fighting the allegations that what they did was improper:
The IRS definition above was included because it means that what transpired constitutes the creation of a new security based on their own definition at a time when their authority under HERA to do so had expired.
In summary, the government seems to have overstepped its bounds, miscategorized the nature of the third amendment, and there is no distinction between an agency acting unlawfully and an agency acting beyond the scope of its bounds, which in this case are defined by HERA. HERA was passed in 2008 and is the prevailing law governing the conservatorship.
In a new case filed by Robinson in Kentucky, plaintiffs took a step back and brought in a lot of information that was created by three forensic accounting reports alleging that what the government did was in fact illegal (report 1, report 2, report 3):
According to Investors Unite, a group dedicated to the preservation of shareholder rights:
It looked as though FHFA officials could not justify seizing control of Fannie and Freddie without creative accounting.
If you’re curious regarding the chicanery behind the government accounting, this is a good place to start. The good news is that for once this has found its way into legal documents:
Summary and Conclusion
Fannie and Freddie’s profits are regulated by Congress and right now the Federal Housing Finance Agency is in charge of everything and has been working in coordinated fashion with US Treasury since conservatorship began to ensure that if you’re a taxpayer you get nothing but if you’re a tax collector you get everything. As such, when a hostile agency is in charge of determining the mechanics of how this all ends, this is not your normal depressed capital structure situation where you try to buy the top, which in this case is the common shares.
My view is that FHFA unilaterally gets to determine what those are worth and if they change capital requirements enough could leave common shareholders out in the cold. I recommend and only own the preferred shares of Fannie Mae and Freddie Mac because they have fixed liquidation preference and call features as well as dividend rate. The idea is that while the commons can be destroyed the preferred cannot be. After all, preferred is what the government owns. On another level, the government’s argument that whatever FHFA does is beyond the scope of judicial review should be concerning to anyone who owns a home or GSE debt securities because there doesn’t seem to be anything stopping FHFA from moving on down the capital structure and violating debtholder rights and covenants if their actions are truly outside the scope of judicial review. Hint: they are not.
As such, the preferreds are a binary situation where they are either worthless or worth par and right now they trade at roughly 20% of par. The commons, on the other hand, could be worth as much as $47 according to Bill Ackman who expects the warrants to be exercised and the companies to be recapitalized organically. With FHFA in charge I’m afraid that seems a bit optimistic given that the more FHFA takes for the government the less is left for the commons.
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