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Bruce Berkowitz Comments on Fannie Mae

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May 20, 2016
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Daniel Schmerin: Let’s turn to Fannie Mae (

FNMA, Financial) and Freddie Mac. Shareholders expressed a lot of support for our ongoing efforts. I know that you recently corresponded with a soldier bravely serving overseas in the 5th Marine Expeditionary Brigade.

Bruce Berkowitz (Trades, Portfolio): Yes, I was thrilled to receive his message and we should all be grateful for his service. A true patriot. Yet, he is one of thousands upon thousands of our shareholders affected by Fannie Mae and Freddie Mac.

Daniel Schmerin: Give listeners a brief overview of the state of play with respect to Fannie and Freddie.

Bruce Berkowitz (Trades, Portfolio): This should be a replay of our experience with AIG. Fannie and Freddie should be treated the same as AIG, and ultimately released of government control.

Let us back up a bit. Fannie Mae and Freddie Mac are absolutely essential to America’s housing market. Who else makes the 30-year pre-payable fixed-rate mortgage widely available through thick and thin? Who else can provide $7 trillion of liquidity to America’s housing market since 2009 helping low and moderate-income Americans buy, rent, or refinance a home?

Fannie and Freddie are two companies that help all Americans, whether they know it or not. Fannie and Freddie are definitely two of the most valuable companies in the world. It is still hard to believe that some in Washington want to eliminate them in the hope of finding something better, or at least finding something that caters better to their special interests and crony capitalists.

But the Companies are not going away. Fannie Mae is relocating to a new million square foot office complex in downtown Washington, and Freddie Mac just announced that they hired several hundred new employees. If this Presidential Election is any indication, the days of such bureaucratic malfeasance are numbered.

I believe the United States Treasury is growing increasingly isolated as a result of its 8-year policy forcing Fannie and Freddie to remain in a state of captivity known as “conservatorship.” It is a shame and a huge delay of game. I am shocked that Senator Corker allowed the President to take $250 billion dollars without Congressional approval, a stunning figure that continues to grow and an action that may well cause the next financial crisis.

Daniel Schmerin: Can you explain the nature of our investments in Fannie and Freddie?

Bruce Berkowitz (Trades, Portfolio): We own preferred stock of two of the most successful companies in American history. Preferred stock is not common stock. Preferred stock is a contract, a contract that protects our bundle of economic rights. One of the rights it protects is a liquidation preference, a priority claim with regard to the repayment of principal. The contract is between a buyer and seller, and it is backed by the nation’s laws.

The Treasury also owns preferred stock. We own Preferred stock, the Treasury owns preferred stock, and a preferred stock is a preferred stock. But the Department of the Treasury seems to make up the rules as they go. They take everything with their preferred stock, and we don’t even receive a return of principal with our preferred stock.

I don’t understand why some believe they are above the law, and that they are able to choose who wins and loses. Fairholme and other shareholders aren’t seeking anything more than for Treasury to respect the capital structure of each company, to respect the economic bundle of rights associated with our securities and to respect the law setting forth the rules of a conservatorship as decreed by Congress in the passing of the Housing and Economic Recovery Act of 2008 (“HERA”).

Daniel Schmerin: A few years have elapsed since you initiated this investment. Do you have more or less conviction in Fannie and Freddie today than when you first bought?

Bruce Berkowitz (Trades, Portfolio): We have made enormous progress over the last 12 months, largely behind the scenes. With each passing day, we seem to be getting closer to the finish line, so I remain very optimistic.

We have the facts on our side. Fannie and Freddie are hugely profitable. We have the law on our side. We have common sense on our side, and we have history on our side. Alexander Hamilton, one of our founding fathers, made a momentous decision after the Revolutionary War to recognize the debt of states as federal debt. Hamilton chose not to differentiate between original holders of bonds and those who later bought the bonds from original holders. Hamilton believed it was imperative for our nation to honor all its obligations. So, while a statue of Hamilton sits outside the Treasury Department today, it doesn’t seem as though those inside today appreciate that precedent he set, but this will change.

Daniel Schmerin: Perhaps you can you elaborate on some of the progress. There are 22 cases pending across the country challenging the so-called “Net Worth Sweep,” the federal government’s blatantly illegal expropriation of private shareholders’ interests in these two companies, and it seems like there are more complaints filed with each passing month.

Bruce Berkowitz (Trades, Portfolio): Dan, anyone who is willing to spend an hour of time understanding the facts ends up shocked and outraged by the government’s unlawful actions. There are cases advancing in the District of Columbia, Iowa, Kentucky, Delaware, and Illinois. I expect that there will be judicial decisions on several of these cases this year.

Our lawyers have taken discovery on various topics relating to the Net Worth Sweep in the Court of Federal Claims. Plaintiffs in other courts have now obtained access to these discovery materials and are amending their complaints to make use of this information. Meanwhile, the government is fighting tooth and nail to withhold over 12,000 documents, and I believe those documents contain very incriminating evidence against the defendants.

So, we are advancing the ball down the field strategically and at an increasingly accelerated pace. It doesn’t look that way when you take a look at the price of our preferred stock, yet we are making substantial progress.

Daniel Schmerin: To pick up on that, in a speech just last week, Mel Watt, the conservator of Fannie and Freddie, expressed serious concern about the inability of these two companies to retain capital. In fact, he highlighted the escalating risks of this perpetual conservatorship.

Do you believe that Fannie and Freddie will need another bailout?

Bruce Berkowitz (Trades, Portfolio): Mel Watt is telling the truth. If you ask Director Watt if the Treasury Department is helping or hurting Fannie and Freddie, do you know what he will say? Treasury is hurting, and in fact making the situation much worse. The Treasury is significantly constraining his ability to effectively manage the conservatorship. He’d tell you that the sheep dog has turned into the wolf.

Fannie and Freddie have over $5 trillion of liabilities outstanding, yet Treasury is milking them of all their income and forcing them to operate with no capital. It’s absurd. If the government takes all of your wealth every quarter as the return on a forced investment, and never allows the repayment of that forced investment, then it is inevitable that there will come a time in the future when the government will force more investment on you, another so-called bailout.

Through the imposition of the Net Worth Sweep, Treasury usurps all past, present, and future earnings of Fannie and Freddie as so-called “dividends” in order to make repayment impossible. It is illegal. It defies contract, corporate, and investment laws that allow confidence in American financial markets.

But I can understand Treasury’s viewpoint. The Net Worth Sweep tries to cement a de facto nationalization of Fannie and Freddie. It has allowed and continues to allow an administration to magically reduce budget deficits and avoid congressional debt ceiling negotiations before presidential elections. I get it. But it is wrong, and it’s shortsighted.

From Bruce Berkowit

Why are all financial institutions except for Fannie and Freddie subject to more stringent capital requirements imposed under Dodd-Frank? Leaving out the two largest financial institutions in the country makes Dodd-Frank toothless. How can you have a designation process for Systemically Important Financial Institutions and not start with Fannie and Freddie? It makes the entire SIFI designation process look like a sham.

Representatives in Congress are just now beginning to learn the truth and consequences of Treasury’s actions. Luckily, Director Watt has ample authority to fix this situation. A few days ago in the Financial Times, Fannie Mae CEO Tim Mayopoulos noted that Mel Watt had a range of options for solving the capital problem, such as allowing the companies to retain earnings, changing the terms of Treasury’s agreements with each company, and pushing the companies out of conservatorship so they can be recapitalized in another way.

Letting the companies retain what they make would be an awfully useful start to this process – after all Fannie and Freddie made over $17 billion in 2015, and they have repaid the government $250 billion to date.

Daniel Schmerin: That’s a lot of money, even in Washington.

Some shareholders have asked whether you believe this investment has a binary outcome, and whether our success hinges solely on a court decision. They also wondered whether there was an alternative dispute resolution mechanism beyond the courts.

Bruce Berkowitz (Trades, Portfolio): I don’t believe this is a binary outcome. This isn’t a light switch, there isn’t an on or off, zero or one. That would clearly violate our investment rules. We have a margin of safety: there is no alternative to Fannie and Freddie. They are tremendously profitable. They are not shrinking; they are growing. Sooner rather than later, they will be transformed into low-risk, public utilities with regulated rates of return just like your local water or electric company.

The government can’t have its cake and eat it too. It cannot de facto nationalize the two largest financial institutions in America, and pretend that it doesn’t have to consolidate their assets and liabilities on the federal balance sheet. Congress did not authorize the Treasury Department to nationalize these two companies. This charade must end soon because our housing market, which comprises 23% of GDP, and our national economy are increasingly at risk. America cannot afford to get this wrong. We remain ready, willing, and able to help explore any feasible option in order to reach a mutually beneficial outcome for all stakeholders. Litigation was not our preferred course of action, but it has proven necessary. Make no mistake, we have been willing to negotiate and compromise from day one. We have been willing to talk constructively with Treasury from the get go.

In 2013, Treasury seemed to believe that Fannie and Freddie were worthless, so a consortium of investors, including Fairholme, offered to buy the insurance businesses of Fannie and Freddie. We received no written response to our offer. More recently, in late 2015, there was settlement communication between plaintiffs and the government, but frankly, given how deep Treasury has dug in its heels and tried to hide the truth by withholding evidence, it remains unclear to me whether Treasury is capable of having an earnest conversation. And the fact that Treasury has sent some staffers to work next door at the White House really raises the specter that the President and his most senior advisors are being purposefully misled.


Bruce Berkowitz (Trades, Portfolio)'s Feb. 23, 2016, Fairholme Fund (Trades, Portfolio) conference call.

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