Few investors are more closely followed in the modern era of investing than Bill Ackman of Pershing Square Capital Management, the investment manager of Pershing Square Holdings, and Michael Burry, who famously made bets against the housing market before its collapse during the Great Recession. Burry, who previously ran Scion Asset Management, recently shut down his fund and launched a newsletter on Substack, where he shares investment advice and knowledge about the stock market.
Now, investors should never mindlessly follow the "smart money's" recommendations for several reasons, including that you don't know the true timelines behind their trades. However, Burry and Ackman have made it very clear that they have high conviction in these two stocks. And the key could lie with President Donald Trump and his administration, which currently has the power to make game-changing decisions that turn these stocks into multibaggers.
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The history of Fannie and Freddie
These two government-sponsored entities (GSEs), Fannie Mae (FNMA 2.44%) and Freddie Mac (FMCC 3.28%), have a long and storied journey. Both play a critical role in the mortgage market by essentially serving as the secondary market and providing liquidity. Fannie Mae and Freddie Mac purchase mortgages from banks and other institutions, then package them into mortgage-backed securities for investors to purchase.
Banks and other mortgage providers are limited in the mortgages they can hold on their balance sheets, so Fannie and Freddie enable them to transfer these mortgages off their balance sheets, allowing them to continue meeting demand. Fannie largely purchases mortgages from large banks, while Freddie buys mortgages from smaller lenders. Fannie and Freddie have a monopoly on this business, primarily because they are backed by an implied government guarantee.
Government involvement in these two mortgage giants traces back to the Great Recession. The GSEs took on too many subprime mortgages and faced massive losses, forcing the U.S. government to step in. The U.S. Treasury Department injected over $187 billion into both companies and, in return, received $190 billion in senior preferred stock and warrants that give it the right to purchase nearly 80% of each company's common shares.
The preferred shares were supposed to yield an annual 10%, but eventually -- and quite controversially -- the agreement changed to a "net worth sweep," in which Fannie and Freddie simply handed over their profits to the government. The government would go on to reap over $300 billion from these payments. During Trump's first term, the administration ended this agreement and set forth a plan, including capital requirements, under which Fannie and Freddie could start retaining their profits and build capital that would eventually forge a path for them to exit government conservatorship.
The complicated path to being released from conservatorship
The Trump administration has indicated that it wants to release Fannie and Freddie from conservatorship, and these highly profitable entities have had no trouble building capital. Fannie alone generated at least $17 billion in profits in both 2023 and 2024. At the end of the third quarter of this year, Fannie had over $105 billion of shareholder equity and appears to be about $44 billion short of meeting one of its regulatory capital requirements.
The Trump administration is reportedly looking into an initial public offering (IPO) that could help Fannie and Freddie close the gap. The Wall Street Journal previously reported that the administration is contemplating an IPO of around $30 billion, which would be the largest ever. However, several issues remain. The first obvious one is significant dilution. Not only does the government own senior preferred stock and warrants that would significantly dilute new investors, but the GSEs also have junior preferred debt.
One proposal from Ackman is to have the government count prior payments from the "net worth sweep" agreement toward repayment of the senior preferred stock. The government could still exercise its warrants, potentially reaping hundreds of billions in profits. This may also be beneficial from a political standpoint in advancing a potential IPO, as there is an ongoing question about how much Congress would be involved in the process of releasing the two GSEs from conservatorship.
"To do an IPO without Congress, you would basically need to eliminate some of the government's ownership position, which is an open legal question of whether that can occur," Daniel Hornung, a senior fellow at MIT and former deputy director of the National Economic Council under former President Joe Biden, told Politico back in August.
OTC: FNMA
Key Data Points
Another roadblock to an IPO is what would actually happen to mortgage rates when Fannie and Freddie are once again independent. Some experts suggest mortgage rates could increase by 0.5% to 1%, primarily because Fannie and Freddie would no longer have the implied backing of the government and, therefore, would be riskier.
If this is the case, there will be little political appetite to release the GSEs, given the current housing crisis in the U.S. However, Fannie and Freddie may still have an implied government backing, even if they aren't under government conservatorship. Similar to the largest banks in the U.S., such as Bank of America, the government, for better or worse, simply cannot afford to allow these two entities to fail because they have become too big to fail.
Burry, who said in his Substack post that he has a large position in Fannie and Freddie, acknowledged that "there remains a final steep, windy and rocky climb to IPO for both," largely due to political and regulatory factors.
How much are Fannie and Freddie worth?
This is a difficult question, given that we don't know what happens with all the preferred stock and the government's warrants. However, I think it's safe to say that if they can figure everything out, Fannie and Freddie would be worth multiples of what they trade at now. Common shares of Fannie currently trade at around a $13 billion market cap, while Freddie is near a $7 billion market cap.
Ackman has said Fannie and Freddie could collectively be worth $400 billion if their stocks were moved from the over-the-counter markets to the New York Stock Exchange, although the government's stake would be worth about $300 billion in this scenario. Burry believes the two GSEs could trade at around 1.5 times to 2 times their book or equity value one or two years after an IPO.
Interested investors should understand that this remains a highly risky investment due to the numerous political and regulatory factors mentioned above. The good news for the bulls is that Trump appears to have a greater appetite than any president before him to release the GSEs from conservatorship, which is why the real window for this to occur may be over the next few years.
The junior preferred shares are the safer play because they face less risk of being wiped out and have priority over the common shares. However, they also offer less upside. The common shares are the highest risk-reward play. Ultimately, I think the common shares are worth a smaller, more speculative position, but nothing too aggressive.
