Bruce Berkowitz on Fannie Mae, Freddie Mac: Mission Accomplished

NEW YORK ( TheStreet) -- Fairholme Capital's Bruce Berkowitz believes it is time for the government to return Fannie Mae ( FNMA) and Freddie Mac ( FMCC) to private hands, as housing giants are back to making profits again, five years after their bailout.

In an interview with CNBC on Wednesday, the investor known for his deep-value, often contrarian, stock-picking style, said the agencies are very valuable franchises and are essential to the running of the mortgage market, as their public mission requires them to step in when private capital becomes scarce.

"There would be no middle-class housing, no cornerstone of American dream of housing, no 30-year mortgage, without Fannie and Freddie. There is no alternative," he said.

Fannie Mae and Freddie Mac were placed into government conservatorship in September 2008, a bailout that cost taxpayers $188 billion in total. Shares plummeted to pennies on the dollar upon the bailout, as investors lost hope that the agencies will ever make a profit.

But in the aftermath of the housing collapse, the agencies have tightened underwriting standards tremendously and increased guarantee fees to shore up profits. These measures, along with improving credit quality thanks to the housing recovery, has led to record profits at the companies. Fannie Mae reported a profit of $10.1 billion in the second quarter of 2013, its sixth straight quarterly profit. Freddie Mac posted a profit of $5 billion in the second quarter.

Still, Congress is now examining two proposals that call for the end of Fannie and Freddie and a new system of housing finance, where private capital plays a greater role.

But Berkowitz and other investors are now calling for a return to the old model.

"Fannie Mae and Freddie Mac have accomplished their mission. They did it. Mission Impossible accomplished," Berkowitz said. "It is time for them to be resuscitated, rehabilitated and to let equity build in these companies and prepare for the next rainy day."

Berkowitz is reopening his $8 billion Fairholme Fund, which makes focused bets on deeply undervalued stocks, to new investors.

The fund manager is among a small group of professional investors who have scooped up junior preferred shares on the theory that the government-sponsored enterprises are now in a position to repay the government, with money left over to pay dividends on junior preferreds.

"The market perceives Fannie and Freddie near death and that makes no sense to me. You can buy the preferreds at such discounts, you can get unbelievable yields," he said.

But that's if they are paid a dividend. Junior preferred shareholders can't get a dividend as things currently stand.

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.

By September, the agencies would have paid $146 billion in dividends to the government, but the payments would not constitute a repayment. Analysts predict taxpayers would be made whole by the end of 2014. But unless the 2012 amendment is reversed, junior preferred and common shareholders of Fannie and Freddie won't see a dime.

Berkowitz is now suing the government, arguing that the amendment violates property rights.

"The 2012 amendment is based as though we are in 2008," Berkowitz told CNBC. "I really don't understand it. The common sense of it does not make sense -- that you can just snap your fingers and take everything."

Shareholders should be given a piece of the pie once the government has recouped its investment, he argues. In any case taxpayers stand to make a handsome profit from the bailout.

"The government is an unbelievable hedge fund. This was a brilliant investment," he said.

The investor lawsuits have little sympathy in Washington. "We didn't take any of their property," Barney Frank, former Massachusetts Rep. Barney Frank, said of the argument, in an interview with TheStreet.

"They're buying up property that we've taken from other people. I don't know enough about takings law to tell you what the answer is on that. I would say this: I wouldn't take it before a jury if I were they."

Republican Senator Bob Corker of Tennessee, who is behind a bipartisan bill calling for the end of Fannie and Freddie, has also dismissed their claims in the press.

But the lawsuit, if successful, could upend efforts to overhaul housing finance in the country.

Berkowitz has bought shares of AIG ( AIG), Bank of America ( BAC), Goldman Sachs ( GS), Morgan Stanley ( MS) and other financial stocks that were battered by the 2008 crisis.

Those investments have proved a rocky ride for shareholders of Fairholme fund, as for a while it looked like the bleeding would not stop. But investors who held on have made fabulous returns on their investments.

"At Fairholme, we buy essential, critical, systemically important companies that look like they are down and out but franchises are still intact, they are still absolutely essential to companies and are here to stay and it is no different for Fannie and Freddie."

Berkowitz also talked about his investments in AIG ( AIG). "I expect some very good returns from AIG," he said, arguing that the stock still trades below book.

See the full interview here

For more on Fannie and Freddie and the future of housing finance, read 5 Years Later, Mortgage Market Still Needs Fannie Mae, Freddie Mac

-- Written by Shanthi Bharatwaj New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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