Summary
Bill Ackman says time is on the side of investors, as the “truth” will prevail.
NY Times raises a banner for shareholders by questioning Obama’s veil of secrecy.
Common shares could eventually reach a full valuation when the companies recapitalize through earnings.

One thing shareholders of Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) ask themselves on a daily basis is whether the system works. Does the court system protect citizens from illegal acts? Does the legislative process fix injustices? Can the truth be revealed when President Obama’s Treasury hides behind the veil of presidential privilege?

These questions take time to answer, but many shareholders believe the answer is ‘yes’ to all three. They’ve patiently waited as $225 billion of equity capital have been removed from the balance sheets of their companies and sent to Treasury for general deficit reduction. This has become the most profitable bailout of any system in the history of the world, but the resulting cash payments have also created an untenable and delicate position for the companies, as they operate without sufficient capital.

In an interview with Bloomberg, Bill Ackman recently said,

“Fannie and Freddie are the - collectively, the largest financial institutions in the world, right. They’ve got almost $6 trillion of outstanding obligations.
Embarrassingly, they are also the least well capitalized financial institution in the world, right. If you think of them as one institution, they have no capital.”
On whether the government can eventually fix this problem, Ackman added,

“The government is not one unified body. It’s a series of people. There are a lot of very intelligent people who work in the Senate and in the Congress. And a, you know, I think that ultimately, truth prevails. That’s been my experience as an investor and my experience in life. And we need to recapitalize Fannie and Freddie.”

New York Times Raises a Banner for Shareholders

Months ago, Gretchen Morgenson reported some startling revelations found in an internal Treasury department memo from 2010 that appeared to promote a secret policy that amounted to a plan to wipe out the existing shareholders. At the time, the 18,000 shareholders of the companies were relying on public statements from Treasury and FHFA that they would “preserve and conserve” assets and restore the entities to a “safe and sound” condition.

Unfortunately, Treasury had other plans, which they enacted on August 17, 2012. With the creation of a “net worth sweep,” Treasury has been able to permanently extend the nationalization of Fannie Mae and Freddie Mac. Shareholders have been pushed aside for the purpose of reducing the deficit.

Now, Morgenson strikes again with a piece that questions the Obama administration’s veil of secrecy. She writes,

On Aug. 17, 2012, the federal government began expropriating all the earnings ofFannie Mae and Freddie Mac, the mortgage finance giants that succumbed to the 2008 crisis.
Now the government is taking extraordinary measures to keep secret the deliberations surrounding that action. What exactly is it trying to hide?
She adds,

Previously undisclosed court records show that the Justice Department has assertedpresidential privilege to prevent 45 documents from being produced. These materials - emails, draft memos and news releases - were created by officials at the Treasury Department and the Federal Housing Finance Agency, the overseer of Fannie and Freddie since they collapsed in 2008.
…
Officials at the Treasury and F.H.F.A. claim that disclosure of documents relating to their actions would destabilize the economy and financial markets and raise mortgage rates.
Really? The documents the judge has ordered the government to produce were created three to seven years ago. How could they unsettle the markets now?
The answer to this question may be unsettling to the financial markets because the truth is that neither the Bush administration or the Obama administration should have placed or kept the companies in conservatorship. The fact that the companies have paid all of the bailout funds back and earned a healthy profit for taxpayers is evidence that they may never have needed a bailout in the first place.

The Opinion Shift With Republicans

In an interesting change of pace, the debate over the future of Fannie and Freddie appears to be shifting to groups within the Republican party.

On one hand, we have Peter Wallison and Ed Pinto at the American Enterprise Institute. Their failed narrative of the financial crisis pins most of the blame on the government. They like to point fingers at Fannie and Freddie. They ignore the fraud that occured with loan originators and the billions of dollars in subprime settlements over private label securities. They ignore the fact that Fannie and Freddie’s business model succeeded for 70 years prior to the crisis and the conforming loans that fit this model performed admirably after the housing bubble burst. And when people question their assertions they publicly brand them as liberals, another affirmation that their message is politically charged. It should be noted that Wallison wrote the only dissenting opinion on the Financial Crisis Inquiry Commission and the other 9 experts fully disagreed with him.

On the other hand, we have Mark Calabria of the CATO institute. In a recent blog post, he wrote that the GSE’s housing policy is not really the main cause of the housing crisis. He agrees with economist Mark Zandi’s analysis that shows that Fannie and Freddie loan losses were only 2.7% versus 5.8% for other depositories. Calabria correctly points out that leverage is a primary concern for financial institutions and for the regulators that oversee them. He says that the GSEs lacked the required capital to make it through the housing crisis. This is where we see the shift occurring.

A few weeks ago, FHFA Director Mel Watt sat through four hours of grilling by the House Financial Services Committee. Almost every Republican lawmaker questioned the authority of the FHFA to fund the affordable housing trusts while the GSEs lacked any equity cushion to absorb losses. Multiple Republicans questioned the excessive levels of leverage in the system.

The middle ground is where progress happens in legislation. One thing that almost everyone can agree on is that Fannie and Freddie need more capital if they are going to continue operating. Currently, Republicans appear to be the only ones raising these issues.

Common Stock Valuation

Last week, Bill Ackman, when speaking about Fannie and Freddie, was also quoted as saying,

“It’s the most interesting risk-reward that I’m aware of in the capital markets right now.”
In the past, Ackman has said that he believes the government’s warrants in Fannie and Freddie could be worth substantially more than the amount that the Obama Administration is budgeting for over the next ten years. The Obama budget recently included $191 billion in value from the two companies over the next ten years. Ackman says that the government’s warrants could be worth more than $300 billion in the long run. So, a common sense approach would be for the White House to listen to Wall Street on this one.

While the common stock is currently trading less than $3, a fair price target for a fully capitalized Fannie or Freddie could be $25, based on a low multiple. In the long run, the companies could actually grow earnings and equity, creating more value. That being said, shareholders need to wait patiently. It could take a while to reach a consensus and as Bill Ackman said, “ultimately, truth prevails.”

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