Fannie and Freddie Show Huge Gains for Week

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) and Freddie Mac ( FMCC) remained red hot on Friday, with both companies' common shares showing very strong returns for the week.

Fannie Mae's common stock was up 8% on Friday to close at $3.30, while Freddie Mac's shares rose over 6% to close at $3.08. Pershing Square, led by Bill Ackman, on Friday disclosed in a filing that it had taken a 9.98% stake in common shares of Fannie and a 9.77% stake in common shares of Freddie.

Fannie Mae and Freddie Mac were taken under government conservatorship at the height of the credit crisis in September 2008. The U.S. Treasury holds $117.1 billion senior preferred Fannie Mae shares and $72.3 billion in senior preferred Freddie Mac shares. Under their modified bailout agreements, the government sponsored enterprises, or GSEs, must pay all earnings to the government in excess of minimal capital cushions of $3 billion apiece.

Following their next dividend payments in December, the government will have received $185.3 billion in dividends from Fannie and Freddie, for a five-year investment of $189.4 billion. But there's no mechanism in place for either GSE to repurchase any government-held preferred shares.

Fairholme Capital and other institutional investors holding common and/or junior shares of Fannie and Freddie have filed multiple lawsuits against the government, saying the modified conservatorship was an illegal seizure of their property.

Fairholme founder Bruce Berkowitz on Wednesday proposed that his mutual fund management firm and a group of private equity investors take over the operating assets of the two government sponsored enterprises, or GSEs.

Under Berkowitz's proposal, the balance sheets of Fannie and Freddie -- including $4.7 trillion in mortgage loans -- would be wound down, while his firm and other institutional investors would provide $17.3 billion to take over the GSEs staffs and other operating assets, forming two new companies to take over the GSEs leading role in the U.S. secondary mortgage market. The proposal also calls for private investors to receive $34.6 billion from Fannie and Freddie in exchange for their preferred shares in the GSEs.

Berkowitz's offer has little chance of passing muster in Washington, but the Pershing Square disclosure shows that private equity investors clearly see a light at the end of the tunnel, with a significant value recovery for non-government shareholders of the GSEs.

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