Investors are Ready to Discover Fannie Mae and Freddie Mac

Plaintiffs suing the U.S. government are a little better off.

Apr 8, 2014 at 7:00AM

Source: Flickr / Georgie Pauwels.

After an amendment to the preferred stock purchase agreement with the U.S. government was added in 2012, shareholders of Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) are forced to rely on the courts to realize any value from their investment.

A recent decision from the court hands an early win to Fannie and Freddie investors and we could soon learn a lot more about their situations.

Early win
For Fannie and Freddie investors, overturning the Sweep Amendment put in place in Aug. 2012 is critical to giving shares any value. Since politicians are generally more eager to wind down the GSEs than give shareholders any value, the courts are the most likely way for the Sweep Amendment to be overturned.

Although there are many parties suing the U.S. government over its handling of Fannie and Freddie, the case put forward by Fairholme Funds is one of the most critical and where the current news comes from.

Last week, a federal judge sided with the plaintiffs, Fairholme Funds, and granted discovery beginning April 7 and ending Jul. 31. In other words, the defendants, The United States, will have to start releasing information beginning at the start of this week.

What it means
The case against the government in the Fannie and Freddie case largely rests on the idea of collusion within the government. The pro-shareholder side alleges that the Federal Housing Finance Agency (FHFA), the conservator and controller of the GSEs, acted with the government to steal the profits of Fannie and Freddie through the Sweep Amendment.

Right now, the story would suggest that something to that effect happened, considering the Sweep Amendment was enacted soon after the GSEs returned to profit, and that no manager of a profitable company would agree to give up its entire future profits for no compensation. However, finding hard evidence to support these allegations has been difficult.

Discovery could grant new insights into the internal acts of the government leading up to the Sweep Amendment and possibly bring hard evidence to back up the allegations of the plaintiffs.

Terms of discovery
First, by granting discovery to begin soon, the plaintiffs are put in a much better position. The battle to save Fannie and Freddie's shareholders is a race between the courts and Congress, the latter of which is looking at different ways to wind down the GSEs and almost certainly wipe out common shareholders. Having discovery begin on April 7 means the lawsuit can progress faster and possible information can come to light before Congress can pass legislation to end Fannie and Freddie.

The terms also call for status conferences every two weeks between the court, the plaintiffs and the defendants. Although status conferences are fairly common in legal proceedings, having one every two weeks should help to keep the government from slowing down the release of requested information and allow the proceedings to move along faster.

Lawsuit investment
In the past decade, Fannie and Freddie have gone from being blue chip stocks, to near worthless penny stocks, to bets on the legal rulings from the nation's courts. Fairholme Funds has been granted discovery to begin next week and they could soon know a lot more about what happened inside the government around the time of the Sweep Amendment.

But we are no where near the end here. Discovery is one of the first parts of a lawsuit and even this stage will continue through the summer. So for Fannie and Freddie investors, your prospects just improved a bit but be prepared for a long, and possibly bumpy, ride.

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Alexander MacLennan owns common shares of Fannie Mae and Freddie Mac. 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.

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