morningstar

The report feels pretty thin. Some of the content there might be useful politically in pushing for a resolution, but I doubt a court is going to hear much of this - there's a reason most of the litigation surrounds the third amendment and not the initial conservatorship. It's just very hard to credibly argue that Fannie/Freddie did not desperately need help in 2008; this report chooses to ignore completely the financing needs of the GSEs, and yes if we assume that the market would have continued to roll over hundreds of billions per quarter of debt at each GSE through 4Q08 and 1Q09, they were probably fine. But I don't think that was a realistic assumption at the time and I doubt a court is going to second guess the decisions based on those assumptions without very very strong evidence they were not taken in good faith.

To me, a settlement would be damaging and embarrassing to the Obama administration (quite hard to spin an agreement that will ink a collection of HFs billions of dollars - there's basically nothing you can even claim you're getting in return). Meanwhile playing out the appeals string all the way to the Supreme Court probably moves any ultimate resolution well into the next administration. So I don't see a lot of logic to settling, especially since most of the people who could potentially be personally damaged by any revelations (in the sense that prior statements of theirs could be indicated as false) are probably already out of the administration.

Lol, yeah I try very hard to avoid commitment bias. But this main argument of theirs makes no sense at all! The sweep is useless without profits, and with profits the PSPA suffices! The point seemed to be that the combination of paying the coupon and not making any money (therefore requiring continuous additional draws) was eating away at the available support, and the deal effectively provided relief, preserving availability without having to stop paying dividends on their major committed capital instrument. This seems perfectly reasonable. If you're running a financial company you don't want to stop paying dividends on your preferred stock if it's at all avoidable since it's a major sign of weakness and instability.

I rather violently disagree. Frank(lira/deutchmark/etc.) conversion to euros was orderly conversion where nobody expected the converted value to drop through the floor. This is completely not applicable to grexit. If they grexit, of course there will be bank runs. So they have to prepare beforehand without everyone knowing and without tipping their hand. This is almost impossible... On any rumor they'd have a bank run anyway. If you had deposits in euros as a person or a business, would you agree to get your money back in worthless drachmas? The better example would be some LatAm countries that had a peg to dollar (Ecuador? Peru? I can't remember offhand) and then broke it. But even that is not a real comparison, since you had money in local currency and you kinda knew the risk that it would unpeg. E.g. Lithuanian litas was pegged to Euro and you could get very high yields in 2009 in banks since there was a rumor/risk of unpegging - so banks had to pay high yields on litas so that people would not convert to euros (which was the strong currency in this example). In Greek case, people/businesses have money in euros and if they only move it to German bank NOW, they have it in euros forever. So how can government turn this into drachmas without huge blowup? Presumably it happens over a weekend and then, if your deposits are in the bank, they've already turned into new drachmas. If you have cash, you're barred from leaving the country with it and its forcibly converted at any border point. There are only 2 ways for money to leave a country - through the banking system or physically over the border - and the government is probably pretty experienced at controlling both. Your last point I think is already happening - people in Greece are well aware of this and deposit flight, though intermittent, has been happening since 2009, accelerating during periods of stress.

I don't agree (but I am not a lawyer :)). One way is to partially nationalize which would dilute the common to the hilt. It's impossible to dilute preferreds. To make prefs worth less than par, you have to go through formal recap in which case they come before common, but might be worth little and common might be worth nothing. In general though, I think most arguments in this case are emotional or mind-screwing variety from people with ownership agenda (i.e. people holding securities that are possibly worthless will argue anything to prove they are right and other side is wrong). Personally, I am on the government (and Munger/Buffett) side on this: if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity. Legal case might have completely different result though - common sense is not what the law is about. ;) On the other hand, the dividend on these prefs is optional ... So it's possible to grow capital for a very long time, building book value for the common while paying nothing to preferred holders. To your other point, I tend to agree and would worry that even in 2012, there was no private market price for the facility the government was providing. I think there's a pretty good case that financially speaking the 2012 amendment was a bargain. That said, a judge could easily come down on either side on that issue.

The big-coupon, highly liquid issues like that one tend to trade at a meaningful premium (as % of par) to the others. e.g. take FMCCP (~10% of par today) vs. FMCKJ (~13% of par). Some of the difference might be explained by difference in coupon, but I think if you are willing to own the smaller/less liquid issues where institutional investors have a tough time playing, you can get yourself better economics to an ultimate favorable resolution.

The government would also like to avoid any elected official having to sign off on a massive payday for hedge fund investors in Fannie/Freddie - can you imagine a more politically tainted group. So if the government has to lose, all the politicians involved want it to be in the Supreme Court and they want it to be far enough in the future that they can blame the incompetence of the former Bush and Obama administrations.

That might be a good legal argument but it is financially naive. But for emergency financing, the companies would have entered bankruptcy in 2008, potentially Chapter 7 as they would have rapidly run out liquidity to even keep the lights on. You keep talking about 2008, and I can't understand it. If you're a doctor, and you save a person's life, are you then entitled to murder them later? We are talking about what happened in 2012. No one needed emergency funding in 2012. Even in 2012, the companies needed access to billions in capital because they had demonstrated that even if things were starting to turn around, they could easily lose billions more very quickly if the economy turned back to the downside. It wasn't emergency financing, but at the same time it was financing you could only get one place - nobody else was offering the same terms as the government did in the Third Amendment, despite claims in some quarters that the companies were by that time thriving. Necessary capital/financing that has only one provider tends to come on tough terms.

@merkhet I think your view is very dependent on a belief that by the time the Third Amendment rolled around, the agencies were seen as long-term profitable and a piggy bank that could be tapped. And that Treasury was basically operating with this agenda, and that FHFA was complicit (or simply lacked any effective independence). If discovery turns up documents indicating that was the case, Fairholme and Perry have a real shot with this investment but I'm skeptical that will happen. It's not as if people were clamouring down the door to make investments in Fannie/Freddie at that time and the government used its control of the company to shut them out. We'd be having a different conversation if in 2012 Berkowitz had gone to the FHFA and said, hey I have $200bn handy and can provide better terms than the Treasury just gave you - lets do a deal. But in practice, the FHFA was managing 2 entities that had one critical funding partner, looked quite likely to need lots of capital from that partner in the future considering the shakiness of the economic recovery (which capital the market might not provide on any terms, the lesson of 2008), and whose businesses were basically 100% dependent on the credit ratings the garnered from that relationship. In that view the Third Amendment could be a pretty reasonable measure to support the long-term solvency of the entities and their continued operation. Again, I'm skeptical you can show in court this wasn't a perfectly reasonable deal for FHFA to take on behalf of the agencies - but the long shot makes more sense as an 8x bagger than when it was trading above 50% of par.

I don't see where there are excess funds pooling ... the Amendment would seem to prevent exactly this from happening, as all excess funding (i.e. generated capital in excess of the amount provided by the senior preferred) is paid out as a dividend. If the company enters a liquidation phase, the government preferred should roughly be made whole and the other equity instruments would recover nothing. I also dispute the idea that private capital would be wary of what happened with Freddie/Fannie and view the government as a bad actor or suspect partner. The GSEs weren't in temporary trouble, they were kaput, and I think the broad global investor based acknowledges this. It's great for Fairholme/Perry if they can make a buck here but if/as they lose in court, I don't think much of the global investors base will view this as an abridgement of capitalism or a shift in the rules. For instance, what happened to bond investors in GM and Chrysler was much more severe, unfair, and coercive, and people seem plenty willing to invest in auto companies.

Good luck doing that without at least some sort of financial backstop. Private markets will essentially perform an adverse selection issue for insurance -- the healthiest borrowers will get mortgages and everyone else will get nothing. I mean just look at how stringent the loan requirements are right now to get a mortgage. Pristine credit. Nothing else will do. This administration literally just went over this with the Affordable Care Act. Same concept. In reverse. This problem will be addressed more in the choice of the next AG and less in how the GSEs are treated. There's no lack of private capital ready to enter the mortgage market - existing portfolios have been bid up to monster levels, there is huge demand across all forms of ABS driven by the Fed's liquidity. Do you really believe we can do $100bn in CLOs and not $1tn in RMBS? Especially if gov't backstops on senior tranches lower their cost. The problems are not on the demand side but on the supply and origination sides - demand is weak because borrowers are already overleveraged and the job market remains thin, and origination is not functioning properly because the administration has put the banks in a position where a sold loan that goes bad - where you made a few hundred bps gain on sale - can create more than its face value in eventual losses. With lawsuits, the CFPB, the QM rules, etc. they have made originating any but the cleanest loans unappealing - even if the bank would love to own the loan once issued. Those restrictions have left the mortgage market still tight while all other forms of credit are back to the 2007 peak. It has little to do with how the GSEs continue to operate, in my view. I think mortgage market would function fine if we remain in the status quo, with Fannie/Freddie continuing to operate and effectively nationalized, and I think the market would adapt fine and probably quite eagerly to the Corker/Warner proposal. That said, any proposal involving private capital, while easy to fund now at the peak of the market, will be much more cyclical than the pure GSE model. Not clear to me if this is a big problem when you consider the availability of other cycle-dampening measures including a much more aggressive Fed.

What discount rate do you think the U.S. government should use? Bringing forward those earning replaces borrowing at 2-odd percent a year. Where's the logic in selling at just a five percent earnings yield? To say nothing of the fact that the net sweep produces more money than their share of common earnings, by a large margin.

There's also a factor that more of the revenue stream will likely accrue to Gross personally, to the extent that he can draw away the assets he had managed at PIMCO. But I think the bigger reality is that tons of assets will go elsewhere - if you're an institution with a PIMCO managed separate account, you want to flee the uncertainty of PIMCO but you also can't credibly take the money to an upstart manager with little real track record in fixed income, even if it has a big name attached. So a lot of that money will wind up with other established credit managers ... BLK has added more than $1bn in market cap today.

AmEx seems built on its affiliation with high value customers, who it attracts by offering them a better rewards/benefits package than competing cards. If you are a frequent pleasure traveller, the platinum card is a pretty hard to beat value despite the fee - not hard to save thousands of dollars/year with it. Hotels and airlines also want these same self-selected customers, who are high spenders, which helps AmEx negotiate the deals. Amex also solidifies its travel provider relationships by controlling one of the two largest corporate travel agencies. Outside of travel, not sure that AmEx's offering is particularly exceptional but that one core advantage has allowed them to build up their brand as the "prestige" card issuer.

In scenario A, worth pointing out the lower coupon older prefereds should still trade well below par for the foreseeable future, maybe forever. For instance if WFC 6% fixed-for-life prefs trade below par (rated investment grade, paying), so will these most likely, even 7 years hence. Especially if rates actually ever move wider. That said, the higher coupons are the much bigger and liquid issues.

I'm not totally convinced that high yield is overpriced, and Chou describes it as fair valued in his letter. Nor does CDX.HY (the sole position of this ETF) seem unusually cheap in a technical sense. The discount of the index to the constituent CDS contracts is pretty close to zero and the basis between cash bonds and CDS is also in its normal range. So I'm guessing Chou would say CDX.HY is fair valued as well. Chou's letter seems to talk about CDS on US Treasuries but that's a more esoteric product which is sentiment driven (similar to VIX in that the relationship to actual underlying economic activity is not very clear) - I don't think CDS on high yield bonds is an analogous position.

A shareholder can certainly do this to enhance their returns, but it's not their job in the traditional understanding of the company-investor relationship nor are the majority of shareholders approaching the market in that way. It also doesn't have any impact on the company's responsibility to maximize value for continuing shareholders ... which isn't enhanced by buying back overvalued stock ... any more than it would be enhanced by purchasing overvalued stock of another, different company.

You are keeping your personal ownership unchanged, by selling some stock, but those continuing shares represent a higher ownership of the company and there's nothing investors can do about it. The company also has an obligation to the continuing investor underlying the shares you sold - that's what's missing in your account. How did increasing that share's ownership of the company, if at a bad price, aid in maximizing its value? Perhaps my terminology is unclear - the continuing investor isn't the individual, its just the share that's remaining outstanding into the future. A share is issued once by the company and eventually may be bought back - through that lifetime, the company's goal is to maximize the value of that share. It may have one or many investors as it changes hands in the secondary market, but that's irrelevant to the company.

Yes, there would certainly be a difference unless your costs basis is zero. Example... I buy BAC at $15 -- that's my cost basis. dividend: they pay a $1 dividend. I pay 33% tax on that dividend. I'm left with 67 cents on the dollar. repurchase: Management decides to repurchase $1 of stock for $15. I sell an offsetting amount of shares at $15 price point (same as my cost basis). I'm left with $1 in cash. No taxes whatsoever! I have roughly 50% more cash. With the difference that in case 1 you're left with a stock price of $14. Okay, now (to fix both cases in my example) you could also comment on case 2 where you would also arrive at a total value of $15. You fixed the first case but not the second. Were you to fix both, you'd have $15 left in both scenarios, but after paying taxes in case 1 you'd only have $14.67. So it's $14.67 vs $15? I'll take $15 every time. Meaning... every time. Don't care where the stock is trading, I just want more money every time. You are assuming a sale of stock by an investor, which is irrelevant to management's decision making. From management's perspective, share transactions only matter when they are with the company - when shares are issued, and when shares are bought back and cancelled. Otherwise, there is a shareholder and it's the company's job to maximize value for him. So here's BAC's perspective. Say they' start with 10 billion shares out - you have two options. (1) Buy back 1 billion shares. My duty in this scenario is to my continuing 9 billion shareholders and I'm giving them each an extra stake in the company - a REINVESTMENT of continuing shareholder capital. (2) Dividend equivalent cash. I still have 10 billion continuing shareholders and I've RETURNED their capital that I couldn't use. Either my continuing shareholder has their stake + cash, or an increased stake. Clearly, if BAC is overvalued, my continuing shareholder should prefer the return of cash. The key is, from BAC's perspective its shareholders CANNOT SELL stock except to the company - they can change identity, but they continue to exist. In short, the only way continuing shareholders can get cash out of a company is through dividends.

I think buybacks are one of those concepts that work well in theory but tend to be far more destructive in practice. The reality is that most companies at any given time are not undervalued and that most people (including investors and company management) can't tell an undervalued company from an overvalued one with any reliability. For instance, one sees a lot of people demanding buybacks from Bank of America, a company that historically has destroyed tens of billions in capital through share repurchases - very few of which were opposed by investors to any meaningful extent. Meanwhile, it's unavoidable that buybacks will be pro-cyclical, especially for banks whose capital return will be curtailed in times of market weakness.

muscleman - Puerto Rico an interesting idea that I've done some work on. My concern with PRHTA is that eventually, Puerto Rico is probably going to need to restructure some debt and it seems clear now that the first debt to be targeted will be the corporation debt. Then, if they've decided to go after corporation debt, why not throw PRHTA in the mix? Why keep paying interest to investors that could go to preserve the PR economy ... I feel like your analysis focuses on the idea PRHTA will be allowed to act as an independent entity with its own cash flows and balance sheet. But in practice I think PR might choose to just cast it in with the rest of the dirty laundry. Once they pull the trigger on restructuring debt, they know that the impact on their economy will be severe, so they are forced to eliminate as much debt as possible in the first cut. (Unless they get the Greece scenario of getting a bailout from the US, but that seems unlikely right now.) Picasso - what are your thoughts on the lower dollar price GOs compared to the 8s, the ones already trading in the 60s? Do you believe the previous GO issues will face steeper haircuts?

It would probably not be too useful for RFP considering they don't have taxable income in the US these days and have huge tax shields still available should that change in the future. It's more appealing to the big corrugated container players who are paying taxes today.

There are various aggregation products out there that assemble data from trustee reports ... e.g. http://clo-i.com/cloiHome ... if you are just interested in one specific issuer as a one time question, sellsiders could probably help you out as well as their CLO trading desks will be subscribers to a service like that one. That said, if an instrument is so thoroughly put away that your sell-side coverage has had no luck soliciting an offer with your bid in hand, I am not sure how much use this will be.

In this environment it would probably be easy enough to find investors for the equity tranches. Look at the absolute thirst for CLO paper of all seniorities. MBS structured in the way proposed here would need less equity than a CLO and offer much better cash arbitrage - the senior paper would likely be very, very cheap as the credit risk is pretty benign and the funding would be better than under the current system (e.g. for banks, Ginnie Mae's actual guarantees are meaningfully more useful than Fannie/Freddie quasi-guarantees). It's probably easy to get a modelled IRR of 15% for the equity - seems like it would be possible to eventually get to the $500bn market size you'd need for that.

I have to say that in my experience if I want to trade a bond that is liquid in the institutional market, I can also buy it via Fidelity close to the market (which might still be a 2% spread). The problem is that 95% of bonds are not liquid in the institutional market - if you want to buy a million you can get a broker to hunt for offers, but if you want to buy $20k you are just out of luck most likely on those issues.