FNMAS - Fannie mae /preferred stock series S

[JRH]

Curious to hear others' thoughts.

 

I think many of those thoughts are very valid, but I personally see huge differences between the key 2008 ("bailout") and 2012 ("third amendment") events.

 

My understanding is that "public purpose" actions are still subject to the requirement for "just compensation" if private property is taken.  In other words, the one is not a justification for bypassing the other.  The 2012 amendment doesn't seem to have given any compensation at all for the taking.

[Luke 532]

The 2012 amendment doesn't seem to have given any compensation at all for the taking.

 

This is the focus of my investment.  I believe it is pretty clear that nothing was given for just taking the profits, and that at least SOME recovery will be given to holders of FNMAS.

[worldaccordingtoGARP]

The 2012 amendment doesn't seem to have given any compensation at all for the taking.

 

This is the focus of my investment.  I believe it is pretty clear that nothing was given for just taking the profits, and that at least SOME recovery will be given to holders of FNMAS.

 

Thanks for the welcome!  There does seem to be something with the 2012 amendment, but isn't the context of the 2008 bailout relevant for determining what kind of compensation is "just" in that case?  The argument that there is value in 2012 "taken" in exchange for nothing ends up tautological at a certain point when viewed in the scope of "the value would most definitely be $0 were it not for the government's bailout and open-ended contributions." 

 

Fair market value is a fairly straightforward question.  It explicitly excludes "intrinsic value" and focuses solely on what willing buyers and sellers would pay for the asset with all facts known.  With publicly traded securities, it's purely the value AT THAT DATE, so liquidation value would be irrelevant.  The one twist is that there is an exemption from using public information when there are distressed/forced buyers and sellers.  For many reasons, I don't think the distressed exemption would be valid here.

 

So I guess my follow-up question is how do you determine "just compensation" in light of the 2008 bailouts, as it pertains to the 2012 amendment?  And notwithstanding that point, does each action w/r/t Freddie/Fannie require further "just" compensation following the original act itself?

 

Next, much of Perry Capital's argument is centered around the distinction between receivership and conservatorship and the various rights attached to each, alleging the Government made clear it would be based on "principles of conservatorship [/http://images.politico.com/global/2013/07/07/treasury_suit_announcement.html]." But, my understanding is the gov't left open the option for receivership[/http://www.fhfa.gov/webfiles/35/FHFACONSERVQA.pdf]:

 

Q: Can the Conservator determine to liquidate the Company?

A: The Conservator cannot make a determination to liquidate the Company, although, short of that, the Conservator has the authority to run the company in whatever way will best achieve the Conservator’s goals (discussed above). However, assuming a statutory ground exists and the Director of FHFA determines that the financial condition of the company requires it, the Director does have the discretion to place any regulated entity, including the Company, into receivership. Receivership is a statutory process for the liquidation of a regulated entity. There are no plans to liquidate the Company.

Q: Can the Company be dissolved?

A: Although the company can be liquidated as explained above, by statute the charter of the Company must be transferred to a new entity and can only be dissolved by an Act of Congress.

 

 

Why wouldn't the gov'ts response to an adverse ruling simply be to pivot to receivership?  Especially considering much of the goals can be accomplished merely by the Director of FHFA (and w/out Congress) and if necessary, by an act of Congress which despite the hostile partisan environment does give bipartisan support to such a liquidation?

[JRH]

Thanks for the welcome!  There does seem to be something with the 2012 amendment, but isn't the context of the 2008 bailout relevant for determining what kind of compensation is "just" in that case?  The argument that there is value in 2012 "taken" in exchange for nothing ends up tautological at a certain point when viewed in the scope of "the value would most definitely be $0 were it not for the government's bailout and open-ended contributions." 

 

Despite the fact that I have so often in the past been willing to speculate, this is going to be one of the few times where I admit my ignorance and abstain! :)  In a sense, it sounds like the question is where contract law ends and constitutional law begins.

 

The one thing I am certain of is that viewed from the perspective of contract law, the two actions (2008, 2012) are completely discrete events and the 2012 event cannot be looked at as a modification of the earlier contract unless the parties to that contract both willingly entered it as such, which appears to be the furthest thing from the case.

[worldaccordingtoGARP]

Thanks for the welcome!  There does seem to be something with the 2012 amendment, but isn't the context of the 2008 bailout relevant for determining what kind of compensation is "just" in that case?  The argument that there is value in 2012 "taken" in exchange for nothing ends up tautological at a certain point when viewed in the scope of "the value would most definitely be $0 were it not for the government's bailout and open-ended contributions." 

 

Despite the fact that I have so often in the past been willing to speculate, this is going to be one of the few times where I admit my ignorance and abstain! :)  In a sense, it sounds like the question is where contract law ends and constitutional law begins.

 

The one thing I am certain of is that viewed from the perspective of contract law, the two actions (2008, 2012) are completely discrete events and the 2012 event cannot be looked at as a modification of the earlier contract unless the parties to that contract both willingly entered it as such, which appears to be the furthest thing from the case.

 

I had a conversation with CrowdTurtle which put my understanding in a different light (and please do correct me if I misstate any of this).  The argument goes as follows: Once the full extent of the bailout money is paid back, the question of "value" will shift towards the private argument.  Further, once all bailout money is repaid, public opinion in the political arena will evolve to reflect that fact.  The bullish scenario would then have the GSEs returning fully to private hands due to the skew of incentives from many political constituencies, with the risk scenario being the run-off of Freddie/Fannie with any proceeds above and beyond the gov'ts contribution returned to private investors.

 

One thing that is particularly interesting are the alliances amongst Constitutional lawyers and advocates in this case.  There are known lefties aligned with known righties on the shareholders' side, and even Ralph Nader.  It's the Congressional arena that remains the tricky point, so long as public opinion is strongly opposed to bailouts that reap taxpayer losses and private sector gains.  That's why I think CrowdTurtle's point is so powerful: it's not about the discourse today, it's about what the discourse will look like when the profits being reaped are far in excess of the committed capital from Uncle Sam.

[nkp007]

Thanks for the welcome!  There does seem to be something with the 2012 amendment, but isn't the context of the 2008 bailout relevant for determining what kind of compensation is "just" in that case?  The argument that there is value in 2012 "taken" in exchange for nothing ends up tautological at a certain point when viewed in the scope of "the value would most definitely be $0 were it not for the government's bailout and open-ended contributions." 

 

Despite the fact that I have so often in the past been willing to speculate, this is going to be one of the few times where I admit my ignorance and abstain! :)  In a sense, it sounds like the question is where contract law ends and constitutional law begins.

 

The one thing I am certain of is that viewed from the perspective of contract law, the two actions (2008, 2012) are completely discrete events and the 2012 event cannot be looked at as a modification of the earlier contract unless the parties to that contract both willingly entered it as such, which appears to be the furthest thing from the case.

 

I had a conversation with CrowdTurtle which put my understanding in a different light (and please do correct me if I misstate any of this).  The argument goes as follows: Once the full extent of the bailout money is paid back, the question of "value" will shift towards the private argument.  Further, once all bailout money is repaid, public opinion in the political arena will evolve to reflect that fact.  The bullish scenario would then have the GSEs returning fully to private hands due to the skew of incentives from many political constituencies, with the risk scenario being the run-off of Freddie/Fannie with any proceeds above and beyond the gov'ts contribution returned to private investors.

 

One thing that is particularly interesting are the alliances amongst Constitutional lawyers and advocates in this case.  There are known lefties aligned with known righties on the shareholders' side, and even Ralph Nader.  It's the Congressional arena that remains the tricky point, so long as public opinion is strongly opposed to bailouts that reap taxpayer losses and private sector gains.  That's why I think CrowdTurtle's point is so powerful: it's not about the discourse today, it's about what the discourse will look like when the profits being reaped are far in excess of the committed capital from Uncle Sam.

 

Yes, this is correct.

 

A powerful force that may come about is a shift in public opinion as the National Association of Realtors etc lobby everyone, which they have successfully done in the past.

 

If Americans hear that:

 

1) Fannie / Freddie have paid taxpayers back

2) The 30 year mortgage is at risk and home ownership costs will rise if F+F are wound down

 

then I think public opinion will shift pretty quickly. At that point Congress may realize that it will be a whole lot more profitable to spin-off F+F (and cash in on their 79.9% stake). The spun-off entities can maintain the current capital structure, have a government guarantee, but be put under numerous heavy restrictions (capital minimums, high down payments, etc.)

 

Ultimately, it's all about incentives. And in this case, the weight is almost all on one side.

 

 

[Luke 532]

Why wouldn't the gov'ts response to an adverse ruling simply be to pivot to receivership?  Especially considering much of the goals can be accomplished merely by the Director of FHFA (and w/out Congress) and if necessary, by an act of Congress which despite the hostile partisan environment does give bipartisan support to such a liquidation?

 

Excellent question!  I hope somebody chimes in with an answer.

[JRH]

A powerful force that may come about is a shift in public opinion as the National Association of Realtors etc lobby everyone, which they have successfully done in the past.

 

If Americans hear that:

 

1) Fannie / Freddie have paid taxpayers back

2) The 30 year mortgage is at risk and home ownership costs will rise if F+F are wound down

 

then I think public opinion will shift pretty quickly. At that point Congress may realize that it will be a whole lot more profitable to spin-off F+F (and cash in on their 79.9% stake). The spun-off entities can maintain the current capital structure, have a government guarantee, but be put under numerous heavy restrictions (capital minimums, high down payments, etc.)

 

Ultimately, it's all about incentives. And in this case, the weight is almost all on one side.

 

That could of course be true, but I don't know how you rely on those assumptions.  How confident could a person possibly be that we'll see that outcome?  I think if you have to make assumptions about legislators' actions at all, it's risky business.

 

But just to argue from Berkowitz's angle ("there is no alternative") - what is the alternative to Fannie/Freddie?  I suppose it is:

 

- We don't want to subsidize home ownership any more (I absolutely don't believe this one, I think that status quo is way too powerful).

- Some other entity besides Fannie/Freddie can do it. (remember Berkowitz's comment on health insurers in 2008? "The government doesn't have a division with 500k people in it somewhere that can take over private insurance."  How possible is it for some other entity to effectively subsidize home ownership?)

[worldaccordingtoGARP]

I don't see the links in here yet, but John Hempton's series on Freddie/Fannie at Bronte is a must read for anyone interested in this investment:

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_12.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_14.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_15.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_18.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_19.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_21.html

 

http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_25.html

 

http://brontecapital.blogspot.com/2009/09/modelling-fannie-mae-and-freddie-mac.html

 

http://brontecapital.blogspot.com/2009/09/fannie-mae-and-freddie-mac-closing.html

[MYDemaray]

 

But just to argue from Berkowitz's angle ("there is no alternative") - what is the alternative to Fannie/Freddie?  I suppose it is:

 

- We don't want to subsidize home ownership any more (I absolutely don't believe this one, I think that status quo is way too powerful).

- Some other entity besides Fannie/Freddie can do it. (remember Berkowitz's comment on health insurers in 2008? "The government doesn't have a division with 500k people in it somewhere that can take over private insurance."  How possible is it for some other entity to effectively subsidize home ownership?)

 

As we saw in the housing bubble, the private market will more than take care of financing during the good times.  It's the counter-cyclical piece that politicians would be ignoring if they do away with a housing backstop.  What happens to lending in the next cycle when all constituents leave the market?  We've already seen that Fannie/Freddie were the only game in town during the downturn.  Just when you think you've killed Freddie, in the next downturn you'll find out....he's baaaack!

[Luke 532]

NY Times on Fannie Mae.  This is good as public opinion is going to be important in this fight...

 

http://www.nytimes.com/2013/08/13/opinion/nocera-dont-kill-fannie-mae.html?_r=0

[Luke 532]

Joel Greenblatt Class on Housing and Freddie Mac

 

http://www.valuewalk.com/2013/08/joel-greenblatt-housing-stocks/

[Guest rwmcpar]

Just saw that luke. Nice.

[MYDemaray]

Larry Summers...no fan of Fannie/Freddie shareholders...unfortunately no mention on view of prefs: http://online.wsj.com/article/SB10001424127887324755104579070991436878668.html?mod=WSJ__MIDDLENexttoWhatsNewsFifth

[Uccmal]

I wrote this summary of my present thinking on the weekend.  I am working through the recent quarterlies on Fannie Mae. 

 

FNMA  Prefs

 

I am trying to get my head around this situation, so forgive me if some of it is a recap. 

 

Prefs are trading at about 23% of par (S series)

 

A) Will the government break up the GSE's? 

 

1) the GSEs provide backstop to greater than 50% of the market and this number doesn't seem to be dropping.

2) Starting a new company would require firing thousands of experienced workers and rehiring or replacing them somehow at the new entity.  This is no simple proposition, even though it may seem simple to congress.  The new entity would require government sponsorship, making it substantially the same as the existing entities.  Putting the existing GSEs into runoff would require layoffs, early retirements, pension and benefits handling of massive proportions.  I think we are looking at years.  I am not sure the political will can be sustained.  It is much easier for congress to spin the story and say that we have recouped the money, made a profit - look at how good we are.

 

On this one item I would say the logistics are difficult to say the least. 

 

B) Will the dividend on the prefs be restored? 

 

1) This question is essentially the same as "will the GSEs be privatized again?" 

 

Scenario a)  The government will want to keep the profits from the GSEs for itself.  This involves a number of problems for government.  First, it is very un- American for government to be in business for profit.  Second, the money itself becomes a problem.  The Dems will want to spend it on health care or some such, the GOP will want to spend it on security or the military.  It seems legislation on where the profits are to go will have to enacted.  Given the perpetual gridlock in Congress, is this even possible?

 

Scenario b) Once the bailout is paid back with some gravy, congress decides to sell warrants out to the public.  The prefs have their dividend re-instated.  The dividends on the prefs must be re-instated in order for new prefs to be issued, or a common stock dividend to be declared. 

 

Summary:

 

In Canada we have something of a tradition of having profitable crown corporations.  To my observation the US has no such tradition.  Even the Municipalities in the US are financed by public debt.  I just dont see the US federal government doing this.  Both parties in the US generally ascribe to a greater or lesser degree that government should not be in business that can be done privately. 

 

So, I think the likely outcome is what Bruce B. is suggesting.  I guess the issue then becomes timing.  On that I have no idea.  Certainly, if one is to take a position in the preferreds, it has to be well before there is talk of re-instating the payouts.

 

My reading so far of the recent quarterlies is that FNMA is investing heavily in technology to up date its business.  Business being done is increasing, not decreasing!

 

Thoughts?

 

 

No position, yet.

 

[valuecfa]

I wrote this summary of my present thinking on the weekend.  I am working through the recent quarterlies on Fannie Mae. 

 

FNMA  Prefs

 

I am trying to get my head around this situation, so forgive me if some of it is a recap. 

 

Prefs are trading at about 23% of par (S series)

 

A) Will the government break up the GSE's? 

 

1) the GSEs provide backstop to greater than 50% of the market and this number doesn't seem to be dropping.

2) Starting a new company would require firing thousands of experienced workers and rehiring or replacing them somehow at the new entity.  This is no simple proposition, even though it may seem simple to congress.  The new entity would require government sponsorship, making it substantially the same as the existing entities.  Putting the existing GSEs into runoff would require layoffs, early retirements, pension and benefits handling of massive proportions.  I think we are looking at years.  I am not sure the political will can be sustained.  It is much easier for congress to spin the story and say that we have recouped the money, made a profit - look at how good we are.

 

On this one item I would say the logistics are difficult to say the least. 

 

B) Will the dividend on the prefs be restored? 

 

1) This question is essentially the same as "will the GSEs be privatized again?" 

 

Scenario a)  The government will want to keep the profits from the GSEs for itself.  This involves a number of problems for government.  First, it is very un- American for government to be in business for profit.  Second, the money itself becomes a problem.  The Dems will want to spend it on health care or some such, the GOP will want to spend it on security or the military.  It seems legislation on where the profits are to go will have to enacted.  Given the perpetual gridlock in Congress, is this even possible?

 

Scenario b) Once the bailout is paid back with some gravy, congress decides to sell warrants out to the public.  The prefs have their dividend re-instated.  The dividends on the prefs must be re-instated in order for new prefs to be issued, or a common stock dividend to be declared. 

 

Summary:

 

In Canada we have something of a tradition of having profitable crown corporations.  To my observation the US has no such tradition.  Even the Municipalities in the US are financed by public debt.  I just dont see the US federal government doing this.  Both parties in the US generally ascribe to a greater or lesser degree that government should not be in business that can be done privately. 

 

So, I think the likely outcome is what Bruce B. is suggesting.  I guess the issue then becomes timing.  On that I have no idea.  Certainly, if one is to take a position in the preferreds, it has to be well before there is talk of re-instating the payouts.

 

My reading so far of the recent quarterlies is that FNMA is investing heavily in technology to up date its business.  Business being done is increasing, not decreasing!

 

Thoughts?

 

 

No position, yet.

 

You might also consider another angle which i consider the most relevant. Is the "expropriation" the government did legal? Will it hold up in court?

[MYDemaray]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

[FreeOption]

I wonder if this difference matters - gov't ruling benefits auto unions at the expense of creditors versus gov't ruling benefits gov't at the expense of creditors?

 

 

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

[Luke 532]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

 

That's the biggest question regarding FNMAS.  If logic and reason prevail then FNMAS holders should do very well.

[nkp007]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

 

One major and notable difference:

 

In this case, you have a growing pie. That makes it much easier to reach a solution that benefits more people.

[onyx1]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

 

That's the biggest question regarding FNMAS.  If logic and reason prevail then FNMAS holders should do very well.

 

It's even more than logic and reason, it's the law.  In a bankruptcy (or a receivership), the law gives the judge (or receiver) wide latitude is deciding the validity, status, and priority of claims.  In the case of the GSE's, they are neither in bankruptcy or receivership, but in a conservatorship where property rights of claimants are not interrupted.  Claimants (read: private preferred shareholders) continue to be protected under the takings clause of the 5th amendment of the US Constitution. 

[argonaut]

Does the link to Joel's class above still work? Or is there a different link available?

[constructive]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

 

That's the biggest question regarding FNMAS.  If logic and reason prevail then FNMAS holders should do very well.

 

It's even more than logic and reason, it's the law.  In a bankruptcy (or a receivership), the law gives the judge (or receiver) wide latitude is deciding the validity, status, and priority of claims.  In the case of the GSE's, they are neither in bankruptcy or receivership, but in a conservatorship where property rights of claimants are not interrupted.  Claimants (read: private preferred shareholders) continue to be protected under the takings clause of the 5th amendment of the US Constitution.

 

Conservatorship is a unique condition. Unlike bankruptcy which has an established set of bankruptcy law and rulings, there is virtually no conservatorship precedent. Thus there is a much wider latitude for judicial interpretation. And obviously, the fact that the conservatorships were enacted by Congress and executed by the Treasury and FHA will play into the court's decision.

 

The normal way to resolve takings clause violations is by paying "just compensation", which use the "fair market value". So even if the 2012 amendments are ruled a takings clause violation (a long shot in my opinion), the court could determine that the fair market value of FNMAS as of August 16, 2012 was $2.35 a share. Or worse, they could decide that the fair market value was $0 and $2.35 was just a speculative price.

[worldaccordingtoGARP]

While Conservatorship is unique, there are some well-established rules. This Q&A from FHFA explains some of the parameters nicely.  (http://www.fhfa.gov/webfiles/35/FHFACONSERVQA.pdf)

 

Two points worth emphasizing:

 

During the conservatorship, the Company’s stock will continue to trade. However, by

statute, the powers of the stockholders are suspended until the conservatorship is

terminated. Stockholders will continue to retain all rights in the stock’s financial worth;

as such worth is determined by the market.

 

The Conservator cannot make a determination to liquidate the Company, although, short

of that, the Conservator has the authority to run the company in whatever way will best

achieve the Conservator’s goals (discussed above). However, assuming a statutory

ground exists and the Director of FHFA determines that the financial condition of the

company requires it, the Director does have the discretion to place any regulated entity,

including the Company, into receivership. Receivership is a statutory process for the

liquidation of a regulated entity. There are no plans to liquidate the Company.

[onyx1]

After creditor treatment in the auto bankruptcies, it's hard to know if legality even matters in some cases involving the government...

 

That's the biggest question regarding FNMAS.  If logic and reason prevail then FNMAS holders should do very well.

 

It's even more than logic and reason, it's the law.  In a bankruptcy (or a receivership), the law gives the judge (or receiver) wide latitude is deciding the validity, status, and priority of claims.  In the case of the GSE's, they are neither in bankruptcy or receivership, but in a conservatorship where property rights of claimants are not interrupted.  Claimants (read: private preferred shareholders) continue to be protected under the takings clause of the 5th amendment of the US Constitution.

 

Conservatorship is a unique condition. Unlike bankruptcy which has an established set of bankruptcy law and rulings, there is virtually no conservatorship precedent. Thus there is a much wider latitude for judicial interpretation. And obviously, the fact that the conservatorships were enacted by Congress and executed by the Treasury and FHA will play into the court's decision.

 

The normal way to resolve takings clause violations is by paying "just compensation", which use the "fair market value". So even if the 2012 amendments are ruled a takings clause violation (a long shot in my opinion), the court could determine that the fair market value of FNMAS as of August 16, 2012 was $2.35 a share. Or worse, they could decide that the fair market value was $0 and $2.35 was just a speculative price.

 

      Claiming that the fair market value is the closing price on the day before the sweep is probably in the ballpark of what the government will argue.  But who had the most information about the health of the GSEs and the likely rate of re-payments and timing of the DTA reserve releases?  It wasn't the outside investors.  It was the insiders at the UST and FHFA that decided to trigger the 3rd amendment.  And you can be assured that the internal paper trail between UST and FHFA discussing the need for the sweep will be subpoenaed.  Will it come to light that the US Treasury and the FHFA saw the avalanche of cash heading their way and acted in their own interest by taking all the profits for themselves?  I believe the answer is yes.  What other reason would they have for the sweep?  This will make an argument for using a closing price set by outsiders investors very difficult to make.