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Fannie and Freddie: Smart Money Sticks to GSE Preferred Shares

Hempton said he would sell his entire investment in GSE preferred shares if he didn't believe there was "a fifth amendment problem."

Another hedge fund manager, Michael Kao of Akanthos Capital Management, has a different reason for hanging on to his investment in the preferred shares, however.

Kao argued the government needs Fannie and Freddie to sustain the housing market and the economy, and won't want to take the lenders onto its balance sheet, as it would increase the deficit by some $5 trillion. The least objectionable of several bad options, he argued, would be for the government to sell its stake back to the public markets. In such an event, the preferred shares would recover all of their original value, he reckoned.

Kao is also encouraged by proposed bipartisan legislation offered by Senators Mark Warner, (D-Va.,) David Vitter, (R-La.), Elizabeth Warren (D., Mass.) and Bob Corker (R., Tenn.) that would prevent Fannie and Freddie from raising the fees they change for backstopping mortgages.

While the proposed bill "may not necessarily be in support of value restoration to the old preferred it is a recognition that the funds ought to stay within the family, if you will, and not just go to anybody's pet pork project," Kao said.

On the other hand, the legislation would prevent the Treasury from selling its own stake in the GSEs, which is also in the form of preferred shares.

"If Treasury were to decide to sell its preferred share investment without Congress having first reformed our housing sector, we would just be returning to a time where gains are for private shareholders and losses are for taxpayers," reads a statement from Corker, which would seem to run contrary to Kao's thesis.

But for those investors who can understand the motivations of these elected officials and their likelihood of success in getting whatever it is they want out of the GSEs, the payoff could be huge.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.
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