Will This Bill Wipe Out Fannie and Freddie Shareholders?

Senator Bob Corker's plan isn't kind to shareholders.

The futures of Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) remain as uncertain as ever as various groups back rival plans for the future of the housing market. But one bill in Congress threatens to wipe out Fannie and Freddie common and preferred shareholders.

Corker-Warner bill
One proposal getting a lot of attention is the Housing Finance Reform and Taxpayer Protection Act, better known as the Corker-Warner bill. As the shorthand name suggests, this bill is sponsored by Bob Corker, a Tennessee Republican, and Mark Warner, a Virginia Democrat. With a few more names from each side of the aisle, this is the most bipartisan proposal to address the government's role in housing.

On Corker's Senate website, the bill is summarized with the following points.

  • Winds down Fannie Mae and Freddie Mac within five years.

  • Transfers appropriate functions to a government utility, the Federal Mortgage Insurance Corporation, or FMIC, which is modeled in part after the FDIC, to provide catastrophic reinsurance behind 10% first-loss, private capital.

  • Charges FMIC to maintain an insurance fund with a minimum reserve balance of 2.5% of the outstanding balance of covered securities as a catastrophic backstop that would be used only in the event that the 10% first-loss private capital is completely wiped out.

  • Removes shareholders from the government utility, but renews competition and innovation by chartering market-capped, private risk-sharing institutions.

  • Ensures that community banks and credit unions have direct access to the secondary market and equitable pricing with larger originators.

Shareholder returns
The first bullet point is critical for shareholders of Fannie and Freddie. Because of the way the GSEs would be wound down, common and junior preferred shareholders are unlikely to see any returns, since they are all in line after the Treasury's senior preferred stake.

The market seems to agree with this sentiment, as shares of the GSEs slid when President Obama spoke of the bill in a favorable tone. Because of this, shareholders of Fannie and Freddie should view this bill as a negative solution from an investment perspective.

Chances of implementation
In September, a White House spokesperson sent an email to Bloomberg saying, "The president strongly supports comprehensive housing finance reform that would forever end Fannie Mae and Freddie Mac's flawed business model that put the American taxpayers on the hook." Whether Obama would want additional changes to the bill remains to be seen, but the bipartisan nature of this legislation could make this bill an easier one to sign.

President Obama speaks with Mark Warner (right).

But the president is not the only hurdle to the passage of the Corker-Warner bill. With the term "Congressional action" becoming an oxymoron, passing this bill through Congress won't be easy. Although the bill does have some support from both Democrats and Republicans, both parties have members that would consider the bill too conservative or too liberal.

Chances are this bill won't pass before the 2014 midterm elections. Not only does major financial-services legislation generally take a lengthy period of time to put together, but the time period shortly before elections is often the slowest in terms of action.

Bipartisan action
The Corker-Warner bill calls for the wind down of Fannie and Freddie and their replacement by the Federal Mortgage Insurance Corporation. Common and junior preferred shareholders of Fannie and Freddie would most likely be wiped out, as the proceeds from the wind-down would first go to the Treasury's senior preferred stake.

Despite a favorable view from the president and some bipartisan support, this bill could be difficult to pass in the near future. Midterm elections are coming up, and this Congress isn't exactly known for taking quick action.

In the meantime, lawsuits from Perry Capital and the Fairholme Fund are challenging the legality of the 2012 changes requiring the GSEs to give all their excess profits to the Treasury. If either of these lawsuits prevail, the futures of Fannie and Freddie could become a lot brighter. So there's a possibility of returns for GSE shareholders, but more likely from the courts than from Congress.

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Read/Post Comments (9) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 12, 2014, at 11:03 AM, smauney wrote:

    Splashy headline - 8 seconds, stock photo - 30 seconds, copy paste buttons - 10 minutes, edit - 5 minutes, publish - 2 seconds. attach bait and something quoting Warren Buffet - 1 second. Done.

  • Report this Comment On February 12, 2014, at 11:33 AM, soad34 wrote:

    Last year called..... they want their article back!!!

  • Report this Comment On February 12, 2014, at 2:07 PM, smauney wrote:

    Gave healthcare website to Accenture who outsourced to India. Corker wants to replace GSE's with expensive mortgage insurance and underwrite it through London insurance markets. Now I understand why The Financial Times & Reuters post articles about winding down the GSE's - they are from Great Britain. Thanks Fools!

  • Report this Comment On February 12, 2014, at 3:23 PM, jmoney949 wrote:

    Dude guys.. at least stay current. This bill was in the works last year and now it's pretty much dead on the floor. How much did you get paid to copy and paste this?

  • Report this Comment On February 12, 2014, at 4:14 PM, joshua85 wrote:

    This article seems to be pretty much pointless as it seems that most investors sentiment leans toward the courts overthrowing this clean sweep amendment.

  • Report this Comment On February 12, 2014, at 10:03 PM, stout7735 wrote:

    Of course the President and the bi-partisan Congress agree to rip off the shareholders and give this cash cow to big banks and Wall Street...These politicians are bought and paid for....The taxpayer will have its total initial investment repaid (by earnings) in the next few weeks and then would make a small fortune unless the entire venture is given away to the robber barons....If FNMA was still a failed venture, these thieves would not be trying to push through a bill to give it all to them....With friends of the taxpayer like that, we don't need any enemies.....

  • Report this Comment On February 12, 2014, at 10:26 PM, neamakri wrote:

    "end Fannie Mae and Freddie Mac's flawed business model" The only flaw that I see is where congress told Fannie and Freddie to back loans to low income people that really could not afford it.

    That being said, is the FMIC subject to the same political flaw? So how is that any different?

    The only perfect solution is to have the Fannie/Freddie/FMIC replacement independent and be able to make real intelligent business decisions based on (1) asset value and (2) ability to repay the loan. Any intervention by congress just makes Fannie and Freddie social programs. Social Programs are not supposed to make a profit! They are designed to take money away from taxpayers and spread it around for votes.

  • Report this Comment On February 12, 2014, at 11:01 PM, maestrolindo wrote:

    Bellicose rhetoric. Big waste of time and money. Old news. Housing reform is a mute point in 2014 and onward. This is the United States. Not Argentina. Not Venezuela.

    Long live FNMA and FMCC!!

  • Report this Comment On February 13, 2014, at 9:57 PM, infinitemf wrote:

    Article look like from old cronies from bygone era.

    Hope they will transmigrate to current era and

    write articles based on current news.

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