Bill Ackman (Trades, Portfolio), who has sued to release Fannie Mae (FNMA, Financial) and Freddie Mac (FMCC, Financial) from government conservatorship, said this week he has increased confidence that the Trump administration would ensure and hasten the reform of the government-sponsored entities, a move that would further enrich him and a number of his hedge and mutual fund peers.
Ackman has wagered roughly 9% of his hedge fund’s assets that the government would return the two entities, which it rescued from collapse in the 2008 mortgage crisis, to private ownership and end its confiscation of their profits. He, along with several other large stakeholders such as Bruce Berkowitz (Trades, Portfolio) of Fairholme Fund (Trades, Portfolio), have already made sizable gains on their bets, as the market hopes for an imminent and profitable decision on the lenders’ fate. Shares of Fannie Mae that traded for under 30 cents in 2013 have already surged 150% since the election.
“Despite significant share price appreciation in 2016, we believe the shares of a reformed Fannie and Freddie will be worth a multiple of their current price,” Ackman said in a shareholder presentation released this week.
Ackman has based his thesis on several known facts that have made making a decision on how to reform the lenders tremendously complicated for politicians and lawmakers. “Fannie and Freddie are essential for widespread access to prepayable 30-year fixed mortgage at a reasonable cost,” he said at the 2014 Ira Sohn investment conference. The two also supply roughly $5 trillion or 60% of home mortgages in the U.S., making them integral to the financial system and the first-time home-ownership dream of many low to moderate-income households.
Hedge funds got reason to believe the finish line in their marathon moved closer as several statements from Trumps’ administration, already known for drastic actions, hinted at big moves on Fannie and Freddie. In his presentation, Ackman said he believes the new administration “will successfully reform Fannie and Freddie,” citing statements from treasury secretary nominee Steve Mnuchin, who called it one of the “top 10” things the young administration plans to accomplish.
“We gotta get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe. So let me just be clear we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again but we gotta get them out of government control,” Mnuchin said on Nov. 3.
Ackman’s presentation left out a clarifying comment Mnuchin made later, at his Jan. 19 Senate confirmation hearing. “My comments were never that there should be recap and release,” Mnuchin said.
He cited Mnuchin’s further comments at the hearing: “For very long periods of time, I think that Fannie and Freddie have been well run without creating risk to the government, as well as they’ve played an important role…I believe these are very important entities to provide the necessary liquidity for housing finance and what I’ve committed to is that I will work with both of the Democrats and Republicans. What I’ve said and I believe, we need housing finance reform, so we shouldn’t just leave Fannie and Freddie as is for the next 4 or 8 years under government control, without a fix. I believe we can find a bipartisan fix for these so on the one hand we don’t end up with a giant bailout, on the other hand that we don’t run the risk of completely limiting housing finance.”
But housing experts see a bigger picture with many nuances that the Trump administration will have to regard no matter its goal-oriented track record.
“While there is a lot of pressure being put on the new administration and lawmakers from hedge funds to act quickly, I am skeptical that privatizing Fannie and Freddie can be done at a breakneck pace,” said Ben Keys, assistant professor of real estate at Wharton School of the University of Pennsylvania.
First, the government will have to decide its role in the housing finance system. A second mortgage crisis could require the government to step in again, but a plan of action will need to be clearly defined. Though several proposals have been floated, none has been put on a fast track to enactment.
The possibility of another mortgage crisis will also force decision makers to consider the risk the private sector should bear for the mortgage market during downturns. Though healthy now, a replay of the mortgage market collapse of 2008 would be “devastating” for homeowners and the economy, Keys said.
The impact of privatization on the group they are meant to serve, homebuyers, must also be considered. Whether the private market would appropriately price financing to homebuyers is unknown. Mortgage credit access has already tightened since the crisis, and privatization could increase costs and limit lending to very qualified first-time homebuyers and lower-income families, placing the 30-year fixed rate mortgage out of reach for many.
Finally, privatization would require more government money. If privatized, Fannie and Freddie would be required to meet capital requirements and stress tests of systemically important financial institutions. With their modest capital reserves, capital may have to come directly from taxpayer dollars. Legislators will likely balk at giving up the net worth sweeps the entities are currently providing.
Of Ackman’s four “key elements” to reform listed in his presentation, he acknowledged the need for an increase in capital requirements, but did not say where the additional capital would come from. Some have suggested that a public share offering could quickly recapitalize the entities.
“In short, there’s no magic wand to wave and privatize these enormous entities, especially when there are huge transition costs, including costs to taxpayers, and there isn’t much political agreement on the long-term role of the government in the mortgage market,” Keys said.
“This privatization should not be taken lightly and should not be done at the fevered pace of this administration’s early days.”
In Ackman’s view, only three steps are needed to reform the GSEs, in addition to raising capital requirements: increase regulatory oversight, eliminate their fixed-income arbitrage business and create compensation and governance policies.
“If the GSEs increase their capital levels and become pure mortgage guarantors, they can be a simple, low-risk and effective solution for housing finance reform,” he said.
Ackman has made gains of 66% on Fannie Mae and 73% on Freddie Mac on his average cost since announcing his positions in October 2013. They were on the winning side of his fund, which declined 13.5% for the year, primarily due to continued losses in his holding Valeant (VRX, Financial), compared to an 11.9% rise in the S&P 500.
See Bill Ackman (Trades, Portfolio)'s portfolio here. See Bruce Berkowitz (Trades, Portfolio)'s portfolio here.
