Big Feet! Fannie, Freddie Soar as Hedge Funds Get Good News on Two Fronts (GSEs + FHA/VA Account For 63% Of Single Family Mortgage Debt Outstanding)

Fannie Mae and Freddie Mac were placed into conservatorship in September 2008, so it has been over ten years after that they may be finally released from conservatorship with their regulator, FHFA. So, Fannie and Freddie may be going home … to the private market.

(Bloomberg) — Fannie Mae and Freddie Mac soared as hedge funds and other investors that have long hoped to make a windfall on their investments in the mortgage giants got a double-dose of good news.

First, shareholders won an important legal victory after markets closed Sept. 6 that gave them renewed optimism of getting their hands on billions of dollars in company profits that now go to the government.

Then, Treasury Secretary Steven Mnuchin said Monday that he will soon reach a deal that allows Fannie and Freddie to hold on to some of their earnings, so they can start rebuilding their capital buffers.

The step is considered crucial in eventually freeing the companies from federal control, which has been their status since the 2008 financial crisis. That’s because Fannie and Freddie are currently restricted from holding more than $3 billion in capital apiece, far short of what they would need to weather another housing crash as private companies.

Fannie jumped 26% to $3.42 as of 11:23 am in New York trading, reaching its highest level since Feb. 2017. Freddie rose 25% to $3.22, also its highest level in more than two years.

Among investors benefiting from the gains are some of the biggest names in finance, including John Paulson, Bill Ackman’s Pershing Square Capital Management and Blackstone Group Inc.

Treasury is “in the process of negotiating” a plan for Fannie and Freddie to retain earnings with the Federal Finance Housing Agency, Fannie and Freddie’s regulator, Mnuchin said early Monday in an interview with Fox Business “We expect a near-term agreement to retain their earnings,” he said.

Revamping Sweep
For Fannie and Freddie to hold on to their earnings, Treasury and FHFA would have to halt or revamp a controversial policy implemented in 2012 during the Obama administration, known as the net worth sweep, that requires the companies to send virtually all their profits to the Treasury.

Hedge funds and other investors that own Fannie and Freddie shares have long fought to end the sweep through litigation, claiming it was illegal. The shareholders won a big victory Sept. 6 when a panel of federal appeals court judges overturned a lower ruling that had backed the government’s right to take all of the mortgage giants’ profits.

The Fifth Circuit appeals court judges, based in New Orleans, also concluded last week that the structure of the FHFA is unconstitutional. Investors still face many hurdles, as the decision just kicks the case back to the lower court. Many other federal courts have ruled against the shareholders, making it more likely that an appeal could ultimately be heard by the Supreme Court if the case isn’t settled before then.

Litigating Shareholders
Fannie and Freddie don’t lend money to home buyers. Instead, they purchase mortgages from banks and other lenders and package them into bonds. Those securities have guarantees that protect investors from the risk of borrowers defaulting. Fannie and Freddie backstop nearly half of the U.S.’s $10 trillion of home loans, a process that keeps the mortgage market harming and borrowing rates low.

Fannie and Freddie were put into federal conservatorship in 2008 as the housing market cratered and were sustained by taxpayer aid. They have since started making money again and paid $115 billion more in dividends to the Treasury, through the net profit sweep, than they received in bailout funds.

Assuming that Fannie and Freddie would eventually released, hedge funds started buying their shares for pennies in the years after the crisis. Paulson & Co., Pershing Square and Blackstone Group’s GSO Capital were among those who got in on the trade.

Until now, shareholders have mostly suffered setbacks in their attempts to overturn the profits sweep. Their Sept. 6 win follows what also might be a watershed moment in Fannie and Freddie getting out of the government’s grip: the release of a Treasury report a day earlier that outlines the Trump administration’s plan to end the conservatorships.

Treasury Report
The Treasury document laid out dozens of suggested reforms to protect Fannie and Freddie from another housing crash, shrink their dominant market shares and create new competitors to the companies. Yet, it is only an initial step in what still would be a long and arduous road to freeing the companies from the government’s grip.

The Treasury Department’s proposal left much to be ironed out, signaling many of the suggested changes may not come until after the 2020 presidential election. And if a Democrat beats President Donald Trump next year, the overhaul would likely be scrapped all together.

Mnuchin said Monday that while he hopes to work with Congress to implement changes to Fannie and Freddie over the next three to six months, he is “perfectly comfortable” making administrative fixes if necessary. Only Congress can create competitors to Fannie and Freddie. But there is much the Trump administration can do on its own with FHFA, including ending the profit sweep.

The Treasury secretary will testify tomorrow on the administration’s plan before the Senate Banking Committee. Joining Mnuchin will be FHFA Director Mark Calabria and Housing and Urban Development Secretary Ben Carson.

The officials are expected to face aggressive push back for Democratic lawmakers, who are concerned that the administration’s proposals will do more to help hedge funds than assist consumers in getting loans, particularly lower-income buyers.

Both Fannie Mae and Freddie Mac saw a surge in their equity price on the news.

fanniedasboard

freddiedash

The GSEs Fannie and Freddie account for nearly 44% of single-family mortgage debt outstanding. Note that GSEs and the Federal government (mostly FHA) jointly account for  63% of mortgage debt.

Screen Shot 2019-09-09 at 12.53.17 PM

Note that after the financial crisis, the FHFA Director Edward DeMarco and FHA Commission David Stevens promised to shrink the footprints of government lending/insurance. Yet they both rose in footprint size.

Here is Treasury’s report on Housing Finance Reform. While it seems to seek a shrinking government footprint, history teaches us that the big foot of government only increases.

bigfoot

 

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