The Freddie Mac "Z" shares (FMCKJ), one of the more widely traded preferred issues, have bounced around dramatically over the past two years after losing 99% of their value when the Treasury put the GSEs into conservatorship in 2008. The "Z" shares have more than doubled in the past month and more than tripled over the past year as the GSES have shown
. They are still worth less than 20% of their original value, however, and Keefe, Bruyette and Woods calls them a "
Whether a big payoff in GSE preferred shares depends upon policymakers is a matter of debate. Millstein actually believes a liquidation of the GSEs might be the surest way for his preferred stake to pay off.
That's because Millstein says the statute under which Fannie and Freddie would be liquidated incorporates an "absolute priority rule," like the U.S. bankruptcy code.
"If there's an excess of cash in the liquidation and all creditors have been paid and the government's been paid then more likely than not it goes to the junior preferred," Millstein says. (The "junior" preferred shares are those in which Millstein and hedge funds are invested, which in a traditional bankruptcy would be next in the line of creditors after the government's senior preferred shares.)
On the other hand, Millstein says, "If my plan were enacted, I don't know, frankly, how it would play out because my plan is based on the government has to get paid first in the AIG-like restructuring and so if it's an AIG-like privatization, whoever's sitting in my chair at Treasury has to be confident that he's got enough of the common stock to pay the outstanding amount of the senior preferred back in full. So when I was sitting in that seat I figured if I had 92% of the common, the Treasury Dept. and the taxpayers would be protected. I don't know what this guy's going to think and I don't know what market conditions are going to look like when that privatization is started in 2015 or '16 and who knows what the junior preferred would be entitled to."
Whatever policymakers ultimately decide, at least one other investor, Bronte Capital's John Hempton, believes the Fifth Amendment prohibition of the taking of private property for public use without just compensation is what will protect his investment in Fannie and Freddie preferred shares.
Specifically, it was the
Aug. 17 amendment to the 2012 Treasury's GSE preferred stock purchase agreements
that Hempton believes will ensure that he gets paid.
"I do not like the original  takeover -- but I do not think it constituted regulatory takings. Indeed they were very careful," Hempton wrote
via email. "Last year they were sloppy," he added. (To see what former House Financial Services Committee Chairman Barney Frank, who authorized the 2008 government GSE takeover, thinks about Fannie and Freddie shareholders
Millstein doesn't agree with Hempton on the Fifth Amendment issue, though the potential professional boost the turnaround adviser could get from being assigned to take Fannie and Freddie private looks to be potentially far greater than whatever he is likely to earn on the preferred share investment.
"If somebody actually decided to implement our plan and Congress passed it, this is -- like AIG -- one of the largest restructurings in the history of the world that will need to be implemented: to privatize these companies and recapitalize them. And it wouldn't hurt Millstein & Co. to have been associated with it."
-- Written by Dan Freed in New York