FNMA and FMCC preferreds. In search of the elusive 10 bagger.

[constructive]

If the value of shares was $0 in 2008-2011, why should it not be $0 in 2012 and beyond?

 

Can you expand on that a little bit? There are many ways to go with what you're saying, and I just want to make sure that I'm understanding your point.

 

Why was the value of the shares $0? Because there were losses at one point in time? Because there was negative equity at one point in time?

 

Just trying to figure out what you're saying.

 

The value of shares was $0 because the financial condition of the company, including the cost of government financing, prevented any reasonable expectation of returns for shareholders.

 

I realize that sounds circular, but it all flows from the validity of the financing.

 

 

One last comment, FHFA has successfully put the company in sound and solvent condition. This has involved putting the public shareholders in clearly unsound condition. The company is not the shareholders.

[merkhet]

I see what you mean now. I mean, I clearly disagree, but I understand what you mean.

 

I suspect that if what you say is true, then there was no point to continue letting the shares trade. Unless these are trading sardines, of course. :)

[abitofvalue]

I see what you mean now. I mean, I clearly disagree, but I understand what you mean.

 

I suspect that if what you say is true, then there was no point to continue letting the shares trade. Unless these are trading sardines, of course. :)

 

I suspect the only reason the shares kept trading is that no one thought about it (i.e. oversight).  It's similar to what happened with GM - iirc a few weeks after it was well known GM was going bankrupt, the shares continued trading and actually increased in value - at which time there were press releases and comments about how the equity was worthless and going to be cancelled etc..  With fannie / freddie, there was less press about the shares continuing to trade and essentially they just kind of hung around <$2 till BB started making noises.  I am guessing that when treasury realized that they had the issue of shareholders getting dividends in the near future, they put the sweep in to avoid the political cost of rewards the same owners that had driven the company into the ground.

[morningstar]

In other words, but for the Sweep, the companies would have built a combined amount of capital equal to about $188 billion

 

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.

[deadspace]

I see what you mean now. I mean, I clearly disagree, but I understand what you mean.

 

I suspect that if what you say is true, then there was no point to continue letting the shares trade. Unless these are trading sardines, of course. :)

 

I suspect the only reason the shares kept trading is that no one thought about it (i.e. oversight).  It's similar to what happened with GM - iirc a few weeks after it was well known GM was going bankrupt, the shares continued trading and actually increased in value - at which time there were press releases and comments about how the equity was worthless and going to be cancelled etc..  With fannie / freddie, there was less press about the shares continuing to trade and essentially they just kind of hung around <$2 till BB started making noises.  I am guessing that when treasury realized that they had the issue of shareholders getting dividends in the near future, they put the sweep in to avoid the political cost of rewards the same owners that had driven the company into the ground.

 

 

That is NOT the reason the shares trade -- this was no oversight !!

You need to be clear as to why the shares still exist because it speaks to how crazy what the government is trying to do actually is here

 

The government does not want all the mortgages of FANNIE/FREDDIE listed as US debt  == they want to own the assets but NOT the liabilities

Remember this is the reason FANNIE MAE was sold to the public in the first place  The US had too much debt from the Vietnam war on their books and were hitting their debt ceilings

 

WHat this system allows the government is to have all the assets and cash but show that the liabilities are with the public corporation and need not be accounted for as US government liabilities

 

night is day and black is white  - we are truly falling down the rabbit hole.....

 

[merkhet]

A few weeks (GM) versus a few years (F&F) is pretty different.

[fareastwarriors]

Fannie-Freddie Case Shows Messy Nature of Deal-Making in a Panic

 

 

http://dealbook.nytimes.com/2014/10/02/fannie-freddie-case-shows-messy-nature-of-deal-making-in-a-panic/?_php=true&_type=blogs&ref=business&_r=0

[colinwalt]

Fannie-Freddie Case Shows Messy Nature of Deal-Making in a Panic

 

 

http://dealbook.nytimes.com/2014/10/02/fannie-freddie-case-shows-messy-nature-of-deal-making-in-a-panic/?_php=true&_type=blogs&ref=business&_r=0

 

The authors reference a much longer related article they wrote:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2480835

 

Warning: It's long, 54 pages...

 

Overall, they argue that shareholders seem to have a case, but feel that any compensation should be based on the value of the shares / preferreds at the time the 3rd amendment was enacted... - they are worried about speculators / hedge funds making out like bandits...

 

P45:

"In other words, what would be the price that Fannie or Freddie would have to pay to purchase the remaining stub at this time?"

 

Not sure what the implications of this are? If there had been a share buyback at the time and holders had voluntarily sold, fair enough, but if you were holding at the time, with no plans to sell at the then prevailing prices because you could see the start of the return to profitability and then, the 3rd amendment was enacted, essentially pulling the rug out from under you, is it then fair to compensate you now at the then prevailing prices?

 

And what does it mean in terms of fair compensation, if you've bought since? So even though you've seen billions taken due to the third amendment and valued the securities based on getting compensated for that - hard luck, even though you win the case, you can't value the securities you are holding based on the earnings that have been "taken"?

 

And if the 3rd amendment sweep is considered a "taking" then the money has to be returned - correct?  How could we end up with the Government losing, and getting off by essentially just having to retroactively "pseudo-buy-out" (if that makes sense?) the current security holders at the Aug 2012 prevailing prices (which I think seems to be the logical conclusion of what they propose) and, at the same time, the Government gets to keep all the profits swept since then?

[merkhet]

I read that a while back. In my opinion, the main defect in their reasoning stems from the application of the entire fairness test, which is a two-pronged test that requires:

 

(1) fair dealing, and

(2) fair price

 

The first prong usually requires that there was an arm's length transaction, which I'm not sure that the government can prove in the case of the Third Amendment. Specifically, it's difficult to use the stock price of the deal at the time, as you point out, given that it was trading at a depressed multiple of the earnings power of the companies.

 

If the Third Amendment is a "Taking" then the government must pay you for what it "took." That would be the key consideration -- and the question would then turn on whether they use stock price or if they use liquidation price -- which turns on whether there was a de facto liquidation.

 

If you think about it, they have basically "liquidated" the equity of the company over five years (Net Worth Sweep and Capital Erosion from 2013 to 2017) and are in the process of running off the portfolio. (Usually, it's the other way around.)

 

My sense is that what they "took" was the natural evolution of things as you wound down the company. Of course, I own preferreds, so I'm possibly biased in this regard.

[merkhet]

So I re-read the Continental Western response to the Motion to Dismiss in the Iowa District. This will be the next catalyst, up or down, for the companies.

 

In this particular case, Treasury & FHFA moved for on a Motion to Dismiss on a facial challenge, which means that the Court takes, for the purposes of a motion to dismiss, the factual allegations made by Continental Western as true. Meaning that (1) FHFA acted arbitrarily and/or illegally and (2) FHFA was acting at the behest of Treasury.

 

The upcoming order should rest heavily on whether HERA's 4617(f) claim bars any and all claims against FHFA and Treasury and/or that no one has standing to sue based on actions originating from HERA, as Judge Lamberth's opinion so audaciously states.

 

I personally think that this has a good case of going our way, but, as has been my common disclaimer at this point, I thought that about the Perry case too.

2014-08-29_Continental_Response_to_Defendants_Motions_to_Dismiss.pdf

[colinwalt]

So I re-read the Continental Western response to the Motion to Dismiss in the Iowa District. This will be the next catalyst, up or down, for the companies.

 

In this particular case, Treasury & FHFA moved for on a Motion to Dismiss on a facial challenge, which means that the Court takes, for the purposes of a motion to dismiss, the factual allegations made by Continental Western as true. Meaning that (1) FHFA acted arbitrarily and/or illegally and (2) FHFA was acting at the behest of Treasury.

 

The upcoming order should rest heavily on whether HERA's 4617(f) claim bars any and all claims against FHFA and Treasury and/or that no one has standing to sue based on actions originating from HERA, as Judge Lamberth's opinion so audaciously states.

 

I personally think that this has a good case of going our way, but, as has been my common disclaimer at this point, I thought that about the Perry case too.

 

Thanks Merkhet, I'm not a lawyer, but it seems to be very well argued... having said that, the issues involved are pretty complex to say the least - but in the end it seems to keep on coming back to the fact that the Government does seem to have arbitrarily taken a whole bunch of money that it shouldn't have and given that this is not Russia or Venezuelan etc, you'd think the shareholders should eventually win...

 

And as you noted in an earlier post:

 

"Given that there's a win for all constituencies out there (either releasing Fannie & Freddie or Berkowitz's restructuring plan), I'm just at a loss as to what's taking so long."

 

Now I haven't run the numbers, but presumably the Treasury would actually get a similar or even better return if it let F&F retain profits and build capital. Given that they legally own 80% of the companies, by losing the case (and returning the swept profits) they'd probably (over time) end up in a better position due to the multiple they'd get on the current share price + dividends – after all F&F as a pair of profitable on-going concerns must (by definition) be more valuable than if liquidated – or am I missing something obvious here?

 

And, if true, that begs the question as to why the sweep was implemented in the first place – just to screw “Hedge Funds / Speculators”? – (assuming one doesn’t believe the “official” reasons put forward so far).

[Mephistopheles]

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

[deadspace]

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

 

The fact still remains that if the government wants the whole company how do they deal with holding the liabilities on the government balance sheet without triggering their debt ceilings.  They need the zombie shareholders to continue this schizophrenic charade    this is unsustainable....

[Mephistopheles]

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

 

The fact still remains that if the government wants the whole company how do they deal with holding the liabilities on the government balance sheet without triggering their debt ceilings.  They need the zombie shareholders to continue this schizophrenic charade    this is unsustainable....

 

So what happens if shareholders lose all the cases? Someone would still have to own the 20.1% stake at the end, and it doesn't have to be the Government. Can't they simply not do anything and continue collecting the profits ad infinitum?

[plato1976]

pardon me, just begin to look into F&F

A naive question, if the gov wins these lawsuits, will these pref go to zero? or there will still be a floor price and floor value left?

 

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

[merkhet]

If the shareholders lose all the cases, the result would then be that F&F remain under the control of the government.

 

However, that creates some problems:

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/fnma-and-fmcc-preferreds-in-search-of-the-elusive-10-bagger/msg191161/#msg191161

 

Unless you believe that the equilibrium position of the mortgage housing market is perpetual nationalized mortgage insurance, then they'll have to deal with the private shareholders at some point.

 

I believe that this is what Berkowitz saw when he started to purchase the preferreds.

[Mephistopheles]

If the shareholders lose all the cases, the result would then be that F&F remain under the control of the government.

 

However, that creates some problems:

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/fnma-and-fmcc-preferreds-in-search-of-the-elusive-10-bagger/msg191161/#msg191161

 

Unless you believe that the equilibrium position of the mortgage housing market is perpetual nationalized mortgage insurance, then they'll have to deal with the private shareholders at some point.

 

I believe that this is what Berkowitz saw when he started to purchase the preferreds.

 

Just quoting you here to make it easier:

 

"(1) Can Fannie & Freddie continue to provide their services as a nationalized entity?

 

Well, sure, but that means that there's no probably no shot of private capital coming in to fill the hole. Think about it this way, if I'm a bank, do I want to own F&F securitized loans with the, at this point, explicit backing of the federal government? Or do I want to own Private JoeCo securitized loans? I'm probably going to want to own the F&F securitized loans -- and the only way that JoeCo can compete is by doing what insurance companies do -- under-reserving and/or pricing incorrectly."

 

This is what I'm afraid of. Shareholders lose all cases. And yes, private capital won't come in, but does it need to? F+F would be effectively nationalized, Govt will secure massive profits for the rest of eternity, it'll help their budget issues, and they'll technically only own 79.9% so no need to place the debt on the balance sheet. So in this case perpetual nationalized mortgage insurance would work, right?

 

[Mephistopheles]

pardon me, just begin to look into F&F

A naive question, if the gov wins these lawsuits, will these pref go to zero? or there will still be a floor price and floor value left?

 

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

 

They would go to zero. They're not paying any dividends and there is no guarantee for them or the common.

[arbcon]

This may not be applicable, but don't the takings rulings in some of the thrifts, specifically Meritor, have some value here( Court of Claims-Judge Loren Smith if I recall correctly)? I think there was even an attempt to argue insolvency because of the low stock price at the date of the receivership. Meritor took 20 years but was successful. My cursory view of this is yes, with a BIG  exception, and that is in this case the opinion seems to be an attempt to rewrite bankruptcy law by muddling the relationship between a conservationship and a receiver, which I did not see in Meritor.

 

Some questions I wonder about:

1. Is this an attempt to nationalize the final mortgage backstop(because fre/fnm are the recipient of loans from the banks.ie., is there a political element here we are missing?, or

2. Is this an attempt to grab the future cashflows because it was clear that the cash buildup was much larger than anticipated? I'm still thinking this through so thoughts appreciated.

[merkhet]

This is what I'm afraid of. Shareholders lose all cases. And yes, private capital won't come in, but does it need to? F+F would be effectively nationalized, Govt will secure massive profits for the rest of eternity, it'll help their budget issues, and they'll technically only own 79.9% so no need to place the debt on the balance sheet. So in this case perpetual nationalized mortgage insurance would work, right?

 

Except, thus far, no one has indicated that this is an acceptable goal -- I can't recall anyone in either party who wants there to be a giant nationalized mortgage insurance arm. Remember, this would mean that the government is explicitly the backstop for all mortgages in the country.

 

This may not be applicable, but don't the takings rulings in some of the thrifts, specifically Meritor, have some value here( Court of Claims-Judge Loren Smith if I recall correctly)? I think there was even an attempt to argue insolvency because of the low stock price at the date of the receivership. Meritor took 20 years but was successful. My cursory view of this is yes, with a BIG  exception, and that is in this case the opinion seems to be an attempt to rewrite bankruptcy law by muddling the relationship between a conservationship and a receiver, which I did not see in Meritor.

 

Some questions I wonder about:

1. Is this an attempt to nationalize the final mortgage backstop(because fre/fnm are the recipient of loans from the banks.ie., is there a political element here we are missing?, or

2. Is this an attempt to grab the future cashflows because it was clear that the cash buildup was much larger than anticipated? I'm still thinking this through so thoughts appreciated.

 

Are you referencing the Slattery case? I'm not that familiar with it, but it might be applicable.

 

(1) I don't think so -- as I stated above, I don't think anyone actually wants a nationalized mortgage backstop.

 

(2) I believe so, and I think discovery in the Judge Sweeney case will show this.

[arbcon]

yes Slattery. I was very involved in Meritor at one point. Sweeney is key.

[morningstar]

I think it was implemented partially for political reasons, as you say to screw "hedge funds and wall street", you know, those people who destroyed our economy. But I also think it was to help pay the bills in Washington which has some serious budget issues.

 

I think everyone has an incentive to keep F+F alive, so I don't think they will be killed. But in terms of the Government's incentive, they'd much rather own 100% (which they do now) vs. 79.9% minus whatever goes to junior prefs (if they lose the case). And hence they'd end up in a worse position if they lose, and that's why it's taking so long.

 

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.

[merkhet]

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.

 

This is an unfortunate wrinkle. The hedge funds involved here (Pershing Square, Icahn, Paulson & Co., Perry Capital, etc.) have the necessary funds to influence the political process -- but unfortunately, they're pretty unsympathetic victims in the media and political landscape.

 

Interestingly enough, I found the following on Twitter.

 

@JonAPrior -- October 2, 2014 -- Fannie, Freddie investors now likely to focus more on Congress, met with Sen. Shelby's staff today politico.pro/Zx81ko

 

Too bad I don't have a Politico Pro subscription.

[deadspace]

 

 

latest WSJ John Carney HIT piece ….. ” Fannie & Freddie: No Looting Here”

 

By JOHN CARNEY

Oct. 5, 2014 4:12 p.m. ET

Why would any company agree to surrender all profits to the U.S. government?

 

That question lies at the heart of the continuing legal dispute between some shareholders in Fannie Mae FNMA +25.17% and Freddie Mac FMCC +22.30% and the government—even after some investor actions suffered a blow last week in the court of U.S. District Judge Royce Lamberth.

 

The answer explains why the investors’ suits are flawed and hopes the companies’ shares have value are likely to be dashed. In short, the profit-sweep agreement wasn’t an illegal taking. It was a second bailout of the mortgage giants.

 

Consider that even after being taken over by the government in 2008, the companies ended up on a death march. And that had grave implications for the financial system.

 

In the original bailout, Treasury agreed to provide each company with up to $100 billion. As losses mounted, that was increased to $200 billion.

 

In return, Treasury received warrants to purchase common stock along with senior preferred stock. The latter paid annual dividends of 10%. This rose to 12% if the payment couldn’t be made in cash.

 

Each quarter, the Federal Housing Finance Agency determined whether their liabilities exceeded their assets. If so, the companies would draw funds and the value of the preferred would rise, dollar for dollar. By the end of 2009, draws were $125 billion—requiring annual dividends of $12.7 billion.

 

Because that was more than they could afford, the companies had to draw funds to pay dividends. This increased future dividends, requiring more draws because the companies posted losses until 2012.

 

At the end of the second quarter of 2012, the companies were on the hook for $19 billion of dividends annually. Fannie had never earned enough in a single year to pay its $11.7 billion dividend in cash. Only once had Freddie earned enough to pay its dividend.

 

In August 2012, Fannie’s finance chief said he couldn’t imagine his company would ever make enough money to cover the dividend payments.

 

That raised the prospect Fannie and Freddie would eventually need to draw down all the government commitment. Doing so, though, would destabilize the companies.

 

At that point, they would each owe over $20 billion in dividends—an amount they would never be able to pay in perpetuity. So, cash payments would stop, forcing them to pay 12%, digging the dividend hole deeper, faster.

 

More important, hitting the funding limit would undermine market confidence. With no capital, the firms’ ability to sell securities and finance themselves was dependent on access to Treasury cash.

 

With each draw moving the companies closer to the limit, investors would inevitably balk at some point. That could have led to their second collapse.

 

Worse, it would raise doubts about the mortgage securities the companies guarantee. That could again undermine the U.S. housing-finance system.

 

While some investors argue the companies should have paid a noncash dividend at 12%, that, too, would have undermined market confidence.

 

Raising the funding cap was a political nonstarter in gridlocked Washington and Treasury lacked the authority to do so unilaterally.

 

Given that, Treasury and the FHFA amended the bailout agreement to do away with the fixed, 10% dividends, replacing them with sliding payouts that matched the companies’ profits. The result: Fannie and Freddie only draw funds to cover actual losses; those draws don’t raise the dividend. In bad quarters, Treasury might get less than 10% or nothing at all. In good quarters, the net-worth sweep rewards the Treasury for taking this additional risk.

 

Whether the firms’ later improved financial results merited this response isn’t the issue. It is whether the move was rational for the government and FHFA.

 

Clearly, it was. That is why investors face an uphill battle in the courts. John Carney

 

 

 

[merkhet]

If that was a second bailout, that's funny, because Treausry didn't have the authorization to engage in a second bailout...