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. 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. According to the report, Senators Corker and Warner would see Fannie and Freddie liquidated within five years, with the U.S. Treasury taking over GSE mortgage guarantees, and "liquidation first would go to the U.S. government as the senior preferred shareholder in each of the companies, and then to holders of junior preferred shares, followed by holders of the common shares." It is very significant that senators of both parties are finally taking all classes of Fannie and Freddie shareholders into account.
The comments from Fairholme could point the way to a deal under which government-held preferred shares could be converted to common shares, thus making the earnings of Fannie and Freddie available to all shareholders, and enabling the GSEs eventually to repurchase the government-held preferred shares. This would be similar to the way in which the massive bailout of American International Group ( AIG) was resolved. In a note to clients on Tuesday discussing the senators' draft bill, FBR analyst Edward Mills wrote "while this legislation faces significant hurdles and GSE reform is still a long ways off, this legislation is significant as it marks the most constructive bipartisan effort yet to move Fannie and Freddie beyond conservatorship." According to Mills, the inclusion of any consideration for non-government shareholders of Fannie and Freddie at this early stage of the political process could lead to a "negative press reaction." "Should the press develop the narrative that Congress is rewarding 'speculative bets' on these securities, we could see efforts to change or modify this provision," Mills wrote. "Not knowing how the final bill will be drafted, it is also difficult to determine what, if any, economic value would be left after Treasury has been repaid its investment." A knee-jerk hostile press relation to the "evil investors" holding junior preferred and common shares of Fannie and Freddie may make for a rough ride in Washington, but the senators will also have voters in mind. After all, Fairholme in its announcement on Monday referred to "thousands of shareholders" of mutual funds holding GSE shares. -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn