Bruce Berkowitz Sues Government Over Fannie, Freddie Preferreds

NEW YORK ( TheStreet) -- Bruce Berkowitz's Fairholme Fund late on Tuesday announced plans to sue the government, arguing that the government violated property rights when it amended the terms of the bailout agreement of housing giants Fannie Mae ( FNMA) and Freddie Mac ( FMCC).

The suit is the second of its kind to be filed in a week. On Sunday, hedge fund Perry Capital filed a lawsuit making a similar argument.

Berkowitz is among a group of professional investors who have been betting on the junior preferred shares of the housing giants on the theory that since the government-sponsored enterprises are profitable, they will one day repay the government, with money left over to pay dividends on junior preferreds.

But that is not possible as things currently stand.

Fannie Mae and Freddie Mac were placed into government conservatorship in September 2008. Under the 2008 deal, the Treasury acquired preferred shares worth $1 billion in the GSEs, paying 10% annual dividends. The Treasury also got warrants to buy 80% of the outstanding common stock and agreed to lend up to $100 billion to the GSEs, a total that was later raised to $200 billion.

But in 2012, Treasury amended the terms of the deal, scrapping the 10% dividend. Instead, the new terms required Fannie and Freddie each to sweep all profits in excess of $3 billion to the Treasury.

This prevents the agencies from recapitalizing themselves.

Now both agencies are once again making profit and it has been a windfall for the government. But owners of junior preferred shares are unlikely to see dividends unless the Treasury reverses the amendment.

""Fannie Mae and Freddie Mac are rapidly repaying the Government," said Berkowitz in a press release. "Their success should surprise no one given the value of Fannie and Freddie. Once the Government has recouped its investment, The Fairholme Fund - on behalf of our shareholders who are predominantly individual Americans with an average investment in the Fund of $43,000 - is owed a contractually specified, non-cumulative dividend for its investment in these companies. As solvent, highly profitable companies, Fannie and Freddie should honor all outstanding obligations to their investors."

The value-oriented fund announced that it is filing suits this week in both the United States Court of Federal Claims and the United States District Court for the District of Columbia "to protect its rights as an owner of preferred stock in Fannie Mae and Freddie Mac, including the right to receive dividends from the profitable companies."

Last month, private shareholders of Fannie Mae and Freddie Mac filed a suit challenging the legality of the companies' takeover.

The suits from Berkowitz and Perry, however, do not challenge the takeover but the 2012 amendment, arguing that it violates the principles of "conservatorship" .

-- Written by Shanthi Bharatwaj in New York.

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