The hedge fund managers, however, argue the best solution for preferred investors is to revive the shares and all cite Fannie and Freddie's improving balance sheets in making their case.
Kao and Derek Pilecki of Gator Capital Management in Tampa, Fla., both make certain pragmatic-sounding political arguments that going back to some version of a public-private model is the least objectionable of several bad options.
Separately, John Hempton of Bronte Capital has a plan to gradually phase out the Government Sponsored Entities (GSEs) that he believes would pay back the government and give him some nice gains on his preferred equity stake.
The fund managers' proposals for Fannie and Freddie and degree of conviction vary slightly from one to the next.Kao, who earned 268% returns for Akanthos in 2009 by buying General Motors (GM - Get Report)shares for pennies on the dollar, believes GM's initial public offering could provide a template for an IPO of Fannie and Freddie, in which some of the government's debt and/or preferred stake could be converted to equity in a reorganized company. Pilecki, a former interest rate risk analyst at Fannie Mae, says Fannie and Freddie preferred shares are his largest positions, accounting for some 5% of his portfolio. "The new business they're putting on is profitable and I also think some of the charges they've taken in the past have been overly conservative," he says. Hempton believes the government exit strategy for Fannie and Freddie should be to force them to gradually increase the price they charge for mortgage guarantees until they eventually lose all their customers to the private sector. As the GSEs are phasing themselves out of existence, Hempton believes they would earn enough money to pay back the government. However, Hempton argues this is not the plan favored by big Wall Street banks like Citigroup (C - Get Report), Bank of America (BAC - Get Report), JPMorgan Chase (JPM - Get Report) and Goldman Sachs (GS - Get Report). Instead, he says Wall Street favors a plan to create several mini versions of Fannie and Freddie that compete with each other to offer low-priced government guarantees on mortgage backed securities.