Nov. 23, 2014 8:24 AM ET

* With the pending change in Congressional leadership, some politicians and pundits have begun a push to end FHFA’s conservatorship of Fannie.
* Returning Fannie to the shareholders by ending the conservatorship has a strong intuitive appeal.
* Ending the conservatorship without first resolving the value destroying elements of the Restated PSPA, will only help the Government by delaying resolution of the shareholder suits.

One of the consequences of the new Congressional blood are articles discussing the possible end of the Fannie Mae (OTCQB:FNMA) conservatorship. See the article by Investors United featured in ValueWalk here. See a Bloomberg News article quoting Senator Tim Johnson, urging Mel Watts to work toward ending the conservatorship here, and a blog article discussing Senator Johnson’s comments here.

Being long Fannie common, this is a terrible idea. First, let’s talk about the practical challenges. Then, second, if those challenges are overcome, the implications on pending Fannie litigation.
The practical challenge

Prior Seeking Alpha articles outline some Fannie litigation issues and background documents here, here, and here.

The articles and pundits urging FHFA to release Fannie from conservatorship ignore the fact that it is not in FHFA’s power to unilaterally exit conservatorship. The Amended and Restated Senior Preferred Stock Purchase Agreement dated September 26, 2008, (Restated PSPA) provides:

5.3. Conservatorship. [Fannie Mae] shall not (and Conservator [FHFA], by its signature below, agrees that it shall not), without the prior written consent of [Treasury], terminate, seek termination of or permit to be terminated the conservatorship of [Fannie Mae]… other than in connection with a receivership pursuant to Section 1367 of the FHE Act [12 USC 4617].

Translation: FHFA cannot terminate Fannie’s conservatorship without the Treasury’s consent. As a federal agency, the Treasury will only act at the direction of the current administration. Possible legislation passed with the new Congressional majorities requiring FHFA to terminate the conservatorship is not a simple solution for two reasons: First, such legislation is not likely to survive a presidential veto. Second, given the current scored earth relationship between the President and Congress, the President would likely simply ignore the legislation prompting more litigation.

[Reader appeal: This is an area where I don’t claim any in-depth legal expertise and would welcome any reader cites to statutory authority for terminating Fannie’s conservatorship. Even if such authority exists, FHFA is still bound by the Restated PSPA §5.3. Note: §5.3 does support the claim in some of the suits that FHFA has illegally subjected its decision making authority to another government agency, but that’s another issue.]

So, as a practical matter, unless a court orders otherwise or something dramatically changes politically, Fannie will remain in conservatorship until sometime after the next administration begins in early 2017.
The Impact on Pending Fannie Litigation

As a thought experiment, let’s consider the impact on Fannie shareholders if someone waves a magic pen and Fannie is removed from conservatorship with a new Board of Directors and executive leadership appointed by FHFA.

First, the new Fannie remains subject to all the contracts entered into by FHFA during the conservatorship. That would include all the purchases and sales of financial instruments in the ordinary course of Fannie business. It would also include the Restated PSPA, referred above, with all the amendments. Hence, the new Fannie would be subject to:

1) The Sweep Amendment, which quarterly transfers all Fannie profits to the Treasury above a shrinking Capital Reserve which goes to zero in 2018.

2) The Warrant, which when exercised by the Treasury gives the Treasury common shares equal to 79.9% of all outstanding common ownership.

3) The Preferred Senior Stock, with its liquidation preference.

4) The mandatory shrinking maximum limit on the amount of Mortgage Assets Fannie may own which goes from not more than $650B as of December 31, 2012, decreasing each year to 85% of the previous year to not less than $250B, in approximately 2018.

So while ending the conservatorship is a necessary step to restoring Fannie to the shareholders, ending the conservatorship does not change any of the value destroying elements of the Restated PSPA.

Second, terminating the conservatorship will greatly complicate the outstanding suits against FHFA and the Treasury. Step back and consider litigation strategy from the defendant’s perspective.

The first goal is to win. If you can’t win on the merits, the second goal is to create downside for the plaintiff by counter suing to set up an eventual settlement if the plaintiff can be convinced it too has a downside. If counter suing is not an option, the final goal is delay.

more
http://seekingalpha.com/article/2704655-fannie-mae-lets-not-end-the-conservatorship-just-yet