Fannie And Freddie Could Be Used To Accomplish Biden's Housing Goals
Nov. 26, 2021 11:37 PM - Glen Bradford
Summary
--- After months of negotiations, House Democrats voted to pass Spending Bill that proposes to spend over $150B on housing.
---This bill is expected to change in the Senate, but shows the administration's intent to invest into American Housing.
--- Fannie and Freddie are the backbone of housing in America and this administration can unlock tens to hundreds of billions of dollars in restructuring them.
Investment Thesis
Fannie and Freddie are in conservatorship retaining their earnings since September of 2019 and are on a path to retain enough earnings to exit conservatorship. Prior FHFA director Mark Calabria pointed out that until Fannie and Freddie are able to raise capital they pose a systemic risk to the financial system.
Lawsuits filed in multiple courts continue to challenge the net worth sweep imposed in 2012 for a few reasons depending on the court, alleging that it was a takings in one and a breach of contract in another and these lawsuits continue to move forward despite the Supreme Court's recent ruling that under HERA, FHFA can do whatever it wants with Fannie and Freddie during conservatorship.
Given that the companies make tens of billions of dollars per year and have enough money already to survive a severe adverse stress test without needing a bailout, exiting conservatorship during this administration would require a balance sheet restructuring of the equity.
The current terms of the Senior Preferred Stock Purchase Agreement and the pending litigation against the net worth sweep prevent Fannie and Freddie from being able to use their underwriters Morgan Stanley and JPMorgan to raise fresh capital and exit conservatorship.
Depending on the timing and terms of the pending balance sheet restructuring, common could be worth significantly more, but if common are worth more, then preferred are worth par value which right now is 7-13x.
Biden's Spending Bill Passed In The House of Representatives
The house of representatives recently voted to pass a spending bill that would fulfill a large part of President Biden's agenda. The bill is expected to change in the Senate, but I think that the spending for housing shows the administration's intent to invest into the housing industry.
This money could come from legislation, but if the Senate decides to cut back on some of these numbers, the Biden administration has two Aces up its sleeve. It could move forward with the restructuring and recapitalization of Fannie and Freddie and possibly generate a similar amount of money to fund these initiatives. This wouldn't be the first time that Fannie and Freddie were used for political purposes to fund White House initiatives. The 2012 net worth sweep funded Obamacare. At least this time, the money could stay in housing.
Conservatorship History
Due to their systemic risk to other financial institutions they were placed into conservatorship in 2008 to ensure that the price of agency mortgage backed securities did not collapse, causing a tidal wave of bank bankruptcies across America in 2008. In order to keep Fannie and Freddie in conservatorship, the government implemented the third amendment net worth sweep in 2012 to prevent them from retaining the earnings the government kept the companies from having between 2008-2011 by systematically writing down their assets to generate temporary accounting losses, retroactively justifying the conservatorships. Investors sued the accounting firms and settled those auditor claims without the companies having to restate their earnings and recalculate the size of the Senior Preferred Stock Purchase Agreement.
Housing has never really been a priority for the administration since 2008. Instead it has been the scape goat and Fannie and Freddie were blamed for everything even though the problem originated and metastasized in non-agency mbs and liar loans, which invariably blew up in 2008 due to underlying loan performance. Having been successfully scapegoated and run aground in 2008 at the end of the Bush administration, Obama raided Fannie and Freddie to pay for Obamacare instead of recapitalizing them. Trump came in trying to save Fannie and Freddie but didn't get the job completely done but did put to bed every scenario that doesn't result in recapitalization and release.
This puts the Biden administration in the position to reap the benefit of having no alternative but to restructure the companies to unlock value to put into initiatives of its own choosing or leave that to future administrations. Given Biden's affinity for spending looking at the Spending Bill and the Infrastructure Bill in conjunction with the specific focus of spending over $150B on housing in the spending bill, unlocking money from restructuring Fannie and Freddie to spend on housing seems attractive to me.
This feels especially true in the context of the bill being cut back from roughly double what it was in July to get it passed by the House Democrats. The Fannie/Freddie money could be used to fill that gap created by negotiations, and who knows? Maybe that was part of the negotiations that went on in the background.
Summary and Conclusion
The Biden administration is in a position where it can unlock tens to hundreds of billions of dollars by restructuring the balance sheets of Fannie and Freddie and it can use this money to fund housing initiatives and this can all be accomplished administratively. Doing nothing simply lets whomever comes after Biden determine how that money should be spent. Generally speaking, politicians prefer to spend all the money they can, and so I am very optimistic that Biden may be earmarking its restructured equity stake in Fannie and Freddie to accomplish his agenda. This restructuring would unlock immense value for preferred shareholders, and depending on the restructuring mechanics could be great for common shareholders as well. I do think that if the market values the pre-IPO equity of Fannie and Freddie in excess of $34B, that the government would want the junior preferred to convert before it exercises its warrants though, which is why I don't agree with valuation scenarios where common significantly outperform preferred.
