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On Fannie, Freddie Reform, Wall Street Is Left of Maxine Waters

Stocks in this article: FNMA FMCC

NEW YORK (TheStreet) -- It is a strange world when the call to keep bailed-out mortgage finance giants Fannie Mae  (FNMA) and Freddie Mac  (FMCC) alive and preserve the government's legacy contribution to American homeownership comes not from Washington liberals but from Wall Street.

Practically every reform proposal being considered in Congress supports the winding down of the government-sponsored entities or GSEs, ending the implicit government subsidy that fueled an unsustainable growth in homeownership in the run up to the bubble.

Yet, big institutional investors are arguing that the companies, which are now making record profits and will have paid out dividends almost equal to the $188 billion in bailout money by December, should be rehabilitated and privatized.

"In this country we fix valuable businesses by restructuring; we do not simply throw them away," Fairholme Fund's Bruce Berkowitz said last week.

The billionaire investor is proposing that the mortgage insurance businesses of the agencies be recapitalized and spun off into two private, state-regulated insurance companies. The new companies would be capitalized with $34.6 billion from the conversion of the GSE's junior preferred stock to common shares. At least another $17 billion of new capital would be raised from the junior preferred stockholders in a rights offering.

The proposal was touted as an answer to the broad bipartisan call for more private capital in the private sector, but the likelihood of it being accepted appears slim.

"An offer of this nature would not be in the public interest," Senator Bob Corker (R.,Tenn) told Bloomberg in an email. "Without meaningful legislative reform we would still have dominant entities owned by the private sector but operating with an implied government guarantee, leaving taxpayers at great risk."

Berkowitz is one of a small group of professional investors who, in recent years, have scooped up Fannie Mae and Freddie Mac common and preferred shares for pennies on the dollar.

Early investors bet that the companies would return to profitability and repay the government, a la AIG (AIG), but their hopes were quashed when the Treasury amended the bailout agreement in 2012. Under the revised terms of the agreement,the companies had to sweep almost all of their profits to the Treasury as dividends. This effectively prevented them from building capital that would allow them to repay the government.

Berkowitz and other investors including hedge fund Perry Capital have filed lawsuits against the Treasury, arguing that it violated shareholder property rights when it amended the agreement. The Treasury says it has acted appropriately.

Despite the likelihood of a long-drawn legal battle with the government, the investor interest in GSE shares has only grown.

On Friday, activist investor Bill Ackman's Pershing Square Capital Management disclosed that it had a roughly 10% stake in Fannie and Freddie common shares. The fund said in a filing that it would be in discussions with the management and the government about the restructuring of the companies.

The Fannie/Freddie trade may have attracted major league investors but political analysts believe the bets could backfire as there is no appetite in Washington to a) return the agencies to their former avatars as publicly- traded companies with a federal charter and b) allow Wall Street firms to profit off their restructuring.

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