It has been a rough month for shareholders of Fannie Mae and Freddie Mac. Last week, a judge dismissed ten claims on behalf of Fannie and Freddie shareholders against the Federal Housing Finance Agency(FHFA). These claims asserted that the “net worth sweep” that funnels every cent that Fannie and Freddie earn into the government’s pocket was a violation of shareholders’ Fifth Amendment rights private property seizure by the government use without appropriate compensation.
The Fanny and Freddie story is a roller coaster that goes all the way back to pre-financial crisis days when the government-sponsored mortgage aggregators were earning a combined $8 billion in profits and shares of the two companies were flying high above $65 per share. But massive losses resulting from Fannie and Freddie’s guarantees on sub-prime mortgage-backed securities required the U.S. Treasury department to step in and provide over $187 billion in bailout money to keep them afloat. In exchange for this liquidity, the Treasury received warrants representing nearly 80 percent ownership of the two entities, as well as $1 billion in preferred shares that pay an annual dividend of 10 percent.
Understandably, this government takeover and the resulting dilution of common shareholders tanked the share prices of Fanny and Freddie by more than 95% from October 2007 to October 2008. But when the economy began to stabilize, Fannie and Freddie returned to profitability.
However, the FHFA changed the game in 2012 by amending the terms of the bailout agreement so that, instead of the 10 percent dividend, the new dividends on the government’s preferred shares would amount to 100 percent of Fannie and Freddie’s profits from that point forward. After becoming de-listed from the NYSE in 2010, Fannie and Freddie shares both fell below $0.20 on the news of the government’s “net worth sweep.”
Despite the government essentially declaring that Fannie and Freddie shares were completely worthless, the two companies’ share prices both gained over 1000 percent in 2013 after the filing of a series of shareholder lawsuits against the government. One of the highest-profile lawsuits was filed on behalf of Bill Ackman’s Pershing Square Capital. Ackman and fellow shareholders were betting on the hope that a court would find that the government acted illegally by changing the terms of the initial bailout agreement.
Unfortunately for Mr. Ackman, Judge Royce Lamberth recently ruled that, from a legal standpoint, the language in the Housing and Economic Recovery Act and the language on the government’s preferred stock certificates allows the FHFA to take every last cent of Fannie and Freddie’s profits. Both companies’ stocks are down more than 50 percent this month as many shareholders threw in the towel after the recent batch of lawsuits were thrown out.
At this point, the only hope remaining for Fannie and Freddie shareholders is that one or more of at least 15 remaining lawsuits, which includes Ackman’s, will somehow persuade a court to rule favorably for shareholders. However, there is no doubt that the already bleak outlook for Fannie and Freddie shareholders is looking even bleaker these days.