Bloomberg News

Paulson Leads Hedge-Fund Lobby Push to Privatize Fannie

April 30, 2013

Paulson Leads Hedge Funds Urging U.S. to Privatize Fannie Mae

Washington-based Fannie Mae buys mortgages from lenders and package them into securities on which they guarantee payments of principal and interest. Photographer: Andrew Harrer/Bloomberg

Hedge funds including Paulson & Co. Inc. are pushing Congress to abandon plans to liquidate Fannie Mae (FNMA) and Freddie Mac (FMCC) as investors buy up preferred stock that has long been considered worthless, according to people with knowledge of the discussions.

The improving finances of the two government-owned mortgage companies have kindled hopes among shareholders that they could be revived as private firms. Even as lawmakers from both parties and U.S. housing officials say that won’t happen, preferred shares of Fannie Mae have more than doubled in price since early March. They closed at $4.75 yesterday.

Paulson & Co. is among funds that met with members of the Senate Banking Committee and with staff members in the House of Representatives, said two of the people briefed on the matter. Claren Road Asset Management LLC and Perry Capital LLC also have lobbied, said those people and a third person. They spoke on condition of anonymity because the meetings weren’t public.

“There are funds that have taken very large positions, large hedge funds, and they are lobbying heavily,” Senator Bob Corker, a Tennessee Republican, said in an interview, declining to confirm any names. “I don’t give investment advice, but I don’t see how these are going to be worth anything down the road.”

Armel Leslie, a spokesman for Paulson, and Liz Gill, a spokeswoman for Carlyle Group LP, majority owner of Claren Road, declined to comment. Perry Capital general counsel Michael Neus didn’t respond to requests for comment.

Lobbying Blitz

The blitz of hedge-fund lobbying reflects how Fannie Mae and Freddie Mac’s return to profitability is complicating discussions about housing finance reform. Lawmakers in the House and Senate are working on bills that would wind down the two government-sponsored enterprises, which currently own or back about half of outstanding home loans.

To date, the Washington debate about housing finance has focused less on how to dispose of Fannie Mae and Freddie Mac and more on how to lure private investments back to the mortgage market. Also at issue is what share of mortgage risk, if any, the U.S. should assume in the future.

Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac buy mortgages from lenders and package them into securities on which they guarantee payments of principal and interest. Their bad investments in risky loans in the run-up to the 2008 credit crisis led to a taxpayer bailout and enshrined them as symbols of excess in the housing market.

No Exit

Treasury holds $188.5 billion in senior preferred shares in the two companies, representing the amount of aid they have drawn from taxpayers to stay afloat. The companies have sent back $65.2 billion in dividends, which count as a return on the government’s investment and not as a repayment. Treasury also holds warrants to purchase nearly 80 percent of the companies’ outstanding common stock.

Under the bailout’s terms, there’s no mechanism for the enterprises to exit conservatorship. Neither Fannie Mae nor Freddie Mac can build capital because Treasury takes virtually all of their quarterly profits.

Holders of the rest of the preferred shares as well as common shares were widely presumed to have been wiped out when the government took over. The companies’ return to profitability has created renewed enthusiasm for the enterprises’ securities.

Hedge funds don’t publicly disclose their holdings of Fannie Mae and Freddie Mac securities. Claren Road and Perry Capital hold preferred shares, according to investors in the funds.

Taxpayer Profit

Fannie Mae’s preferred and common shares spiked after the company reported record earnings of $17.2 billion for 2012 on April 2. Common shares closed yesterday at 83 cents, giving the company a market capitalization of $4.8 billion, up from $1.5 billion at the end of 2012, according to data compiled by Bloomberg.

If the housing market continues to improve, and Fannie Mae and Freddie Mac remain in conservatorship for the next 10 years, taxpayers would come out ahead by $50 billion, White House budget analysts have projected.

Hedge fund lobbyists are arriving at Capitol Hill meetings with detailed financial analyses contending that selling off the government’s shares and recapitalizing the companies could make taxpayers an even larger profit, the people said. That also would boost chances that investors in preferred shares would benefit. The funds are making it clear they would be interested in buying the shares now held by Treasury, the people said.

Millstein Plan

The funds’ proposal is similar to one being circulated by James Millstein, the former Treasury official who oversaw the restructuring of bailed-out insurer American International Group (AIG). Millstein’s multiple-step blueprint calls for recapitalizing the two mortgage companies, eliminating their implicit government backing and selling off the Treasury stake. He would also create a new U.S. agency to reinsure loans. Millstein said his plan could leave taxpayers with $100 billion to $190 billion in profit.

Millstein, now chief executive officer of his own turnaround advisory firm, Millstein & Co., said that would be better than liquidating Fannie Mae and Freddie Mac.

“If policy makers get the size or pace of a forced wind-down wrong, we will suffer a credit contraction, house prices will fall and the U.S. economy will once again be at risk for a recession,” he told the House Financial Services Committee April 24.

Millstein said he holds some of Fannie Mae’s preferred shares himself.

‘Best Interest’

The only justification for liquidating the enterprises instead of privatizing them would be to punish them for their past, said Tim Rood, managing director at Collingwood Group LLC, a financial services consulting firm based in Washington.

“The issues that led to the housing crisis in which they played a role have largely been legislated away,” Rood said in a telephone interview. “Now it’s just a matter of what’s in the best interest of the federal government in terms of getting its money back.”

Still, President Barack Obama and lawmakers from both parties in Congress have called instead for winding down Fannie Mae and Freddie Mac.

“From the standpoint of the taxpayer, it could make a lot of sense to spin these back off to the public as much smaller, heavily regulated utilities,” Jaret Seiberg, an analyst at Guggenheim Securities LLC’s Washington Research Group, said in an interview.

Political Reality

“It’s a way to turn what could be a loss on the enterprises into a profit,” Seiberg said. “But that theory ignores the political reality that Fannie and Freddie are toxic and almost no one on Capitol Hill can advocate keeping them around.”

Corker in February introduced a bipartisan bill that would ensure Treasury can’t act without congressional approval to sell its senior preferred shares to private investors. Co-sponsors include Elizabeth Warren, a Massachusetts Democrat, Mark Warner, a Virginia Democrat, and Senator David Vitter, a Louisiana Republican.

Vitter brought up the hedge-fund lobbying campaign during a hearing April 18. He asked Edward J. DeMarco, regulator of Fannie Mae and Freddie Mac, what he thought would happen if Treasury’s stake in the companies were sold off in the absence of a restructuring of the mortgage finance market. DeMarco said such an about-face would generate confusion.

“It would certainly conflict with the notion that we’re trying to bring private capital back into this marketplace,” DeMarco said.

Corker, in the interview, said he’s been blunt with the hedge funds that hope to profit by betting that the two companies will stay alive.

“I tell them it’s a lottery ticket at best,” Corker said. “I just don’t see any appetite in Congress for Fannie and Freddie ever being returned to the private market.”

To contact the reporters on this story: Clea Benson in Washington at cbenson20@bloomberg.net; Cheyenne Hopkins at chopkins19@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net


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