This Billionaire's Case For Saving Fannie Mae and Freddie Mac

Why is Ackman's Pershing Square Capital investing in companies that the government is tearing apart?

Jun 14, 2014 at 1:00PM

Flickr / insider_monkey.

After researching a recent article I wrote on the aftermath of the financial crisis, I decided to dig deeper into the story that Bill Ackman (rockstar hedge fund manager, CEO of Pershing Square Capital, and on-again/off-again arch-nemesis of Carl Ichan) has been boosting a large position in Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC).

To understand why Ackman would choose to bet on these two government-run casualties of the financial crisis, we first need to take a look at some history.

What happened to Fannie and Freddie?
The tailspins in Fannie Mae and Freddie Mac started during the housing bubble when mortgage originators started approving sub-prime mortgages to borrowers with bad credit. 

The idea seemed to be that by bundling a bunch of terrible sub-prime mortgages into a mortgage-backed security (MBS), you end up with a security that is not nearly as risky as each of the underlying mortgages itself was.

As it turns out, a bundle of crappy mortgages produces a crappy MBS.

The problem was that the investors that were buying these crappy MBSs had no idea how bad they were because many of them were still AAA-rated by credit agencies, the highest rating possible for a security. 

When the sub-prime mortgage borrowers inevitably defaulted on their payments, Fannie and Freddie stopped receiving mortgage payments. That meant that the GSEs did not have the capital to pay the the guarantees they owed to MBS investors, and the market value of MBSs started to tank.

Unfortunately, Fannie and Freddie combined had over $1.5 trillion of these mortgage-related assets on their own balance sheets, which compounded the GSEs massive losses from their guarantee business.

Losses were so overwhelming that Fannie and Freddie required a $187 billion government bailout and were placed under conservatorship by the Federal Housing Finance Agency (FHFA) in 2008.

Initial terms of the bailout
In return for the liquidity to remain operational, Fannie and Freddie initially accepted the following bailout terms from the government. First, the Treasury received warrants to purchase 79.9% of the common shared of the GSEs for a "nominal" price of $0.00001 per share. 

In addition, Fannie and Freddie each issued the Treasury $1 billion in shares of preferred stock that pay an annual 10% dividend. In order to make these dividend payments from 2008 to 2011, the GSEs issued even more shares of preferred stock to the Treasury. However, when Fannie Mae and Freddie Mac eventually returned to profitability in 2012, they were finally able to pay the 10% dividend from their own pockets for the first time. 


Treasury changes the rules
Things were looking slightly up for Fannie and Freddie shareholders in 2012 until the Treasury dropped a bombshell: they amended the terms of their preferred shares to pay dividends amounting to 100% of the earnings of the GSEs.

In other words, this "net worth sweep" means that every single cent that Fannie and Freddie earn from this point forward will be siphoned off by the government. 

Ackman's Case
Bill Ackman and other Fannie and Freddie shareholders believe that this one-sided change in the terms of the bailout agreement is illegal and will eventually be overturned in court. 

Ackman believes that, as a conservator, the FHFA has a duty to preserve and conserve the assets of the GSEs.

Last month, Ackman presented his argument that, if the net worth sweep is repealed, he sees plausible price targets for the GSEs ranging from $23 per share to $47 per share.

Source: Ira Sohn Conference Presentation.

Ackman's plan for the GSEs involves dramatically raising their capital requirements and ditching their fixed-income arbitrage business all together. In his presentation, Ackman asserts,

If the GSEs increase their capital levels and become pure mortgage guarantors, they can be a simple, low-risk, and effective solution for housing finance reform.

Ackman argues that relying on the private sector to take over the role that the GSEs currently serve in the housing market, is risky, untested, and impractical. In fact, Ackman shows that potential minimum capital requirements up to $500 billion for the GSEs existing $5 trillion MBS portfolio is more capital than was raised in all the U.S. IPOs from 2004 to 2013 combined! 

Even if the private sector could come up with this unprecedented amount of capital, g-fees and interest rates could skyrocket to a level that would discourage mortgage originations and lead to another downturn in the housing market.

What's a shareholder to do?
The takeaway message from Ackman's presentation is not that shareholders should expect their $4 Fannie Mae stock to be trading at $40 in a few years. For Fannie and Freddie shares to get to Ackman's target of $23 to $47, a series of favorable events need to take place first.

In fact, until the net worth sweep is overturned in court, Fannie and Freddie shares aren't worth the paper they're printed on.

One thing seems certain: the potential for large returns on these stocks exists, but for now shareholders are left with nothing more than hope.

Warren Buffett just bought nearly 9 million shares of this company
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

Wayne Duggan is the author of Beating Wall Street with Common Sense and the developer of Wayne Duggan has no position in any stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers