BackgroundFannie and Freddie, known as the government-sponsored enterprises, or GSEs, together hold roughly $5.2 trillion in mortgage loans and mortgage-backed securities, and remain crucial to the U.S housing market, as they purchase about 90% of newly originated mortgage loans in the United States. The two companies were taken under government conservatorship at the height of the financial crisis in 2008.
The U.S. Treasury holds $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares, in lieu of bailout funds provided to the GSEs. Both GSEs returned to profitability last year, and have been making very significant dividend payments on the senior preferred shares, while dividends on junior preferred shares have remained suspended since September 2008. Per their amended bailout agreements, Fannie and Freddie are required to pay dividends to the government equal to all of their earnings, less $3 billion apiece in retained earnings to provide a minimal equity buffer. As a further sweetener, the government holds warrants to purchase common shares in Fannie and Freddie in sufficient quantities to give the Treasury a 79.9% stake in each GSE, at a very low price of $0.00001 a share. Fannie Mae announced on May 9 it would pay the Treasury a second-quarter dividend of $59.5 billion, after determining it could recapture most of its valuation allowance for deferred tax assets (DTA) at the end of the first quarter. Freddie Mac announced on May 8 that it would pay a dividend of $7 billion to the Treasury in June. Following the June dividend payments from Fannie and Freddie, the government will have received dividends totaling $131.6 billion on its combined GSE preferred investment of $189.4 billion. That is quite a solid return to U.S. taxpayers, especially considering that a few years ago, the GSEs were all but given up for dead. But no matter how much Fannie and Freddie can now earn, there is no mechanism in place allowing either Fannie or Freddie to repurchase any government-held preferred stock.
High-Profile Investors Fight for Private ShareholdersTwo recent statements by high-profile investors in Fannie Mae and Freddie Mac have huge political significance. Ralph Nader in an op-ed piece published in the Wall Street Journal on May 24 said he was a shareholder in both GSEs and that common shareholders of Fannie and Freddie should fight against the federal government's "great Fannie and Freddie rip-off."
"The zombie common shareholders have no rights or remedies against Fannie and Freddie, both operationally active companies, or their regulator -- the Federal Housing Finance Agency," Nader wrote, adding that "FHFA ordered the Fannie and Freddie boards and executives to suspend communications with shareholders and abolish the annual stockholders meeting." Despite the continued cries to "break up Fannie and Freddie" from some politicians and pundits, President Obama and Congress have been in no hurry to come to an agreement on a way forward for home financing in the U.S. During an economic recovery that has included a slow increase in employment, there has been understandable hesitation to radically transform the largest segment of the economy.
You may be shaking your head at how unlikely it might be for the junior preferred dividends to be restored, but the junior preferred shareholders could be "made whole" in another way. Fairholme's letter on Monday contained some very interesting comments. Fairholme (and therefore Berkowitz) said "there are no substitutes. Fannie and Freddie currently purchase or insure 6 out of every 10 home mortgages in America. Today, they are stronger than ever -- enabling the United States Treasury to rapidly recoup its temporary emergency investments in both entities." Of course, those who wish to see Fannie and Freddie, with $5.2 trillion in assets, simply "go away," may forget that even if the GSEs were to be broken up, all that mortgage paper would still exist, and shareholders would have claims on those assets.
Fairholme made it pretty clear that hundreds of thousands of investors -- voters -- would be displeased if the president and Congress were to force the GSEs to continue paying outsized dividends to the Treasury while not allowing Fannie or Freddie to repurchase any of the government's senior preferred shares. Fairholme also neatly tied its offer of assistance to the government's conversion of senior preferred shares in American International Group to common shares, which enabled AIG to move past its bailout, with the Treasury and the Federal Reserve both claiming tidy profits . Such a move could raise the junior preferred shares to par value and would also enable Fannie and Freddie to begin rebuilding their capital levels, since they would no longer be paying all of their earnings to the government. Then, like AIG, the GSEs could repurchase government-held common shares, thus lowering the share count, increasing earnings-per-share, and possibly setting up huge gains for the common stockholders. Anticipating the expected negotiations between President Obama and Congress over the GSEs future, Nader wrote that "the common shareholders of Fannie and Freddie need to organize and make their voices heard in Washington. Clearly, they should have a say in how Fannie and Freddie are managed -- in the board room and in Congress -- from here onward."