Fannie Mae-No Politics (FNMA)

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Department Of Justice Petition For Secrecy Hurts GSE Shareholders

Oct. 28, 2016 6:23 AM ET| Glen Bradford ...

..... Summary .....

-- The Department Of Justice says Judge Sweeney has improperly allowed documents produced by discovery to be used in other lawsuits.

-- The Department of Justice says it correctly asserted privilege and that Judge Sweeney doesn't understand how privilege works.

-- The government's argument effectively boils down to one of government secrecy being necessary in order for the government to function properly.

-- These petitions take priority and it's reasonable to expect a ruling in the coming months if not weeks.

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two privately owned government sponsored enterprises (GSEs) that make roughly $15B/annum on a normalized basis and presently are controlled by the government that takes over 100% of their annualized profits until their net worth is wound down to $0 in the coming years. Since Fannie and Freddie's conservatorship started in 2008, they have been consistently making money but have been forced as a matter of public policy to report massive losses in their early years thereby issuing unprecedented amounts of government stock. These reported losses, having been overstated, were subsequently reversed and reported as massive profits but not before the government decided to effect the third amendment net worth sweep on behalf of the enterprises (GSEs). Although I'm sympathetic to the government's cause to instill confidence in the mortgage market, I have yet to be convinced that taking 100% of the net worth of two companies entering conservatorship at their highest levels of capital that consistently make cash profits during conservatorship instills confidence in capital markets. The way the government has Fannie and Freddie structured, common and preferred shareholders that are not the government are allowed to own shares that effectively have no real economic value whereas the government has preferred shares that take all Fannie and Freddie's profits.

Investment Thesis: Although the shares are intrinsically worthless the way things are currently structured there are many lawsuits filed by private investors seeking a reversal of at least the net worth sweep. The government has asserted that they have implemented a new capital paradigm which boils down to a zero price nationalization and that plaintiffs would be reversing gears and making the government follow an old capital paradigm where capital is a measure of business health. In the event the net worth sweep is reversed and the enterprises are allowed to keep some of the money they make shareholders that aren't the government such as myself stand to see substantial intrinsic value gains. Further, Fannie Mae and Freddie Mac are Fortune 50 companies so this change is highly visible. When considering GSE preferred shares, consider the issuance date, the dividend terms which may comprise variable and fixed attributes, the liquidation preference, the call terms, whether or not the series is convertible to common and lastly which GSE of issuance. Right now the preferreds trade at massive discounts to their par value. When considering the common shares, consider the future earnings power based on who shares in the earnings, what happens in a potential liquidation/runoff scenario, and fully diluted share counts now and in the event plaintiffs start winning lawsuits. The common shares arguably have scenarios with more upside than the preferred shares. I own preferred shares and I hope that common shares do better than me.

Petition For A Writ Of Mandamus To The United States Court Of Federal Claims

I am not a lawyer, but I'm not sure you need to be to understand what is going on here. There are a few documents that are useful in reviewing what each side has to say in this dispute. The Petition includes Judge Sweeney's order, but I think it's also useful to look at the original motion to compel and the government's response.

Attorneys for the United States have stepped in saying that Judge Sweeney doesn't understand how privilege works and that the order on the motion to compel needs to be reversed:



Before we begin let's look at what the Department of Justice wants:



The overview of the petition:



There are some interesting things to note in this petition, like when DOJ lawyers point out that Judge Sweeney gave them the benefit of the doubt:



The government otherwise suggests that Judge Sweeney didn't put in much effort into the order on the motion to compel:



Note that this Writ is 31 pages and Judge Sweeney's public redacted order is 80 pages. The DOJ basically does its best throughout the Petition to cast Judge Sweeney in the most unfavorable light possible:



I've read the Writ and my assessment boils down to "What other options did the government have left?" Judge Sweeney has been consistently ruling against the government and treating their assertions of privilege as if they were made incorrectly. The government argues that its assertions were made correctly and as such has to make Sweeney out to look careless. Plaintiffs have suggested the opposite: Judge Sweeney went further than necessary in the original order. The writ implies that Judge Sweeney violated the protective order by allowing documents to flow through to other cases:



While the government publicly promotes transparency, it sure seems to be fighting hard for secrecy in regards to thousands of documents surrounding the conservatorship of Fannie Mae and Freddie Mac.

Order: Show Us What You Showed Judge Sweeney

The United States Court of Appeals for the Federal Circuit issued an order already. This is going to be relatively fast:



The court wants to see the documents that Judge Sweeney deliberated over and they want responses in a matter of days. The sooner respondents file their responses the sooner the United States is ordered to reply.

Does Future Business Profitability Matter In Valuing A Private Business

According to the government, it does not:



That seems to directly contrast fundamental security analysis. If the thoughts of an agency regarding an enterprises future profitability do not matter when that agency is controlling the enterprise and the agency gives the net worth of the company to the government and claims that its actions are unreviewable in law then I'm not sure what matters to begin with. FHFA has previously asserted that it entered into the net worth sweep to save the enterprises from their lack of future profitability. Now the DOJ has joined FHFA in arguing that it doesn't matter. I seem to disagree by thinking that future estimates of profitability are the quintessential metric by which to value the worth of any business. I can see DOJ's perspective, however, as it supports their ability to nationalize Fannie Mae and Freddie Mac at zero cost.

Summary and Conclusion

The government doesn't want the public to know what really happened behind the closed doors of conservatorship that have swallowed Fannie Mae and Freddie Mac. The cash flow that the two have produced for the government has been enormous and even though the government is taking the net worth of the two companies it has not consolidated the two onto its balance sheet. Publicly traded shares that have effectively been drained of their economic value are the technical reason the GSE balance sheets have not been consolidated onto the government's balance sheet.

The government is now arguing that Judge Sweeney has not been ruling correctly with regards to their document productions. The Department of Justice has stepped in asking for the motion to compel order that favors plaintiffs to be reversed. In effect, this would put a lid on the discovery process and effectively take steps to preventing future private shareholders from obtaining relevant discovery documents in situations when the government decides to assert discretionary privileges. This more or less has the potential of defeating the purpose of discovery in the first place and it highlights the fact that to date none of these lawsuits have forced the government to produce an administrative record.

Fortunately for plaintiffs the government has already produced lots of documents that cast significant doubt on the truthiness to their arguments they are making these days. Instead of arguing the government entered into the net worth sweep to protect shareholders, now the government is arguing that it doesn't matter what they did and that their actions are unreviewable in court. Further they are now arguing that the court system is failing to appreciate how far privilege assertions are supposed to go. It's a tough argument to make considering that the Judge issuing the order on the motion to compel seemed to go far out of their way in interpreting government assertions of privilege in as favorably as possible as the judge could in favor of the government.