The most important developments for Fannie and Freddie shareholders will likely come from the courts where some of the most prominent investors today are challenging the current allocation of the GSEs' profits.
What's at stake?
In Part 1 of this series, I mentioned the amendment made to the senior preferred stock purchase agreement whereby the GSEs would no longer pay 10% interest on the senior preferred stock but would instead pay all of their profits to the Treasury.
Although this wasn't seen as that big a deal at the time when Fannie and Freddie were only slightly profitable and shares traded around $0.30, with the GSEs making billions in quarterly profits today, investors are challenging the legality of this amendment.
Bruce Berkowitz, manager of Fairholme Funds, and Richard Perry, manager of Perry Capital are among those suing the government over its handling of Fannie Mae and Freddie Mac.
Both plaintiffs' cases are argued with a basis of seeking compensation under the Fifth Amendment to the U.S. Constitution.
They argue the net worth sweep of Fannie and Freddie constitutes an unjust taking without compensation and the plaintiffs seek to end the net worth sweep and obtain compensation.
These will no doubt be major cases as nothing less than tens of billions of dollars in annual profits is at stake.
If the plaintiffs lose, it becomes tough to see how the preferred or common stock would have anything more than negligible value.
However, both preferred and common shares could more than double if the plaintiffs win. (More discussion on the outlooks and valuations for preferred and common stock will be in Part 4 and Part 5 of this series, respectively).
Right now, Fairholme Funds v. United States of America is in the discovery phase as plaintiffs seek key pieces of information from various parts of the government concerning Fannie Mae and Freddie Mac. With discovery being one of the earliest phases of a trial, investors should not expect a near term ruling on this issue.
With the amount of money at stake and the determination of each party to obtain it, this case could be one that heads all the way to the Supreme Court.
But for investors, the final ruling is critical to determining the value of their investment.
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This article is part of a series of articles that looks at Fannie Mae and Freddie Mac from an investment perspective. To read the full analysis, click here.