Ackman's Puzzling Investment in Fannie Mae and Freddie Mac

Source: Future Atlas.

Bill Ackman's Pershing Square Capital has a big stake of Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) . His firm announced a nearly 10% stake in both government sponsored entities just one week ago.

Ackman is doing it differently, buying the common stock and not the preferred stock like fellow fund manager Bruce Berkowitz.

A look back at Fannie and Freddie
In 2011, Bill Ackman was invited to discuss the credit markets on CNBC. There, he joined Clayton Rose, a then-board member of Freddie Mac.

The discussion turned interesting when the two discussed the board's role at Freddie Mac.

Ackman asked who the board represents. He questioned, "Who are you a fiduciary for? The shareholders?"

Rose said, "Our fiduciary duties run strictly to the conservator."

Ackman became more pointed with his questions, "So you can make decisions that are adverse to shareholders?"

Rose replied, "Correct."

This was a huge story at the time, covered by Dealbook and others. Today, it's mostly forgotten as people think about the riches that could be had if Fannie and Freddie were returned to public hands.

But it makes me wonder why exactly Ackman would announce such a large stake in Fannie and Freddie just two years after a Freddie Mac board member said, on national TV, that Freddie Mac was run for the government, not the shareholders.

A financial chess game
Ackman is working with Berkowitz to put Fannie Mae and Freddie Mac back in private hands. But the problem, just as it has always been, is who the Fannie Mae and Freddie Mac board members really work for.

If they work for the government -- if they have a duty to make decisions in the best interest of the government -- then releasing Fannie Mae and Freddie Mac to private investors seems absolutely backwards. In Berkowitz's plan for the GSEs, the U.S. Treasury would have to give up its net sweep agreement that sends virtually all of the GSE's positive net worth balance at the end of every quarter back to the U.S. Treasury.

Secondly, if Fannie and Freddie are sold to private shareholders, how could it possibly be in the best interest of the U.S. government?

Just by virtue of the financial markets, it's impossible to see how a private party could provide a price reasonable to buy Fannie or Freddie from the government. Finance 101 tells us that U.S. Treasuries are a risk-free investment. The government can literally print money. It has the lowest cost of capital in the world -- practically free.

No private investor has that luxury, and thus, the GSEs are inherently worth more to the U.S. government than they are to private shareholders. No board member who has a fiduciary duty to the U.S. government could support giving Fannie or Freddie back to private shareholders.

A political mess
The good news for the small shareholder in Fannie and Freddie is that fund manager participation ensures this will not go down quietly. Berkowitz has nearly $1.5 billion invested in preferred shares of Fannie Mae. Ackman has about half a billion dollars in play when you combine his stakes in Fannie Mae and Freddie Mac common stock.

What concerns me, though, is that Ackman and Berkowitz are entering this trade after some of their worst years on record. Ackman's short thesis on Herbalife is getting crushed by a robust bull market while he walks away from a huge losing trade on J.C. Penney. Berkowitz's funds had a miserable year in 2011, and investors fled. Were it not for a huge concentrated bet on AIG, Fairholme's recent performance would still be lagging the market.

To an outsider, it almost appears that the two see this as their "get-even" trade, whereby they commit a small amount of capital with the hopes of knocking it out of the park and papering over recent poor performance. I fear many smaller investors are doing the same, looking for a big multi-bagger while accepting the risk of complete and total capital loss should the U.S. government keep control of Fannie Mae or Freddie Mac -- or both. 

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Read/Post Comments (11) | Recommend This Article (7)

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  • Report this Comment On November 23, 2013, at 12:50 PM, infinitemf wrote:

    Why analysts at MF, play devil's advocate.

    Is it a way to validate your invest strategies or

    ignorance?

  • Report this Comment On November 23, 2013, at 1:07 PM, stocksdd wrote:

    You are skimming it. Stocks DD has dumped a lot of information which can be used as basis of research here -> http://stocksdd.blogspot.com/2013/11/stocks-dd-cites-berkowi...

  • Report this Comment On November 23, 2013, at 1:21 PM, notafool2013 wrote:

    That is what the contrarian is all about. If you get one right, then you can afford to miss other four. You don't have to get it right all the time.

    No one knows what the US government and congress are going to do. However, the Senator Corker found the proposal interesting. In addition, the main reject reason from the administration was the final two entities would be still too big. These two are encouraging signs.

    The final details could be just the purchase price and the market share the US government is willing to give up at what speed. It would facilitate the process if Fannie and Freddie could be split into smaller entities. These small Tom, Jane, John, and Bob could be sold to the public one by one.

  • Report this Comment On November 23, 2013, at 3:03 PM, okjerryds wrote:

    Am I the only one here that is blind... Insider Trading... The SOB is going to get rich off our backs... Again

  • Report this Comment On November 23, 2013, at 3:07 PM, Mega wrote:

    "Ackman is working with Berkowitz to put Fannie Mae and Freddie Mac back in private hands."

    Ackman isn't working with Berkowtiz. He's stated that he opposes the Fairholme plan.

  • Report this Comment On November 23, 2013, at 3:10 PM, TMFValueMagnet wrote:

    Mega,

    Unfortunately, that news came out after this article was written. You're correct, apparently Ackman has his own plan for Fannie and Freddie.

  • Report this Comment On November 23, 2013, at 3:18 PM, TMFValueMagnet wrote:

    infinitemf,

    I don't think I'm playing devil's advocate at all. If anything, Fannie and Freddie are priced as if the odds of the GSEs going into private hands is low.

    notafool2013,

    The fact that no one knows what's going to come of Fannie or Freddie is what makes this uninvestable, in my view. It's really pure speculation.

    The good news is that we can all have different perspectives.

  • Report this Comment On November 24, 2013, at 8:26 AM, gameforfools wrote:

    We will never learn! Ackman and Berkowitz' (losers in their own right with Herbalife and J C Penney) "puzzling 10% stake" - nothing puzzling when you put it in the Madoff perspective - its the bait - watch the fools jumping at this opportunity with the Ackman Berkowitz Hedgers - the last big Hurrah before joining Madoff at Club Med...

  • Report this Comment On November 24, 2013, at 8:47 AM, gameforfools wrote:

    With enough of their cronies on the Board the headline could read: Did Bill and Bruce hijack Fannie Mae and Freddie Mac?.. and here's the newly invigorated WizKidNeel with his inaugural - tooting transparency and moral values - fresh out of detox from the Sacs affair

    Pipeline of rats from foreign soils to the U.S. till the cupboard runs bare.

  • Report this Comment On November 24, 2013, at 10:59 AM, plange01 wrote:

    ackman has a lot worse investments than fannie and freddie which are being shut down...

  • Report this Comment On November 24, 2013, at 11:01 AM, GordonZ wrote:

    The conservatorship deal was outragiously tilted in favor of the Treasury Department. The terms of the so-called bail out has given the Treasury Department all of the reward with little risk. It is now seen that the GSE's debt obligations will be completely fulfilled to the Treasury, but there is no plan to release the GSE's from conservatorship?

    What is that! Were there any such conditions placed on AIG or BAC? In effect Washington politics have nationalized the GSE's. Washington politics could not play such a direct role in reforming the corporate structure of TBTF/SIFIs such as AIG, BAC, C and GS. Washington politics cannot nationalize these corporations ... perhaps that can be done in Argentina or Venezuela, but not in America!

    There must be an end game to the "conservatorship" yoke placed on the GSEs after the debt obligations are fulfilled. It would be ludicrious to "unwind down" the structure that has made good on its debt obligations. Policy mistakes were made in the past, but is it not obvious that those policies were righted?

    Washington politics are using the GSEs as a cash cow. Politics have nationalized the GSE. That needs to be changed if this is America.

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