Fannie Mae-No Politics (FNMA)

[navycmdr]

Should GSE Debt Trade Higher Than Equity Without Fiduciary Duties ?

Sep. 14, 2016 3:35 PM ET| Glen Bradford ...


..... Summary .....

-- FHFA says that plaintiffs sur-reply concerning Pagliara decision impact on accounting fraud lawsuits.

-- Pagliara wants to have oral arguments.

-- According to FHFA's interpretation of law, making the GSEs run out of net capital in 2018 makes me wonder why GSE debt trades at higher percent of par than equity.

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are publicly traded Fortune 50 companies that are overseen by a Federal Agency that alleges that it has no fiduciary duties. The two companies combined make over $15B/annum, technically making Melvin Watt one of the most powerful people alive since he is the director of the Federal Housing Finance Agency which is an Independent Agency not subject to any other Federal Agency.

Without fiduciary duties, there is technically nothing stopping Melvin Watt from building a fleet of yachts as long as he sweeps the remainder to the US Treasury. Fortunately, Melvin Watt is an honorable man who doesn't appear to have misappropriated funds. In fact, he is so honorable that there's no need to allow the public to inspect the books and records or to sue the auditors for accounting fraud according to the government's interpretation of the law.

The law prevents security by permitting the government to take what it wants as long as it doesn't ask. If it asked, the answer would be no. That's how we got here in the first place. So what can you do about it?

Investment Thesis: Here's how I see it. The lower court judges' job description is precisely what they've been doing. They've been upholding their interpretation of the law. Lamberth ruled that according to his interpretation of the law which was so aggressive that he blamed congress that the facts don't matter and the government can do whatever they want. Although that required misinterpreting the purpose of having a statute or laws governing securities and fiduciary duties in the first place, many other judges have subsequently seen this ruling and 'partied on' so to speak.

Now four judges have started using it and it's proving to be addictive and you might be wondering if the court system can kick the habit. This is what appeals courts are for. When lower court judges do their best to dismiss claims and clear dockets, it seems that appeals courts are designed around providing justice when the system goes wrong as it interprets previously untested laws.

That's what makes all the recent rulings such a strong advocate for a pro-shareholder ruling out of the Perry Capital Appeal. The claims that the government is making now undermine the definition of security.

Security is something you look for when you put money into investments. Permitting the government to establish an agency that has $15B/annum of allocation power without controls at the direct expense of taxpayers was never the intent of congress based on my read of HERA, which is the statute governing the FHFA.

I'm not a lawyer but Bill Ackman and Richard Bove suggest that the common stock is worth upwards of $20 if the net worth sweep dies. I'm not as optimistic and I don't know why but the problem is circularly that FHFA is in charge and I'm suffering abandonment issues. What does fiduciary duty mean when the theoretical fiduciary says it doesn't exist and then is told by a court that it's indeed a fiduciary? As such, I own preferreds.

FHFA's Motion For Leave To File Reply

FHFA says that plaintiffs miscategorize the Pagliara decision. This is what FHFA says, and then we'll examine what Plaintiffs said:



That's interesting. I wonder what Plaintiffs argued:



It would seem that the government doesn't want plaintiffs to have standing to sue the auditor responsible for signing off on the accounting fraud. What I don't get is why did they even commit accounting fraud if the facts don't matter. That's the catch-22 here if you're paying attention:



In the accounting fraud lawsuit, they don't want plaintiffs to have standing to sue the auditors. That's the problem that the government has with the plaintiffs' interpretation of Pagliara. This is about direct vs. indirect if you ask plaintiffs:



My bet here is that the government is going to say that Pagliara was stopped because his objective was to interfere with FHFA's plans and so too is the objective of the plaintiffs in the accounting fraud lawsuits. Unfortunately, for the government, I'm not sure if they're going to be able to fully apply Lamberth's the-facts-don't-matter stance in lawsuits against private parties that committed wrongdoing in assisting a nationalization.

It is the FHFA that doesn't have a fiduciary duty if you ask them. Just because the FHFA doesn't think it has a fiduciary duty does not mean that the accounting firms working with them don't have a fiduciary duty:



It would seem that the FHFA would argue that the plaintiffs had no economic rights in the first place since the FHFA was in control of the two companies without any fiduciary duties to begin with:



Yikes. It seems like Pagliara made it pretty clear that plaintiffs in the Deloitte case have standing. I'm not sure how the FHFA is going to talk their way out of this one. I guess if you really pushed the envelope you could argue that because there were no economic rights since the FHFA does not have a fiduciary duty then the case should be dismissed if you extend the opinions from the judges that have ruled so far.

It could be decided that although Pagliara ruled as favorably as possible considering Lamberth prevented it from going forward, there is enough in the Robinson ruling to make for a truly sensationalistic ruling.

I think it's possible but the fact that plaintiff interests have now been buried by over $150B of senior preferred stock that takes everything in exchange for nothing does not mean that plaintiffs do not have interests that could have been damaged. The preferred shares have a liquidation preference, which sure seems like an economic right to me as long as words have meaning. That liquidation preference seems to prevent the FHFA from foreclosing on the argument that Plaintiffs have no economic rights.

The argument that the lawsuit against the auditors is derivative doesn't hold up either because it's a lawsuit against the auditors and it is direct. What the FHFA wishes is that it could take this lawsuit and make it against them, because Lamberth ruled that the FHFA can do whatever they want. Unfortunately, I doubt that the courts are going to rule that the auditors can go along with them. As such, the accounting fraud lawsuits still feel like the golden ticket.

Plaintiff Timothy J. Pagliara's Request For Oral Argument

This is great news assuming that it buys time to permit Lamberth's ruling to be potentially remanded or reversed before the Judge here can use it to dismiss:



As you'll recall, this is the Fannie case whereas the Freddie one got dismissed already thanks to Lamberth's original ruling. The logic is that because Lamberth said that the facts don't matter that inspecting the facts is a waste of a legal ruling. Seems easy enough.

How This Nationalization Impacts The General Public

A shareholder wrote to me:

The government has found another new tax. The increased fees make everyone buying a new home the new victims. As FNMA & FHLMC become (even more of) a monopoly, borrowers will have no choice but to pay whatever fees the Treasury (or IRS) thinks it needs to run another inefficient government program at a profit and still contribute to other unrelated government spending.

Just another reason I am strongly against the illegal takeover of billions of shares distributed among taxpayers retirement accounts often without their knowledge hidden in mutual funds or managed funds.

He shared his perspective that if you lost a lot of money in 2008, part of it if you owned a mutual fund is likely money that was taken by the government. That is to say, chances are really good that the government took money out of your account by establishing a federal agency that claims to not have fiduciary duties and putting it in charge of two companies that were in most retirement accounts.

The Government Notices Saxton

The government effectively sent their Robinson/Lamberth laundry list of why the Saxton case should dismiss plaintiff claims:



The FHFA defines a new form of conservator, one we've never seen in history, one which has no fiduciary duty, is defined by permissive powers, can legally act with irrelevant motives, is immune to APA claims and although IRS guidelines would classify what it did as a purchase of securities - labeling it as an amendment prevents it from being a purchase.

I personally find these notices being sent around as the most compelling reason to own GSE equities and at the very least this stuff has got to be concerning to GSE debt holders. How do you hold debt in a company that is overseen that way? What claims do you have? I'm curious, please advise, are we investing in GSE debt with blind expectations because the next step once the government is done stripping equity holders of their economic value the big money is in the debt.

$200B is a drop in the bucket compared to the $5T or however much debt there is outstanding. One would think that if the equity is wiped out in 2018 and things get rolling, it's odd for the debt to trade as highly as it does when there are no fiduciary duties.

Summary & Conclusion

My friends Jeff and Aaron said that they love how often I cover the topic because they love reading up to date comments on my articles and accused me of being repetitive. That's a good thing in this case because it puts the topic on the map in front of thousands of interested parties that are directly and indirectly involved. The Perry Capital Appeal is going to be great for me if you ask me.

Fannie Mae and Freddie Mac could become issues of national security. If you thought that the government taking all the equity was bad there's always been a lot more debt than equity. It would seem that the debt part of the capital structure is wearing rose-colored glasses regarding the intrinsic value of their securities as part of a capital structure that is being looted by a federal agency without fiduciary duties.

That's the sort of trajectory that this is going to be heading in if this is allowed to continue to go on and that's why I own GSE preferreds. Either securities have value that cannot be expropriated in this country by a series of anti-conserving actions by a so-called conservator or the money that I would otherwise have in my bank account can't buy me the security I want in my life anyway.