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Fannie and Freddie: Smart Money Sticks to GSE Preferred Shares

Even if the common shares return to their pre-crisis levels of roughly $50 (or $10 in today's terms, since Treasury now owns 80% of the common shares) that would be a roughly nine-fold gain based on Wednesday's closing price of $1.08 for both Fannie and Freddie common shares. The preferred, meanwhile, would offer roughly the same return if it recaptured its original valuation of roughly $37 billion.

What's more, the main event that has investors piling into the common shares is the increasing profitability of Fannie and Freddie, which to Hempton and the other hedge fund managers isn't especially surprising.

The bigger wager they are making is a political one: that the government will stop seizing all the profits of Fannie and Freddie and show some willingness to make payments to preferred shareholders.

"There is absolute political consensus that these things are dead and that they should be buried and that the equity and preferred holders should be wiped out," Hempton said of the GSEs.

Indeed, Hayman Advisors' Kyle Bass told TheStreet via email Aug. 17 that he sold his GSE preferred shares early in 2012 "when we determined that both sides of the aisle wanted them dead." In a follow-up email exchange on Tuesday, Bass wrote, "We have no position. Period. I won't comment on anything else."

It was on Aug. 17 that the Treasury announced it would claim all the profits of Fannie and Freddie instead of the 10% annual dividend it had been receiving as compensation for backstopping the housing lenders. Freddie Mac "Z" preferred shares (FMCKJ) lost more than 60% of their value following the Treasury's announcement.

The result of that Aug. 17 Treasury decision, Hempton pointed out, is that "Fannie and Freddie could make $500 billion tomorrow and my preferreds would still be worthless."

Except that such a windfall, he believes, would attract an "enterprising lawyer who would take the case all the way to the Supreme Court and win."

On the other hand, "as long as they're only making $5 or $10 or $15 billion the Treasury's going to steal it all," Hempton argued.

Hempton believes the Aug. 17 move violated the Fifth Amendment, which requires that "just compensation" be given if the government seizes private property for public use.

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