FAIRHOLME CAPITAL MANAGEMENT, L.L.C.
PORTFOLIO MANAGER’S REPORT
For the Year Ended December 31, 2014
January 28, 2015
To the Shareholders and the Directors of The Fairholme Fund:
When we initiated the Fund’s investments in Fannie Mae (4.5%) and Freddie Mac (3.5%), conventional wisdom was that the companies would be liquidated. We disagreed. Our investment was predicated on a simple thesis: there are no substitutes. Fannie and Freddie provide services that are absolutely essential to the American way of life. They help make the popular 30-year fixed-rate mortgage available and affordable. They provide liquidity and stability to the nation’s housing finance system – during good and, especially, in bad times. No one does it better.
Time is proving our thesis true. Fannie and Freddie have already benefited from post-crisis reform and are returning to simpler, safer business models. Under a range of scenarios, the companies are collectively expected to earn at least $21 billion per year. The United States Treasury has already recouped $36 billion more than it disbursed to Fannie and Freddie during the crisis, rendering this our nation’s most successful equity investment ever. In fact, Treasury’s current profit from Fannie and Freddie is almost three times more than it made from all of its other financial rescue programs combined. These figures do not even account for Treasury’s warrants to acquire 79.9% of each company’s common stock.
Today, Washington bureaucrats are unlawfully holding these profitable companies captive in a perpetual conservatorship. Congress never authorized Treasury to become Fannie and Freddie’s “overlord” – forcing the companies to spend all their capital on executive branch prerogatives and circumventing the legislature’s appropriations process. Indeed, the power of the purse remains vested in Congress under the Constitution. The Housing and Economic Recovery Act of 2008 does not authorize any federal agency to use these two publicly traded, shareholder-owned companies as a piggy bank. Yet, in an unprecedented abuse of executive power, the bureaucrats have illegally expropriated and de facto nationalized two of the most valuable companies in the world with apparent impunity. Worse still, their actions are now endangering our housing market, making it more difficult for lower- and middle-income Americans to access mortgage credit.
By preventing Fannie and Freddie from accumulating any cushion against potential future losses, Treasury is obstructing the ability of the Federal Housing Finance Agency (“FHFA”) to perform its duties as safety and soundness regulator of both companies. Treasury’s actions are also directly impeding the statutory obligations of the FHFA, as conservator, to “preserve and conserve [their] assets and property.” Even Fannie and Freddie’s political foes admit that this situation is untenable.
Given the dim prospects for comprehensive housing finance reform legislation in the foreseeable future, we believe that FHFA will ultimately heed the pragmatic advice offered by Senate Banking Chairman Tim Johnson on November 19 at a congressional hearing and “engage the Treasury Department in talks to end the conservatorship.” Johnson is not alone in his call for such action.
The Leadership Conference on Civil and Human Rights recently voiced concerns about the housing market’s growing inequities: “Any successful policy to promote affordable homeownership must involve strong leadership by Fannie Mae and Freddie Mac… eliminat[ing] the GSEs would be counterproductive; it would negatively impact communities of color and young people, and it would impede our ability to grow our nation’s middle class… in order to ensure the best path forward to increasing homeownership in the communities we represent, we believe it is vital to initiate serious discussions about unwinding the conservatorship and allowing Fannie and Freddie to begin rebuilding their capital… Fannie and Freddie can be fixed; discarding them in entirety would be a colossal mistake.”
In the interim, the Fund continues to pursue litigation against FHFA and Treasury to defend its rights as an owner of the companies. To date, the Fund’s lawyers have received approximately 387,000 pages of documents – most of which have come from Fannie Mae, Freddie Mac, and their respective auditors. Not only has the government insisted on shrouding all documents in a veil of secrecy known as a “protective order,” but FHFA and Treasury have further shielded responsive documents from disclosure by broadly asserting executive privilege. Examples from the recently released Privilege Log are indicative.
One of the documents cited above is a news summary containing public information prepared by a third-party aggregator after the Net Worth Sweep was announced in August 2012 that is being withheld from discovery due to “Presidential Privilege.” Why are FHFA and, particularly, Treasury resisting discovery so fiercely? Is it because the document trail directly implicates some of the President’s most senior advisors in the White House?
FHFA and Treasury have argued that courts have no jurisdiction to review their administrative actions in this matter. However, recent comments by several Supreme Court justices in Mach Mining v. EEOC challenge the government’s similar attempt to evade judicial scrutiny in a separate case. The government’s claim – “We think this is a matter that is entrusted to the agency that is not for court review”– was met with skepticism by the highest court in the land. Chief Justice Roberts swiftly responded: “Trust you? Just trust you? I am very troubled by the idea that the government can do something and we can’t even look at whether they’ve complied with the law.” Justice Scalia echoed those concerns, noting how he found it “extraordinary” that the government wanted to be exempted from litigation. Justice Breyer weighed in: “In my mind, of course, there should be judicial review.” Sunlight is indeed the best disinfectant.
More than just patience, this investment requires persistence. Every major financial institution relied upon federal government assistance during the 2008 crisis. Each institution repaid the Treasury in full, plus interest. The same is true of Fannie and Freddie, yet only they remain under the day-to-day control of a federal agency. Government cannot pick private market winners and losers. We forge ahead with the facts squarely on our side, and the assurance that no one is above the law.