Hedge Funds Lobby D.C. On Fannie, Freddie Privatization

NEW YORK ( TheStreet) -- Hedge funds betting on the re-privatization of Government-sponsored enterprises (GSEs) Fannie Mae ( FNMA)and Freddie Mac ( FMCC) have been taking their case to the nation's capital.

"There are hedge funds who are up on the Hill who have invested in these GSE preferred shares which are like lottery tickets right now. Of course they're trying to sell the White House on doing that and raising $200 billion, if you will, to pay off debt," said Sen. Bob Corker (R., Tenn) in an interview last week.

Corker has been on the receiving end of these pitches as well, which come from large hedge funds and smaller investors in GSE preferred shares, he says. He declined to identify the investors, however.

The push to reform U.S. housing finance is gathering steam, and while nearly everyone in the Obama Administration and in Congress would like to see the government reduce its role, they are hesitant to upset the apple cart for fear of slowing the economy. Currently about 90% of new mortgages are government guaranteed.

Hedge funds have been betting on a recovery in preferred shares of Fannie and Freddie for well over two years. Among those that have publicly identified themselves as participating in this bet, the largest is Hayman Capital Management, which manages $750 million. That is not especially large by hedge fund standards, and Kyle Bass, managing director in charge of the fund, told TheStreet in August 2012 that he sold the shares earlier that year when he concluded that both Republicans and Democrats "wanted them dead." Contacted by e-mail Tuesday, Bass responded, "I am not going to discuss anything regarding the GSEs."

Corker's language suggests a bigger fish, however.

"Let me put it this way: some really big really large hedge funds have taken positions in these preferred shares and they believe that somehow or another--at least some of them believe that, number one they want it spun off. Some of the arguments that are being put forth by the smaller owners are that, you know, the Federal Government's going to have to deal with them at some point. They can't just snuff 'em out," Corker said.

Paulson & Co., the $18 billion money manager run by subprime seer John Paulson, has been rumored to own GSE preferred shares. That would make sense, since Robert Lacoursiere, who worked for Paulson before leaving to start up his own fund in recent months, was a sell-side analyst who covered the GSEs. A spokesman for Paulson & Co. declined comment, and Lacoursiere didn't respond to an email query.

As for whether Fannie and Freddie privatization has a decent chance of happening and whether it needs to happen for preferred shares to be a good investment, views are all over the map.

Many politicians on both sides of the aisle want to sound as tough as possible on Fannie and Freddie, and Corker is certainly doing his best.

"These companies going private and them still having the implicit government guarantee is a non-starter. I don't see that having any traction at all right now. It certainly has no traction with me," Corker said in the interview last week.

That's one of the reasons Corker is taking a hard look at a plan published recently by the Bipartisan Policy Center, a think tank founded by four former Senate majority leaders including two Republicans and two Democrats. The BPC plan favors winding down the GSEs in the hope of replacing them with private mortgage insurers.

"We're spending a lot of time looking at the Bipartisan Policy proposal. It does have a government guarantee in it but we think there may be a way to take a kernel of that idea and do some things where eventually the market may figure out that there really just is no need for a government guarantee at all. But we're still noodling on that and we're still working with others," he said.

Competing proposals have been put forward by Jim Millstein, a former Treasury official who was in charge of the government's AIG ( AIG) investment and is now head of restructuring firm Millstein & Co.

Millstein, who served during the Obama Administration, has aligned himself with Phillip Swagel , who worked at Treasury during the Bush Administration. Swagel has put forward his own proposals which also involve returning Fannie and Freddie to the private markets. Millstein also owns Freddie and Fannie preferred shares, an investment he thinks may look even better if the GSEs are liquidated instead of being taken private.

While the Millstein and Swagel proposals face the politically difficult hurdle of getting politicians to support rebuilding Fannie and Freddie, they take great pains to argue they are not merely endorsing a return to the old system where GSE profits -- boosted by an implicit government guarantee -- went to shareholders and taxpayers were stuck with the losses.

They argue for higher capital requirements for the GSEs, and a government backstop for the mortgages they guarantee, but not for the institutions themselves. Whether that proposal keeps the government far enough away to satisfy Corker and other lawmakers remains to be seen, however.

For the time being, Corker wants to be sure the GSEs aren't privatized without the consent of Congress, and that their profits don't turn into a "piggy bank" for pet projects. With those goals in mind, he has co-sponsored legislation called the Jumpstart GSE Reform Act, along with Sen. Elizabeth Warren (D., -Mass.), David Vitter (R., La.) and Sen. Mark Warner (D., Va.) to ensure that the Treasury can't sell its stake in the GSEs without Congressional consent, and that increases in the fees it charges can't be used to offset other government spending.

"It's pretty unbelievable to me that we have so many people who are worried about the housing market getting rolling even more healthfully than it is today and at the same time they're jacking up the cost of loans by increasing insurance costs charged by Fannie and Freddie and using it to fund government expenditures," Corker said. "It's unbelievable that that's been taking place, and I hate to say it but over the last couple of years people on both sides on the aisle have been doing that. It's beyond belief to me that that's what we'd be doing."

-- 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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