Fannie Mae-No Politics (FNMA)

[robigus]

and Freddie Rally on Wishful Thinking
Shareholders won a court decision unsealing documents, but recent investor euphoria goes too far
By
John Carney
April 14, 2016 2:12 p.m. ET
Shares of Fannie Mae and Freddie Mac are again rising on investor euphoria over the prospects lawsuits against the U.S. government will succeed.
Fannie shares are up about 40% since the start of April, and Freddie’s around 34%. The proximate cause of these sharp moves up was the unsealing of documents Monday in one of the cases brought by shareholders protesting the deal that requires the mortgage giants to send all their profits to the Treasury.
The unsealed documents, which the government had argued against making public, include a deposition last July of Susan McFarland, Fannie’s former finance chief. Ms. McFarland testified that she told officials at the Treasury on Aug. 9, 2012 that the company was “now in a sustainable profitability, that we would be able to deliver sustainable profits over time.”
Shareholders’ attorneys have argued that the fact Treasury officials knew the companies would be profitable undercuts the government’s rationale for the 2012 change to Fannie’s and Freddie’s bailout agreements. These substituted the profit sweep for an earlier requirement the companies pay a 10% dividend on senior preferred stock held by the government.
But that argument confuses the purpose of the sweep. It wasn’t meant to address fears the companies would never be profitable. Why sweep profits that would never exist? It arose because of concerns the companies wouldn’t be reliably profitable enough to fulfill their dividend obligations to taxpayers.
That could cause them to draw more bailout funds to pay the government, digging them into an ever deeper hole. That would bring them closer to the limits of government support, something that could roil debt markets.
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The sweep took that prospect off the table. The amount the companies owe varies with their profits.
Recent history shows the prudence of this approach. After three years in which profits came in well above what would have been owed under the 10% dividend, profitability at both companies fell short last year.
That is telling. Profits in boom years were driven by reversals of past losses and giant legal settlements from banks. Yet last year was likely much more indicative of the companies’ long-term profitability.
So while the unsealing of the documents represents a legal setback for the government, it isn’t a serious blow to the government’s sweep defense.
Investors buying into this rally may end up regretting it.