The Fairholme Fund (Trades, Portfolio) sold a total of 6,828,000 shares of Fannie Mae common stock to Icahn on March 11, at a price of $4.03 per share. It also sold 5,742,000 shares of Freddie Mac common stocks on the same date at $4.04 per share.
The fracas surrounding the two mortgage entities over the past several years developed as the Federal Housing Finance Administration began the process of extricating itself as their conservator, a power that it was granted as part of the Housing Economic Recovery Act of 2008. At that time, to avoid a total implosion of the housing market, the Treasury invested $200 billion in the previously privately owned, publicly traded companies, for a total of 79.9% of their common stock and $1 billion in preferred stock, which carried a 10% dividend.
Though the value of the companies’ shares immediately plummeted, private investors voiced a stronger outcry in 2012, when the FHFA and Treasury announced a “full income sweep” of all future Fannie Mae and Freddie Mac earnings, leaving nothing for shareholders. The numerous legal questions surrounding many of the government’s actions regarding the companies prompted a number of lawsuits.
While Fairholme stands to benefit from victories in many of these suits, its own Fairholme Fund (Trades, Portfolio)s Inc. vs. Federal Housing Finance Agency, et al, alleges that the August 2012 actions violated the Administrative Procedure Act (APA). Namely, the government’s aim to restore the companies back to functioning private corporations and protect private interests in them precludes it from usurping those interests for itself. The lawsuit moves to nullify any government action that did not comply with the APA, strike down the 2012 transaction, and restore rights of private common shareholders.
Berkowitz launched the lawsuit on July 10, 2013, and began his vast investment in multiple share classes of Fannie Mae and Freddie Mac in the fourth quarter of 2013. Since then, the value of Fannie Mae shares has soared more than 250%.
Berkowitz’s campaign with Fannie and Freddie echoes his outsized financial crisis-era bets on other cheap, broken-down companies safeguarded from certain death by the U.S. government due to their systemic importance, such as AIG (AIG), Bank of America (BAC) and Citigroup (C).
“When a recovering icon trades at half of our understanding of intrinsic value for a reason that has nothing to do with its prospects, we swing big,” he said of AIG in 2011.
Berkowitz’s shareholding history of AIG:
In his January 2014 letter to shareholders, he said of Fannie and Freddie:
“Two of our best performers during the period were Fannie Mae and Freddie Mac. Both are absolutely essential for uniquely-american, affordable mortgages. If you disagree, try getting a 30-year, sub-5% mortgage outside of the United States. In 2008, both companies agreed to U.S. conservatorship and extraordinarily harsh terms and conditions during a time of global crisis. The plan worked. Fannie and Freddie saved the day, repaid nearly every penny of cash received from the u.s. Treasury, and can look forward to resuming a prosperous future based just on the aging of assets held. However, many believe Fannie and Freddie will be victims of a government-sponsored expropriation that brings our country closer to a future conceived by George Orwell in his novel, 1984. We disagree.”
Certain signs indicate that Fannie Mae is recovering as well on the back of the housing market recovery. Though it has had negative book value, which Berkowitz uses as a proxy for intrinsic value, since 2008, Fannie Mae returned to profitability in 2012. In 2013 it reaped $84.96 billion in net income. Both companies have also fully repaid their bailout funds.
The sword hanging over his strategy this time is Senate legislation that could dismantle the two entities and dismiss shareholders’ rights as it remakes the national housing finance system. The bill was approved on May 15, and now moves on for vote in the full Senate. Though the bill has the support of the White House, it failed to receive approval from key panel Democrats, and will likely not be voted on this year.
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