Will This Bill Wipe Out Fannie and Freddie Shareholders?

Housing reform was mentioned during the State of the Union, but will it mean the end of Fannie and Freddie?

Feb 12, 2014 at 10:35AM

Bob

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.

Warner

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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Alexander MacLennan owns shares of Freddie Mac common stock. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security.

The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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