Richard X. Bove, Chief Strategist | (516) 535-3829 | bover@raffcap.com
VOL. 6 NO 4 JANUARY 28, 2019
Keep Updated on Fannie Mae and Freddie Mac: More news coming
Politico has indicated that there is serious conversation in the Administration to free these companies from their conservatorships. This very likely means sizable capital gains for shareholders of the preferreds. There is also danger for housing lurking here if the government walks away from the 30-year fixed rate mortgage (see page 4)
MORE ON FANNIE AND FREDDIE
There is Movement
The shares of Fannie Mae and Freddie Mac made new 52-week highs this past week. In fact, if one looks at a chart of either stock, it appears that they have been shot out of a cannon from the beginning of January to the present.
The reason for this was laid out in two of these commentaries in early January. The Administration had nominated Mark Calabria to head the Federal Housing Finance Agency (FHFA). Mr. Calabria’s views were clear on the subject as to what should be done with these two companies:
They should be released from their conservator status as was intended by the Housing and Economic Act of 2008 (HERA).
The holders of these shares should obtain the payments they were entitled to if this happened or the credibility of the government in these matters would be shattered.
These concepts were furthered by statements made by Joseph Otting, the Comptroller of the Currency, and the acting head of the FHFA. It appears that Mr. Otting will be holding meetings to discuss the status of Fannie and Freddie while Mr. Calabria goes through the nomination process in the Senate.
Current Status
From my personal perspective, the actions of the government toward these two companies is more than a little discouraging since it appears that the government made a conscious decision to avoid the law.
In 2008, the two government sponsored enterprises were supposedly facing mortgage losses that would drive them into bankruptcy. The government reacted by putting both companies into a conservatorship with the requirement that they be returned to public status once their balance sheets were restored to financial health.
For long-term observers of these companies, the reasoning for placing the companies into conservatorship in the first place was highly suspect because they were both cash flow positive. Subsequent events would strongly conform this view.
Once they were in the conservatorship, it was made very clear by Congress that the FHFA was to regulate these companies and that neither the Treasury Secretary nor the President were to interfere with their operation. Simply stated the Treasury Secretaries have simply considered the demand of Congress, which is U.S. law, to be a joke worth ignoring and they have clearly interfered with the decision making in these companies.
Enterprising hedge fund managers recognizing that the law was being broken acquired large positions in these stocks and they went to court to force the government to obey the law.
The Federal District Court under Judge Royce Lamberth refused to read the monographs provided by the plaintiffs in the key case and refused to allow plaintiff lawyers to speak in his court on the matter. He decided that the government could do whatever it chose and threw the case out. Courts around the country followed Judge Lamberth’s lead and threw out case after case on the matter. The Federal Claims Court was more amenable to the plaintiffs and aided them in obtaining discovery documents. However, it has refused to this point to make any judgments on what was discovered.
Only when the Federal Appeals Court reviewed the Lamberth decision was some light seen in this matter. The Appeals Court directed Judge Lamberth to review one portion of his decision. The Appeals Court acknowledged that there was a contractual relationship between the companies and the preferred shareholders and that Judge Lamberth should review this matter. He has not done so.
Congress got into the Act by writing a number of pieces of legislation concerning what the new mortgage would look like without Fannie or Freddie. The legislation was so unbelievably convoluted that it was never voted on by either House of Congress. Bottom line these bills would have created enormous multilayered bureaucracies that would have completely nationalized residential mortgage originations in the United States.
Ultimately, it was recognized by the Congress that the housing industry in the United States could not do without the 30-year fixed rate mortgage. This led to an understanding that this mortgage could not exist without Fannie and Freddie. Once Congress understood this it did nothing to change the current situation.
We are now going into the 11th year since this series of events occurred. Now, there is some possibility that there will be a resolution to the dilemma. This is being driven by the understanding that by any fair assessment of Fannie and Freddie the government has driven the two companies into insolvency. They lack the capital to back their guarantees. At some point if this continues their debts will be put on the budget of the United States adding $5 trillion.
Thus, maybe Calabria and Otting will take the necessary steps to right the incredible wrongs of the past ten years. If they do there is money to be made by the U.S. taxpayer here.
