We remain confident in our preferred equity ownership. For evidence, look no further than the latest developments.
Last month, the White House released a paper advocating for a series of government reforms, including ending the conservatorship of Fannie and Freddie, with the goal for these mission critical institutions to remain shareholder-owned. Secretary Mnuchin believes 2019 is the year to resolve remaining issues.
This month, the Fifth Circuit Court of Appeals ruled that the Federal Housing Finance Agency (FHFA), Fannie and Freddieâs conservator, is unconstitutionally structured, as the court concluded that a variety of factors unlawfully sheltered the FHFA from presidential oversight. Although the Net Worth Sweep was not vacated, this is a positive development for shareholders, as it increases the odds of further review by the en banc Fifth Circuit, the Supreme Court, or both. However, by a two-to-one vote, the Fifth Circuit rejected the plaintiffsâ argument that the FHFA exceeded its statutory authority under HERA and that the Net Worth Sweep agreement violated the Administrative Procedure Act. Judge Don Willett, the lone dissenter, provided a powerful and highly persuasive dissent concluding that âthe net worth sweep strips the GSEs of their capital reserves, and it isthus antithetical to the FHFAâs statutory command that it âpreserve and conserve the assets and propertyâ of the GSEsâ. When acting as conservator, HERA does not authorize the FHFA âto bleed the GSEs profits in perpetuity.â We agree and the Eighth Circuit, which has yet to rule on Saxton v.FHFA, was notified of Judge Willettâs sound analysis.
Meanwhile, Fannie (FNMA) and Freddie continue to report strong quarterly profits, highlighting the strength of the core operating franchises. Had the Net Worth Sweep never been implemented, Fannie and Freddie would have retained earnings well over $100 billion, which highlights how quickly capital can be restored. Trading at approximately one-quarter of their intrinsic value, we continue to view the preferred shares as an excellent investment.
From Bruce Berkowitz (Trades, Portfolio)'s second quarter 2018 Fairholme Fund (Trades, Portfolio) shareholder letter.
