Bruce Berkowitz Asking Questions

Bruce Berkowitz’s Fairholme Fund – Ownership of Fannie Mae and Freddie Mac preferred stock

Today, shareholders of The Fairholme Fund collectively own $3.4 billion liquidation value of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) preferred stock. That means each shareholder effectively owns approximately $25,000 (on average) of two of the most profitable franchises in America.

Yet for reasons that are not entirely understood, some in government apparently want their friends in the mortgage-industrial complex to take for free what you, the shareholders of these companies, paid for with cash. So we continue to search for the truth:

  • Why did federal regulators design a financial support program for Fannie and Freddie on the basis of academic estimates of future performance rather than tried and true statutory accounting and claims-paying ability (which is the standard for all regulated mortgage insurers)?
  • Why did federal regulators require Fannie and Freddie, while in conservatorship, to purchase $40 billion per month in underperforming junk bonds from competitors?
  • Why did federal regulators force Fannie and Freddie, while in conservatorship, to participate in Treasury’s Home Affordable Modification Program (HAMP) and Home Affordable Refinance Program (HARP), which resulted in more than $46 billion of losses that the companies would not have otherwise incurred?
  • Why did mortgage-backed securities issued by Fannie and Freddie perform dramatically better than private label securities issued by big banks throughout the financial crisis?
  • Why did federal regulators settle litigation cases initiated by Fannie and Freddie against major financial institutions for significantly less than what other similarly situated plaintiffs recovered?
  • Why did federal regulators seize more than $18 billion in litigation proceeds recovered by Fannie and Freddie to date?
  • Why did federal regulators order Fannie and Freddie to delist their securities from the New York Stock Exchange in 2010?
  • Why did federal regulators prohibit Fannie Mae from selling $3 billion of Low Income Housing Tax Credits to third-party investors?
  • Why were Fannie and Freddie, while in conservatorship, forced to divert billions of dollars in guaranty fees to Treasury to offset the cost of a payroll tax cut?
  • Why did FHFA, as conservator, force Fannie and Freddie to gift all of their capital and all future earnings to Treasury in perpetuity?
  • Why were Fannie and Freddie, while in conservatorship, forced to pay “voluntary” cash dividends to Treasury if funds were not available and the regulated entities were “not in capital compliance?”
  • Why did FHFA force Fannie and Freddie, while in conservatorship, to issue debt in order to monetize their deferred tax assets and pay the proceeds to Treasury in 2013, particularly when FHFA had previously stated that deferred tax assets “[could] not be monetized?”
  • Why did Fannie Mae CEO Tim Mayapoulos describe the Net Worth Sweep as a “positive change” with “a lot of good in it” in his August 2012 announcement to employees? Was he coerced by federal regulators?
  • Why has the Securities and Exchange Commission permitted a single controlling shareholder (i.e., Treasury) and its affiliates to simultaneously act as director, regulator, conservator, supervisor, contingent capital provider, and preferred stock investor of two publicly traded companies?
  • Why do some Treasury officials question the sustainability of Fannie and Freddie’s earnings power in the years ahead, when Treasury’s own 2014 Annual Report indicates that the companies will be c onsistently profitable for each of the next 25 years?
  • Were certain federal government employees who crafted the Net Worth Sweep acting at the behest of crony capitalists seeking to displace Fannie and Freddie?

As owners, we demand answers to these and many other questions. Administration officials and their beneficiaries respond with alternative narratives that are wholly unsupported by the facts. They delay discovery and judicial proceedings at every opportunity. They deliberately conceal and withhold pertinent information. They conduct the business of government with little regard for the law.

Often the comments are just as good as the article… Part 2

Yesterday, I posted here regarding the comments that readers post after reading an article. Those comments are often as good, if not better, than the article itself.  As follow-up, in this part two post I’ve copied comments received in response to an Op-Ed piece written by Bethany McLean in The New York Times on July 20, 2015: “Fannie and Freddie are Back, Bigger and Badder Than Ever.”

I’ll reserve personal comment on the article as I believe many of the following readers some it up best:

Dave K
is a trusted commenter Cleveland, OH July 20, 2015

This starts off with a complete fabrication, and doesn’t get much better.

When the author says that “everyone agreed” that we should get rid of Fannie and Freddie, what she really means is that conservatives decided (without any real evidence) that the government was to blame for the financial crisis. This was because their ideology demanded that big business hadn’t screwed up and wrecked the economy, so they seized on any government involvement they could.

The first big claim was that the Community Reinvestment Act caused it. This claim was subtly racist, actually, because it was arguing that the crisis was the result of the government forcing banks to lend to black people. Researchers looked into it, and learned that black families and CRA-qualified loans were getting repaid at least as diligently as everybody else.

The second big claim was that Fannie and Freddie caused it by getting into subprime loans. But that was nonsense too, because everybody else had gotten heavily involved before Fannie and Freddie, and Ms McLean’s former employer Goldman Sachs was far more involved than Fannie and Freddie had ever been.

The reality is that the big banks and mortgage brokers did this almost entirely on their own, and the regulators who should have stopped it were either bribed or asleep on the job.



Orlando July 20, 2015

Fannie and Freddie were the only entities keeping the housing market afloat after the banking collapse. It didn’t get involved in the criminally reckless business of sub-prime loans, liar’s loans and all the other irresponsible banking behavior that brought in a lot of money to corrupt and unethical.bankers It should be applauded as a bulwark of safety in a time of peril as much as unemployment insurance and social security to keep our economy going in the toughest times. These New Deal safeguards were far more useful than the ridiculous bank bailout and prevented another Great Depression IMO.



Verona, N.J. July 20, 2015

The 2008 financial crisis was created by Wall St. and their mortgage-broker front men “innovation” of new ‘financial products’ such as zero-documentation-zero-verification-zero-interest-teaser-rate loans….also known as economic plutonium…and the crisis was compounded by the slicing and dicing of that economic plutonium into ‘AAA’-rated security sales to pensions, 401K plans, municipal and sovereign governments and general investors.

The 2008 financial crisis was entirely the making of unregulated Wall St. greed and psychopathy.

Fannie and Freddie were simply passengers on the evil bus driven by the greediest and most dangerous people in the business world – Wall St. and bankster psychopaths.

Bring back Glass Steagall and regulate bankster greed.

Freddie and Fannie are doing just fine.


Look Ahead

is a trusted commenter WA July 20, 2015

This strange article starts with a right wing falsehood, dispelled in an extensive examination by the Fed.

After complaining that Fannie and Freddie only benefited shareholders and executives while being guaranteed by the government, it then criticizes the sweeping of profits into the Treasury.

Finally, it acknowledges the important role of the two companies, especially in providing equitable access to home buyers with lower incomes.

But most importantly, it fails to acknowledge the dramatically changed standards for new loans in the secondary market imposed by the two organizations.

Very confused article.



Rhode Island July 20, 2015

Former Goldman Sachs investment banker and writer of this Op-Ed piece BETHANY McLEAN would like us to believe it was Freddie’s and Fannie’s fault we almost fell into another Great Depression and not the Biblical greed of places like Goldman Sachs, who were bailed out to the tune of $125 billion in tax payer funded money.
I wonder why Mrs. McLean isn’t wringing her hands about Goldman’s continued existence in the wake of it’s massive fraud.



Rhode Island July 20, 2015

The 2016 Presidential Election is in full swing and, as is par for the course on the right, their first order of business is to muddy the historical economic waters to once again trick low information conservative voters to vote against their own economic self interest…again.

And what better way to do this than point their fingers at Fannie and Freddie, that serve Joe Six Pack and away from true cause of the collapse Goldman Sachs, Bank of America, Wachovia, Citigroup, J.P. Morgan and the rest of the money changers on Wall-Street that serve only themselves.

When will the conservative voter wake up and realize that the master manipulators on Wall-Street are laughing their doughy arses off at them?

I mean even Pavlov’s dog caught on eventually…

Often the comments are just as good as the article…

Glen Brandford posted a piece on Seeking Alpha on July 19, 2015 titled: “FHFA Writedowns Continue To Be Greatest Threat To GSE Investment Thesis.”

Glen’s piece was informative, as usual. However, if you’re like me, you find just as much value in the comments that people post after the article.  Here is such a comment that I enjoyed reading from “Poor Dude”…

Poor Dude

Bang the drum, Glen. Hopefully, someone of importance is listening. Viewed from a high-level perspective, I’m convinced that the government siezed Fannie and Freddie in 2008 for no other reason than to give them the financial might and world-wide influence to save large teetering banks and re-instill confidence in our financial markets during a major market panic.

The fact that a special law was passed (in advance) to allow it tells you that is was planned well before it actually happened.

As soon as they were seized, the companies were instructed to start buying up Alt-A and subprime mortgage securities from the marketplace to the tune of $40 billion per month. That’s hardly something that “distressed” companies would do of their own volition (which is why their boards were replaced and new “bosses” installed who would do as instructed without question).

The “line of credit” issued to them (at an exhorbitant interest rate, by comparison to the rates charged to any other distressed company at the time – other than AIG, of course) was used for no purpose other than to increase their “firepower” in sucking up bad assets from the large banks and marketplace in general. It was called a “rescue” of Fannie and Freddie in the press, although Fannie and Freddie were never in financial trouble and would never HAVE been, except POSSIBLY in the worst-case scenario that the market panic wasn’t averted and the entire western financial system collapsed and the entire world entered a “Greatest Depression”. In that case, Fannie and Freddie may have actually gotten into trouble and needed “rescuing”. But absent the realization of that worst-case scenario, or prior to its occurrence, their seizure was nothing more than another back-door bailout of the large banks and investment firms (just as AIG was used at the time).

The companies were forced to “mark-to-market” their trillion-dollar portfolios, at 30 cents on the dollar or so (the market-panic low), then account for those reduced valuations as “losses” – despite the fact that their top-tier portfolios (and they handled little else) continued to perform and generate income with only very minimal or no degradation at all. Those “losses”, although existing on paper only and not in any real sense, provided justification for the government’s actions.

And it worked. Mission accomplished. The companies’ continuing profits, their significant positive cash flow, and their new line of “credit” from the US Treasury was put to good use. The market collapse ended, the panic faded, and things slowly began to return to normal.

Fast-forward to 2012, and all the accountants and financial experts and lawyers are informing the government that the charade of “distress” can no longer be continued. Market valuations are returning to normal, and the loss reserves must be reversed. No two ways about it. And that’s going to result in the companies showing HUGE profits and possibly even buying their way out of their rescue without being “wound down” as Paulson and others expected because it would do two things: 1) It would cover their backsides for their actions, and 2) it would align with their basic philosophical objections to the companies’ existence to begin with (at least, in their present form). Paulson et al wanted the GSEs gone, done away with.

The fix for this new problem? A third amendment to the SPSPA, wherein the companies would just send all their profits forever to the US Treasury. Screw the shareholders, who they never cared about to begin with. So long as the change was made before the companies announced the reversals of their loss reserves, the change could be justified as “necessary to end an endless cycle of borrowing to repay debt”. Just explain it as necessary to end the “Greek Method” (and I would argue “American Method”) of operation. Problem solved, as far as “public perception” is concerned!

But that still left one huge issue to be dealt with: The fact that the companies held on their balance sheets roughly $1.5 trillion in real, tangible assets in their “retained portfolios”. That represented most of the companies’ (and shareholder) wealth which had been slowly accumulated over nearly a century of successful operation in the case of Fannie Mae and a somewhat shorter period in the case of Freddie Mac. And with loss reserves reversing, that number was growing rapidly (aside from the fact that it consisted mostly of 100% title to property which had been financed on a 30-year fixed-price basis and would allow (in an adverse scenario where people defaulted on their loans after 20 or 25 years of payments) a recovery AT LEAST equal to – and more likely far exceeding – the “book value” of the assets). $1.5 trillion understated the true wealth held there by a large sum, and there was no way in Hell the companies could be put into Receivership or otherwise liquidated until that “asset” was first removed.

How to fix this problem? Easy. Order the companies to start selling off their retained portfolios at a rate of 10-15% per year, until they are gone and the shareholder “equity” in the firms has been slowly reduced to zero (with any and all gains going directly to the US Treasury instead of remaining on the companies’ books). My guess is that they’d have ordered it done faster, but calculated the maximum amount the private markets could absorb in a given year was somewhere between 10 and 15% of the retained portfolios. $1.5 trillion is a LOT of money to “pawn off”, and it takes time to get rid of that much property.

Being suspicious by nature, I’m guessing that a “deep dive” into the assets being sold off, and to whom they are being sold (and at what price), would disclose all manner of insider dealings between politicians, bureaucrats, and their “favored” constituents. I have no proof of that, of course, but wouldn’t doubt it in the least should someone come forward with facts or evidence to support the contention.

I think the whole thing, from start to finish, has been a sham designed to “redistribute” wealth from average investors and pensioners into the hands of those “more in favor” with those who run our government. And it truly sickens me.

Blame Excellent Financial Conditions For Fannie And Freddie Conservatorship

By Glen Bradford  June 29, 2105


  • The consent clause was used to place Fannie Mae and Freddie Mac into conservatorship.
  • According to FHFA Director Lockhart, a very strong case was made to the boards of directors so that they did not have a choice.
  • If the third amendment is struck down, Fannie and Freddie are worth upwards of $20, if the entire conservatorship is voided Fannie and Freddie commons are worth upwards of $100.

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two government sponsored enterprises operating in conservatorship since September 6, 2008 when FHFA used its authorities to place them into conservatorship, which is not receivership.

The Housing and Economic Recovery Act of 2008, commonly referred to asHERA, enacted in July 30, 2008 was designed primarily to address the subprime mortgage crisis. 12 U.S. Code § 4617 (A)(3) entitled “Grounds for discretionary appointment of conservator or receiver” is the focal point of this article.

The Consent Clause Was Used To Place Fannie And Freddie Into Conservatorship

Fannie Mae and Freddie Mac were placed into conservatorship using the ninth option (pictured below) which has nothing to do with the financial conditions of Fannie Mae and Freddie Mac:

(click to enlarge)

Henry M. Paulson Jr. wrote a book about how it all happened entitled ‘On the Brink’ where Paulson provides a once-in-a-lifetime first person account of how he as Treasury Secretary worked to save the world from impending financial Armageddon. I find this to be an invaluable resource in the context of the framing up the recent accounting restatements that have been proposed. If you’re looking for a deeper analysis on a point by point basis regarding the section entitled “Grounds for discretionary appointment of conservator or receiver” start here.

The first excerpt from Paulson’s book that I’ll reference sets the stage for consent:

(click to enlarge)

Key HERA Provision Used To Enact The Consent Clause

12 U.S. Code § (6) provided safety for the board of directors to consent without being liable and this clause is not present in any other regulatory statute:

(click to enlarge)

This clause is important because as long as the board of directors consent in good faith using the consent clause, they are not liable. This view was corroborated by Paulson in front of the board of directors:

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Paulson Planned Consent Carefully In Advance

On Thursday, September 4, 2008 Paulson told President Bush, “Mr. President we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.”

(click to enlarge)

Paulson didn’t tell Fannie Mae and Freddie Mac executives that their plans came with punitive terms structured to crush shareholders even though they asked:

The Fannie executives asked how much equity capital we planned to put in. How would we structure it? We wouldn’t say.

One thing that is remarkable is that so far the members on these consenting boards of directors have not said anything publicly about the conservatorships since they’ve began. Again, Paulson’s book comes in handy:

As we had with Fannie Mae, we swore everyone in the room to silence.

Part of this particular consenting process involved being sworn to silence. The boards were sworn to silence before they were expected to voluntarily agree to a consent agreement. This sort of process might look somewhat familiar to members of secret societies where at the end of pledgeship you become an active in similar surprise fashion. CEO of Fannie Mae Daniel H. Mudd doesn’t appear to be the biggest fan of operating in secrecy as Paulson confirms from his first person perspective narrative:

(click to enlarge)

According to the Financial Crisis Inquiry Commission Report, Mudd told the FCIC: “I did not think in any way it was fair for the government to have been in a position of being in the chorus for the company to add capital, and then to inject itself into the capital structure.”

Mudd’s dialog with Paulson seems to suggest that Fannie and Freddie were doing really well and were zooming along while doing everything Treasury asked and being as cooperative as possible. Mudd could sense that something was up, but he couldn’t tell that there were plans of a conservatorship that were made in silence to slam the brakes on Fannie and Freddie as going concerns. It simply was not possible for Mudd to know this when he was purposely not told Treasury had made plans in advance to set up a structure with FHFA that was disadvantageous to shareholders.

(click to enlarge ascari chicane in Italy)

After Fannie Mae and Freddie Mac were placed into conservatorship, FHFA’s Director James Lockhart recalls a similar story:

Sears Holdings (NASDAQ:SHLD) had some interesting thoughts on the GSEs in their February 2009 chairman’s letter:

The logical explanation for the boards of directors giving consent rests with the presumption that if they did not consent, there was some other threat that would have been even worse for those directors. As for the shareholders the directors represented, it is hard to imagine anything worse than having their investment effectively wiped out, and they had no vote on the matter.

How Hide and Seek Accounting Gets Found

The financial statements Fannie and Freddie have produced in conservatorship mimic a game of hide and seek with a toddler if you know enough about accounting to know where to look. Poor financial conditions at Fannie and Freddie were not the reason why they were placed into conservatorship so hide comes first. Once in conservatorship, FHFA was in charge of accounting and FHFA signed a deal with Treasury where FHFA could subsequently trigger non-cash write downs that would provide future dividends to Treasury and at the same time cover up the fact that Fannie and Freddie didn’t need money since they were cash money profitable.

For years, FHFA made lots of write downs and made it look like the decision to place Fannie and Freddie into conservatorship was because Fannie and Freddie were deteriorating business models hemorrhaging lots of money, but they were gradually inching closer to making sure that Fannie and Freddie could never come back. FHFA signed several amendments to the original PSPA. The most recent amendment they signed gives all the money Fannie and Freddie produce the privilege of going anywhere except to recapitalize Fannie and Freddie. Once the money goes to Treasury it becomes part of the general revenue fund which offsets government spending.

This is the point in time when things started happening that started making people who were paying attention really start seeking answers. The first thing that happens is that FHFA allows Fannie and Freddie to slowly write back up their write downs as slowly as possible. At this same time, FHFA is winning legal settlements with the true culprits of the private label mortgage backed security crisis. This temporarily inflates accounting profits and accounting profits after the third amendment trigger flows of capital that go off to Treasury where they aren’t specifically accounted for.

This is seems like it might be a very smart way for Treasury to take over Fannie Mae and Freddie Mac. There is, however, a series of problems:

  1. The first problem is that Fannie and Freddie were not in any financial troubles at all and could have weathered the crisis just fine without any bailout.
  2. The second problem is that Treasury had to override Fannie Mae’s board of directors.
  3. The third problem was that Treasury had to override Freddie Mac’s board of directors because Fannie Mae’s board could only be overridden if Freddie Mac’s board was overridden.
  4. The fourth problem was that the board of directors had to be silenced so that they couldn’t talk about it or know about it before it was going to happen or after it happened.
  5. The fifth problem is FHFA had to override their auditors as conservator to force write downs causing Technical draws from Treasury.
  6. The sixth problem is that FHFA had to forget that they forced write downs causing technical draws when they were making forward looking projections.
  7. The seventh problem is that they had waited too long and the companies had already written down everything before they were making these projections.
  8. The eighth problem is that FHFA had to drop forecasts by 50% month to month in the process of making the projections to justify that the companies were not ever going to be profitable again in excess of Treasury’s dividend take.
  9. The ninth problem is that FHFA and Treasury were government agencies and FHFA was supposed to be independent even though Mario Ugoletti worked on the PSPA when he drafted it at Treasury and when he amended it at FHFA.
  10. The tenth problem is that in order to justify the full income sweep is that FHFA had to overlook the PIK option.
  11. The eleventh problem is that they didn’t put Fannie and Freddie into receivership because they couldn’t and the stock is still outstanding.
  12. The twelfth problem is that Fannie and Freddie have been making money all along and when Treasury worked with FHFA to reverse the flow of funds putting the cover on top of the big accounting hole that FHFA had made Fannie and Freddie dig for themselves it filled up with money so fast that it exploded profits out of the top of it and made Fannie and Freddie pay back more than they had borrowed by over $40B so far.
  13. The thirteenth problem is that Treasury and FHFA did not swear the auditors to silence.
  14. The fourteenth problem is that an agreement that violates the law is still subject to the law even if the agency that makes it is not restrained by the law if they operate within the law.
  15. The fifteenth problem is that a security that participates in the residual income of a business is common equity, not preferred.
  16. The sixteenth problem is that Treasury and FHFA cannot prevent private investors from accessing their email records simply by marking it as privileged in a court of law as the plaintiffs have a right to know if what gets said to have happened actually happened that way or not.
  17. The seventeenth problem is that Treasury and FHFA officials cannot prevent officials from being deposed when plaintiffs would like to ask them questions about things that they find peculiar.
  18. The eighteenth problem is that Treasury and FHFA cannot sustainably win legal battles with demonstrably incomplete administrative records.
  19. The nineteenth problem is that FHFA provided detailed review of quarterly and annual SEC filings and the companies reviewed their deferred tax assets every quarter according to Treasury’s administrative record.
  20. The twentieth problem is that crushing a company’s stock price is not the same as crushing the underlying business.

The list of problems Treasury and FHFA have faced is incomplete and some have yet to happen. The biggest problem here is that poor financial conditions were not the reason Fannie and Freddie were put into conservatorship.

Treasury preferred Fannie and Freddie in conservatorship rather than out of conservatorship as a means of control since the financial conditions of Fannie and Freddie were so good that even during the crisis when everyone else seemed to be running out of money Fannie and Freddie did not actually need the money FHFA forced them to take from Treasury.

In the name of tax payers, the money has even been paid back, according to acting Treasury Secretary Jack Lew. Jack Lew says Fannie and Freddie haven’t removed the risk from the explicit federal backstop, which is interesting, because according to the White House, they don’t have one.

A forensic accounting analysis took a look and found that Fannie Mae and Freddie Mac were extremely cash profitable during the same periods of time they were manufacturing financial statements showing losses of net income on a quarterly basis. After these financial statements were produced, the very same losses they took were reversed in a later period. If you didn’t have the context of conservatorship, you might wonder how FHFA was forcing Fannie Mae and Freddie Mac to manufacture financial statements inconsistent with their cash operations.

Without conservatorship, FHFA would not have been able to run the accounting department and overrule Deloitte and PricewaterhouseCoopers and make it look like Fannie Mae and Freddie Mac were losing money when they were actually making billions of dollars of cash money per quarter. One way to remove the risk from Fannie Mae and Freddie Mac’s balance sheets would be to remove them from conservatorship because outside of conservatorship FHFA will be less able to invoke improper write downs and make it look like the businesses are falling apart when they actually aren’t.

The choice of conservatorship by Treasury has produced over $40B of net proceeds so far and is set to increase. Perhaps this is a case of Treasury seeing Fannie and Freddie as too profitable for their own good during the time of crisis and thinking that perhaps it would be better if they served the public good more than their respective charters permitted. The familiar adage goes: “Never let a good crisis go to waste.” Treasury’s and FHFA’s quest to serve tax payers has not only been closed to the public, but will continue to be closed to the public:

(click to enlarge)

The Purpose Of The Third Amendment

The year following the third amendment resulted in Fannie Mae reporting financials that made it the world’s most profitable company in history that nobody talked about because Fannie was proactively prevented from recapitalizing itself. According to prior Fannie Mae CFO Timothy Howard:

The third amendment to the senior preferred stock agreement was adopted to prevent Fannie Mae from benefiting from the reversal of extremely conservative accounting decisions made earlier

Peter J. Wallison, author of ‘Hidden in Plain Sight’ and co-director of the American Enterprise Institute’s program on financial policy studies corroborates the answer:

(click to enlarge)

Fannie Mae and Freddie Mac are in conservatorship and not receivership as Wallison was quoted as saying. Fannie and Freddie were in such good financial condition that Treasury and FHFA needed consent to put them into conservatorship and are proving to be in such good condition that prior Secretary of the Treasury Tim Geithner was afraid of Fannie and Freddie looking like a successful, profitable corporation.

The fear was not that Fannie and Freddie were a successful, profitable corporation as they have proven to be throughout the crisis. The problem was one of appearance and that Geithner thought it was dangerous if Fannie and Freddie looked as profitable as they actually are before the crisis, during the crisis, and still are today.

If nothing wrong has happened, no one should be afraid of Fannie and Freddie looking like a profitable, successful corporation. In Treasury’s case, control was and still appears to be based on Fannie and Freddie appearing to be broke so that people believe their business models are failures. The notion that appearances may be deceiving has not been lost on Treasury. It might seem that the GSEs were forced into conservatorship so that they could be forced to look like they needed to be in conservatorship so that they could be forced to stay in conservatorship so that justifications could eventually be made that transitioned the GSEs into receivership and wound them down.

There isn’t anything wrong with private companies making money and being successful. It remains to be seen whether or not there is something wrong with the aforementioned systematic way of separating profitable, successful businesses from their shareholders when every step along the way requires soliciting consent in conditions of secrecy and silence. United States District Judge Royce C. Lamberth expresses this feeling in his memorandum opinion:

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What looks like a multi-year game of hide and seek that is finally coming into focus as discovery has been fruitful in document production and depositions of key officials are currently underway and under wraps is really a game of pass the buck. Below is a picture of profits for Fannie Mae going back to 1989:

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Note that the profits are not unlike the path you’d expect to take if you came across a chicane (pictured above and below).

(click to enlarge)

A chicane is an artificial feature creating extra turns in a pathway than otherwise would be necessary. When graphed, Fannie Mae and Freddie Mac’s financial statements since they have been in government conservatorship look like a chicane. The government chicanery that is seen in the roller-coasteresque profits of the GSEs has been causing a slowing effect on the housing recovery. Fewer people today have access to mortgages through the GSEs than used to and as time passes personal credit histories that were destroyed by the crisis are being repaired which means that over time we can expect that some people who lost their homes in the crisis will come back as boomerang buyers.

June 29, 2015

Investors Unite released an analysis of the joint letter by the Community Mortgage Lenders of America and the Community Home Lenders Association to FHFA Director Mel Watt “to express concern over the Administration’s seemingly shifting narrative on the purpose of the recent Common Securitization Platform.” Investors Unite argues that placing the fate of the entire market in the hands of a select group of systemically important financial institutions will not provide for continued access to mortgage credit while insuring as much stability as possible.

In addition, the government has filed a motion for an enlargement of time to respond to plaintiffs’ motion to remove the “protected information” designation from the depositions of Edward Demarco and Mario Ugoletti. The government needs more time so that they can consult with agency counsel to obtain internal review in order to coordinate a meaningful response to Fairholme’s motion and they want fourteen days when Fairholme only was willing to approve up to seven:

(click to enlarge)

First, I would be interested to know if there was a deposition scheduled between seven and fourteen days from now. Second, asking for more time to do something on the date that something is due as opposed to in advance is a technique that I’ve seen implemented in academia amongst those who were able to put falling behind to their advantage.

Either way, it sounds like the government is going to do its best to prevent these depositions from being made public and that is important because according to the plaintiffs these depositions not being made public allows the government to provide different sets of facts to different courts. While this motioning is in Sweeney’s Court of Claims, there are claims of relevancy in the D.C. District Court of Appeals. Regardless, Sweeney granted this motion to the government less than two hours after it was filed:

Accordingly, its motion is GRANTED. Defendant shall file its response by no later than Monday, July 13, 2015.

Perry Capital LLC filed its initial opening brief for institutional plaintiffs. Perry cites Treasury’s very own administrative record as evidence that Treasury was the driving force to the companies’ supposed financial problems:

Although Fannie and Freddie haven’t had any non-conservatorship related financial problems on a cash basis, the CMLA and the CHLA think that other companies may have financial problems if the CSP is built by Fannie and Freddie and it is taken from them for use by a small group of systemically important financial institutions. As the joint letter by the CMLA and the CHLA puts it in their letter:

While on its face, a statement that the CSP could be adaptable for use by other secondary market participants sounds laudatory, in practice any such access will likely not accrue to small lenders, which do not have the ability to invest large fixed sums in staffing and systems to take advantage of issuing and hedging securities. Instead, the largest banks would be the main beneficiaries, as they can invest the sums of money to enter this marketplace and use their existing federal subsidies to help underwrite this new endeavor.

Small lenders would suffer if Fannie and Freddie are no longer able to run their business. Perry also makes it clear that FHFA had considered the Companies’ multi-billion-dollar deferred tax assets as they provided “detailed review of quarterly and annual SEC filings”:

(click to enlarge)

The benefit of the doubt appears to travel far and wide when you’re the government. The most interesting part of the filing to me is FHFA and Treasury appear to have won in Lamberth’s D.C. District Court with demonstrably incomplete records:

Summary and Valuation

Right now all but one of the shareholder lawsuits contests the Third Amendment. The Washington Federal lawsuit contests the entire conservatorship. Section 6.7 of Fannie and Freddie‘s Senior Preferred Stock Agreements sets an interesting stage:

If the entire conservatorship is unwound per section 6.7, the long term valuation for the common shares of Fannie Mae and Freddie Mac is upwards of $100.

If the third amendment is reversed and the warrants are cancelled, the long term valuation is upwards of $20.

If the following three criteria are met, Fannie and Freddie commons are worth $0:

  1. Third Amendment stands; and
  2. The accounting is not restated; and
  3. The conservatorship stands

Conservatorships are designed to be temporary in nature. If the above three are true, we should expect that at some point in time Fannie and Freddie would be put into receivership by the acting director of the FHFA, who presently is Melvin L. Watt. This would likely happen sometime around 2018, when Fannie and Freddie’s capital is zero, and might involve the FHFA writing down DTAs for a second time to ensure that the capital hole leaves nothing for common shareholders.