onyx1

A bombshell indeed. The government's entire case is starting to unravel from many sides. In addition to the obvious lack of FHFA independence, and failure to disclose key documents (I bet there will be more), there is an additional angle: One of the reasons the DOJ gave for declaring documents as "privileged" was that any disclosure of discussions about the fate of the GSE would create "chaos" in the world financial markets. Now that this discussion paper has been released and, of course, no "chaos" has been observed, the entire privilege argument begins to fall away.

If intellectuals didn't have an impending crisis to warn us about, they would live out their entire lives in obscurity.

Thanks for sharing Merkhet!

Maybe we can use this common sense logic toward deficit reduction. A small business gets hit by lightening, the fire department saves the business, clearly the municipality should have nearly 100% ownership of the business based on the fact that without the fire dept. the business would have gone BK, right? Or, a policeman saves a hostage that would have been killed, the municipality should have the benefit of all the assets and future earnings of the hostage, right? Or even better, a terrorist plot is foiled by the FBI that would have ruined an entire town, jackpot! The government now owns the town! Who needs property rights when the beneficiary is the taxpayers, right?

Thanks for the update merkhet

I agree the Republicans are giving Watt all the ammo he needs, and more, to declare an end to the conservatorship. Watt is also on record now saying the GSEs are "stabilized". That alone is justification enough for him to return the GSEs back to shareholders and recapitalize. Either the Dems don't have a clue of what is going on, or they do and are avoiding entirely the opportunity to object to the errors and inconsistencies in the Republican statements such as "GSE haven't paid back the taxpayers", or Royce's assertion that the Housing Trust fund payments are bad for the capitalization of the GSE (but the alternative of sending the same money to the UST is somehow better?) I think the Democrats DO have a clue. If your opponent is well on his way to hanging himself, you should not get in the way -- let the Republicans get on a roll and hand them more rope. :) If they do, then they are doing a great job coordinating their strategy.

I agree the Republicans are giving Watt all the ammo he needs, and more, to declare an end to the conservatorship. Watt is also on record now saying the GSEs are "stabilized". That alone is justification enough for him to return the GSEs back to shareholders and recapitalize. Either the Dems don't have a clue of what is going on, or they do and are avoiding entirely the opportunity to object to the errors and inconsistencies in the Republican statements such as "GSE haven't paid back the taxpayers", or Royce's assertion that the Housing Trust fund payments are bad for the capitalization of the GSE (but the alternative of sending the same money to the UST is somehow better?) Merket - I'd really appreciate any observations you can offer from tomorrows conference.

To see a video of yesterday's oral argument for the motion to dismiss in the Continental Western Case, go here: http://www.uscourts.gov/Multimedia/Cameras/SouthernDistrictofIowa.aspx

I don't know if it makes any difference, but it is worth noting that Berkeley and their subs have owned Jr preferred shares since the early 2000's.

Looks like information is leaking out about what we suspected all along. Namely that the UST (and WH) are the puppeteers and the FHFA is the puppet. I hope the leaker is in touch with Cooper & Kirk lawyers. Evidence of outside control of FHFA duties is a so damaging to the government's legal case, and potentially so embarrassing to the politicians, that I wonder if the FHFA (with encouragement from their puppeteers of course) will come to the politically-expedient conclusion that the best course of action is to release the GSEs and end the discovery process.

No, you're not being bitchy but it's pretty clear you don't understand. I will help you here. I could give you a long winded explanation, but instead I will go a step further. There are several truisms in the investing world that the sooner you commit to memory, the easier your investing will be. If after reading through these and digesting them you still don't understand please let me know and I will discuss further. In no particular order, here they are: 1. Any decision by Buffett is correct. 2. Any statement by Buffett or Munger is witty, profound and embedded with the truth of the universe. 3. Fairfax will compound book value at 15% a year. 4. Any time the market falls more than 0.1% Fairfax's hedges are proven correct. 5. Eddie is a genius and the more his decisions are incomprehensible to the average person, the more genius they are. 6. Eddie is a kick ass capital allocator and, thus, his capital allocation decisions are kick ass. Hope this helps. Classic!

Plaintiffs Brief in Opposition to Defendants Motion to Dismiss, USDC Iowa, attached. Continental Western's reply to UST's filing of Lamberth decision to Iowa court "On the Perry court’s understanding of Section 4617(f), then, FHFA need not offer any rehabilitative rationale for its actions or otherwise even pretend to pursue the traditional goals and actions of a conservator to avail itself of immunity from suit. So long as Fannie and Freddie continue to operate profitably, FHFA is free to give all of the Companies’ assets to anyone, for any reason. Congress surely did not intend Section 4617(f) to bring about such absurd results." 49-1.pdf

http://www.bloomberg.com/news/2014-10-02/you-know-it-s-a-tough-market-when-ben-bernanke-can-t-refinance.html “I think it’s entirely possible” that lenders “may have gone a little bit too far on mortgage credit conditions,” he said.

I'm left wondering if he has left the door open, or as least provided a strong hint, to plaintiffs to challenge HERA, in its entirety, on constitutional grounds.

Well done Merket! In reading Carney's responses to your tweets, I get the feeling he is in contact with Gov't attorneys. His arguments seem circular and inconsistent. Journalists frequently get intoxicated from direct access to power and he likely understands that his continued access is dependent on the reporting of information that reflects favorably on his sources. Either way, your arguments are both consistent and well reasoned. You got your moneys worth from law school!

Skeptical about the way this book was promoted by Gates, I took a shot and ordered it anyway. I finished it last night. Bill, if you are reading this, I am sorry for being cynical. This is one of the best books I have ever read about business. Sure, the book won't show readers a path to riches, and the subject matter (insider trading, stockholder meetings, intellectual property, business successes, business failures) may, at first glance, leave one wondering: Why bother, haven't I read enough about these subjects? What makes this book so rewarding is that in addition to taking readers on a chronological path through each true story, Brooks, at the same time, delves so richly into the people involved that instead of reading it, I often felt like I was living it. A fascinating set of stories where human nature plays a key role, and how greed, envy, luck, and incentives combine for dramatic outcomes. A classic book that will still be relevant in another 50 years.

What Happens if the Government Loses... http://www.forbes.com/sites/richardepstein/2014/09/10/what-happens-if-the-government-loses-on-the-third-amendment-the-senior-preferred-stock-certificates-spell-nothing-but-trouble-for-the-government/ This is the first cogent explanation I have read on how & why the senior preferred would likely be retired in the event UST was forced to return 3rd Amendment excess distributions. The longer the government delays, Epstein argues, the better off private shareholders will fare in the event of a favorable ruling as at some point 3rd Amendment dollars returned will exceed that required to retire all senior preferred plus coupon interest. The excess dollars would have to be deemed capital, making it harder for FHFA to justify not retiring the senior preferred as allowed under Sections 3 & 4 of the senior preferred stock certificates.

To the extent gross negligence is a part of breaching fiduciary duty, we'll get an answer to that question when Judge Sweeney gives us a ruling. Sooner the better.

Huh? There is no set time limit on declaring a receivership. HERA not only gives the option to FHFA to declare a receivership if, in the Directors opinion, it appears that assets < liabilities or the enterprise will not be able to meet its obligation when they come due, but requires the appointment of a receiver if the Director determines that for any period of 60 days assets < liabilities. The accounting standard is not specified so there is wide latitude for interpretation and misuse. Note also that a receiver can be appointed even if current cash and payment obligations are being met.

I thought capital requirements for the GSEs were set by statute in 12 USC 4612: "For purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of— (1) 2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles..." As of 6-31-14, FNMA had total assets of $3,218 B and equity of $6.1 B or less than .2%. But with the remaining credit line from Treasury under the SPSA ( about $83 B), one could argue under sec. 4502 (23) that FNMA has total capital of $89 B available under conservatorship or 2.76% which meets the statutory minimum. Note that FNMA had cap ratios of 4.66%, 4.92%, and 4.98% before the crisis for YE 2005-07. There are very few certainties in life, but incrementally higher required capital levels on the GSEs if they were to emerge from a conservatorship could be one of them; then throw in a SIFI buffer and stress tests on top of all that. This, or the potential of it, would weigh on any historically-based market multiple. A bad scenario indeed, and with the gov't anything is possible. But they had a chance to do this in 2008 and choose not to (and they are paying the price for it in terms of this litigation). One of the reasons they avoided it in 2008 was so as not to throw a wrench into the agency MBS market which operates with a slightly less than government guarantee. There are trillions ($5? currently, I don't know the exact number) of these securities in hands all over the world and a receivership would crater the world financial markets overnight; (FHFA head Mel Watt is currently under oath that a mere disclosure of discussions about the future of the GSEs would throw the world into financial crisis). The only way to avoid the chaos is to declare all agency MBS fully guaranteed by the US gov't (like GNMA). The problem for the UST is that all that debt would be placed on the US gov't balance sheet raising the debt levels from $17 trillion to $22 overnight. There would be heavy credit and political prices to pay for this avoidable action and in the end the logical political calculus would likely be that it is not worth the $80 billion when your legacy is at stake.

Thesis summary Buy FNMA common at $4.00 because: 1. Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury. 2. He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst). 3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit. (Note: Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A. (Note: FHFA did compile an administrative record at the time of the 1A and 2A.) 4. Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question. 5. Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding. 6. The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain. My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely. But wouldn't steps 4 and 5 be a given if the sweep is vacated? Why would the judge rule that it's illegal but not compensate the shareholders for $80 billion in excess dividends. Also, correct me if I'm wrong, but step 6 only seems to value the shares based on the returned $68 billion, but not on any future earnings power. My back of the envelope calculation indicates that the common would be worth 4x, or 300% more if the 3A was revoked, and the Jr. Pfds were paid off at par. I based it by annualizing 2Q profits: 1) Net income of $3.7 billion x 4 = $14.7 billion. 2) Back out the $81 billion in excess dividends, arrive at a Sr. liquidation preference of $36 billion. 10% dividend on this is $3.6 billion. 3) $14.7 - $3.6 billion = $11.1 billion 4) EPS = $11.1/5,762 = $1.92. 10x multiple = $19.25. 5) Jr. Pfd of $19.1 billion/5,762 = $3.32/share 6) Common value = $19.25 - $3.32 = ~$16 per share. 7) $16/4 = 4x return vs. the 2.5x return of the Jr. Pfds. You are not wrong. There is additional upside to the common based on a market multiple of, say, annualized 2Q earnings which appear to be somewhat normalized. However, the market will likely enforce a large discount due to a number of looming outside events such as timing of housing reform, emergence out of conservatorship, and potential dilution from refinancing of the UST preferred. The biggest headwind to a market multiple, in my opinion, will come from that which we saw at BAC which is the need to rebuild capital. The scenario above leaves the GSEs without any capital at all. Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty.

Yes. The gov't claims that the sweep was intended to calm "fears" in the market that the GSEs would enter into "death spiral" where gov't support capacity would eventually end because up until returning to profitability, the GSEs needed to draw from the Treasury's credit line and then immediately pay that money back to the Treasury in the form of a 10% dividend. This doesn't pass muster on many levels. Leaving aside the fact that GSEs debt showed no evidence of this "fear", the gov't preferred had a PIK option at 12% that could have been utilized if credit capacity ever became an issue. Furthermore, and more significantly for the legal case, this was an after-the-fact justification for the sweep. The courts afford great deference to federal agencies actions as long as they can show they acted reasonable. In order to show reasonableness, the agencies are required to compile an administrative record prior to taking action to demonstrate to an outside reviewer that they deliberated and considered alternative actions. This is a strict requirement of the APA and the initial burden of compilation falls on the agency. But once complete, an administrative record usually provides a tremendous shield against wronged parties claiming that the agency acted in an arbitrary manner. Will a court find that the FHFA acted reasonable? The answer is likely no. Why? Because the FHFA failed to compile an administrative record and admits to this failure. This alone is justification for vacating the sweep. See Perry Injunction for more details 13-1053. HERA prohibits the FHFA from taking direction from any other agency. The 2010 Treasury memo is a smoking gun in many respects. The Ackman suit just filed (14-1404) shows a timeline of statements by FHFA officials from the beginning of the conservatorship in 2008 to present. For years, FHFA officials asserted its duty to conserving the assets of the GSEs. But in 2012, out of nowhere, FHFA asserted their duty was now to protect taxpayers and wind down the GSEs. Enter the sweep. This is wholly inconsistent with the purpose of a conservatorship, and is strong circumstantial evidence (now subject to a discovery action in the Fairholme suit 13-465) that Treasury was calling the shots at the FHFA. Evidence that Treasury directed the sweep and benefited itself by taking all the GSE capital is game over for the gov't and a win for shareholders since the 5th Amendment to the US Constitution demands compensation for those whose property was taken. More details can be found in Fairholme 13-465. Although this tread is interesting as the thesis has morphed over the years from a capital structure arbitrage to a levered bet on a small housing recover to a legal case with many dimensions, your time is best spent on the court cases and the replies. Keep in mind that there are two claims: The Federal Court of Claims cases deal with seeking compensation for taking of property under the 5th Amendment. The Fairholme case here is in the discovery phase and will take a long time to come to a conclusion. The District Courts cases deal with the the violations of the well established Administrative Proceedures Act (APA) that if successful would allow an immediate vacation of the sweep and send the excess sweep money back to the GSEs. This is the Perry Injunction suit.

Thesis summary Buy FNMA common at $4.00 because: 1. Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury. 2. He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst). 3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit. (Note: Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A. (Note: FHFA did compile an administrative record at the time of the 1A and 2A.) 4. Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question. 5. Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding. 6. The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain. My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely. In my opinion, the common thesis of 7x - 10x return rests in the fact that the government is doing the taxpayer an incredible disservice by not exercising its warrants and unlocking that value to the American taxpayer. Any future reform can include the existing common as it stands as opposed to wiping it out and starting over, effectively costing the taxpayer over $150 billion. I think logical heads in the Treasury/FHFA/government will eventually prevail and realize the value the taxpayer would sacrifice. The 7x-10x is certainly within the realm of plausible. But consider all that would need to happen: Prevailing powers in DC need to agree that the GSEs should be saved and then agreed to act on it, GSEs fees would need to be raised (Ackman suggests 60-100bp), and then the market would need to apply a 15x multiple to GSE earnings. Whew! How can anyone put a time frame on it?

Thesis summary Buy FNMA common at $4.00 because: 1. Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury. 2. He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst). 3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit. (Note: Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A. (Note: FHFA did compile an administrative record at the time of the 1A and 2A.) 4. Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question. 5. Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding. 6. The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain. My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely.

The simple reason is this: It's not a clear cut open and shut case. The only way to get your arms around the investment thesis is to take the first step and read each claim and response. If you don't have a PACER account you can find them at timhoward717.com. No one is going to spoon feed you bullet points.