FNMA and FMCC preferreds. In search of the elusive 10 bagger.

[Luke 5:32]

You have been brainwashed with all the books written by the experts

The word "all" is dangerous.  Writing a book does not make one an expert.  The content of their book that has stood the test of time makes one an expert.  There are only a handful of books one needs, and the one I've recommended to you in the past is The Intelligent Investor, so I'm guessing that's what you have in mind as the source of my being brainwashed.

The Intelligent Investor, although not directly quantifiable, is likely responsible for 95% of why I'm a self-made millionaire.  I'll gladly be brainwashed, if that's what you call it.

I've mentioned before that you need to guard yourself against emotions (read The Little Book of Behavioral Investing if you haven't already).  That's not unique to you, it's something all investors need to do.  Posting/griping about the current situation and current stock prices is more of an emotional release that results in wasted energy.

[Sunrider]

Emily, with all due respect, many (not all) of your posts are simply a complaint about the current situation.  That doesn't add value to the board and just bogs it down.  With that said, I do appreciate it when you post something that adds value to the board.  Thank you.

Amen.

[locutusoftexas]

So I read/scanned through the Document detailing the ruling by the Seventh Circuit Court of Appeals (filed 5/03). As I understand it, the Court ruled that Treasury and  FHFA acted in accordance with HERA and consistently with precedent in past court cases involving, e.g., FDIC. The most chilling option provided by HERA was: "(ii) collect all obligations and money due the regulated entity." Naively, I interpret that to mean that they can legally take all of the money/earnings (NWS). The Court, however, specifically pointed to the Court of Claims regarding the 5th Amendment and taking of property without appropriate compensation to owners.

Although I believe that the argument that the companies have been nationalized is a slam dunk and that the shareholders are due appropriate compensation under the 5th, I find the past rulings regarding the legality of Treasury and FHFA actions vis a vis HERA and NWS to be very discouraging. This is especially in the context of item (ii) quoted above. For this reason and the general trend of plaintiffs losing in federal court, I see the odds of a ruling for plaintiffs by Sweeney to be 50-50 at best. Ultimately the Supreme Court will have to rule, which will incur the passage of a few more years at least. If the plaintiffs lose in the SCOTUS (again 50-50 at best), Treasury will continue to grab all of the free money until circumstances force a resolution. In this scenario, the common and junior preferred will necessarily decrease in value. Unfortunately, such "forcing" circumstances are likely to be dire, in which case the value of these shares will approach zero (and stocks in general will also decline significantly). My conclusion: the most likely scenario is long-term loss of capital for common and junior preferred shareholders and the passage of a decade or more before these shares are worth more than zero.

Other "standard" models of stock valuation (e.g., Buffett or Graham) also support a value of approximately zero.

[Midas79]

So I read/scanned through the Document detailing the ruling by the Seventh Circuit Court of Appeals (filed 5/03). As I understand it, the Court ruled that Treasury and  FHFA acted in accordance with HERA and consistently with precedent in past court cases involving, e.g., FDIC. The most chilling option provided by HERA was: "(ii) collect all obligations and money due the regulated entity." Naively, I interpret that to mean that they can legally take all of the money/earnings (NWS). The Court, however, specifically pointed to the Court of Claims regarding the 5th Amendment and taking of property without appropriate compensation to owners.

Although I believe that the argument that the companies have been nationalized is a slam dunk and that the shareholders are due appropriate compensation under the 5th, I find the past rulings regarding the legality of Treasury and FHFA actions vis a vis HERA and NWS to be very discouraging. This is especially in the context of item (ii) quoted above. For this reason and the general trend of plaintiffs losing in federal court, I see the odds of a ruling for plaintiffs by Sweeney to be 50-50 at best. Ultimately the Supreme Court will have to rule, which will incur the passage of a few more years at least. If the plaintiffs lose in the SCOTUS (again 50-50 at best), Treasury will continue to grab all of the free money until circumstances force a resolution. In this scenario, the common and junior preferred will necessarily decrease in value. Unfortunately, such "forcing" circumstances are likely to be dire, in which case the value of these shares will approach zero (and stocks in general will also decline significantly). My conclusion: the most likely scenario is long-term loss of capital for common and junior preferred shareholders and the passage of a decade or more before these shares are worth more than zero.

Other "standard" models of stock valuation (e.g., Buffett or Graham) also support a value of approximately zero.

I would need a better understanding of the different claims made by the different plaintiffs to know how the Roberts appeal affirmance affects other cases. The Roberts opinion, to me, boiled down to another re-affirmation that the NWS was the act of a conservator and not ultra vires, and thus 4617(f) bars claims. Same as all the other cases I have seen so far. It also said that plaintiffs' claims were, by and large, derivative and also thus not applicable.

Graham-style valuations are naturally going to be zero because shareholders don't participate in any of the companies' profits. The thesis most of us preferred holders have is that i) there is no (plausible) alternative to Fannie and Freddie, meaning that they will eventually be released and the junior prefs will either be redeemed or have their dividends turned back on, and ii) the cases have largely been brought by junior pref holders. If a court awards damages then ostensibly any other junior pref holder (who held since before the NWS) can also sue for the same damages, right? I don't know where this leaves people who bought junior prefs after the NWS.

I disagree that "forcing" action must necessarily be bad for junior pref holders. If getting out from under those contracts was that easy, FnF/Treasury would have done so long ago.

[Cox022]

Petrou on Mnuchin's comments this week and GSE reform.

http://www.fedfin.com/blog/2671-karen-petrou-on-why-treasury-will-recraft-housing-finance

[cherzeca]

Petrou on Mnuchin's comments this week and GSE reform.

http://www.fedfin.com/blog/2671-karen-petrou-on-why-treasury-will-recraft-housing-finance

i did not understand a word.  anyone translate?

[locutusoftexas]

Midas,

The thesis that Fannie and Freddie are the only viable option (which I readily accept) implies neither that, in the absence of negative events or issues, Treasury/FHFA will willingly change the current situation (in which it accepts free money with common and junior preferred shareholders in limbo) nor that Congress will pass appropriate legislation. Furthermore, the existence of private shareholders maintains the fiction that the companies are separate from the government, providing "cover" for Treasury's de facto nationalization of the companies. If something goes wrong, this separation allows Treasury to deflect criticism to the companies' officers and leaves the private shareholders holding the bag. The complaint filed in Sweeney's court by Mason Capital on April 11 addresses this by focusing not on Treasury's misuse of HERA and NWS but instead on the de facto nationalization of the companies without proper compensation of the private shareholders. Compensation is what Mason Capital seeks. This would force Treasury to address the nationalization publicly. An easy solution for Treasury would be to  have the companies borrow money from Treasury to make a tender offer for all common and junior preferred shares. The shares could be cancelled upon being tendered. The nationalization would then be complete and official. Of course, Treasury does not want to do this for reasons given above and possibly for additional reasons that I cannot imagine. More impartantly, if the private shareholders cannot win a case on nationalization in violation of the 5th amendment, then the shares are truly worthless. 

[DocSnowball]

This is now in the too hard pile for me. Legal thesis is all but disconfirmed. Administrative action thesis is too hard to predict. Will look to reinvest when the companies offer shareholder rights again in the future and are available at a margin of safety. Good luck to everyone, and very sincere thanks for sharing your thoughts and feelings on this journey for the last few years.

[Midas79]

The thesis that Fannie and Freddie are the only viable option (which I readily accept) implies neither that, in the absence of negative events or issues, Treasury/FHFA will willingly change the current situation (in which it accepts free money with common and junior preferred shareholders in limbo) nor that Congress will pass appropriate legislation.

I agree here. But Mnuchin is on record saying that the companies will not be in conservatorship by the end of Trump's term. While the status quo is comfortable for the major players, the person with the most authority to effect a change has said that something will happen within 2.5 years. I can't see Congress agreeing on sweeping housing finance reform that kills FnF: the Republicans have just about run out of time and the Democrats, who are likely to take at least one chamber of Congress in November, don't want them dead.

Furthermore, the existence of private shareholders maintains the fiction that the companies are separate from the government, providing "cover" for Treasury's de facto nationalization of the companies. If something goes wrong, this separation allows Treasury to deflect criticism to the companies' officers and leaves the private shareholders holding the bag.

A fair point, but also a potentially good one for existing shareholders. Somebody other than the government has to own the companies when it's all said and done, and it's hard to argue that existing shareholders won't be among them. Dilution to common is all but inevitable in my eyes, making the prefs a safer investment.

The complaint filed in Sweeney's court by Mason Capital on April 11 addresses this by focusing not on Treasury's misuse of HERA and NWS but instead on the de facto nationalization of the companies without proper compensation of the private shareholders. Compensation is what Mason Capital seeks. This would force Treasury to address the nationalization publicly.

Thanks for drawing my attention to this specific case. I will read the complaint more carefully; I skimmed through it the first time. If it can avoid claims that are barred by 4617(f) then it has a fighting chance.

An easy solution for Treasury would be to  have the companies borrow money from Treasury to make a tender offer for all common and junior preferred shares. The shares could be cancelled upon being tendered. The nationalization would then be complete and official. Of course, Treasury does not want to do this for reasons given above and possibly for additional reasons that I cannot imagine. More impartantly, if the private shareholders cannot win a case on nationalization in violation of the 5th amendment, then the shares are truly worthless.

I can see a clear reason that this won't happen. Nationalizing the companies would make the GSEs essentially government agencies, and at that point they would have to consolidate FnF's assets and liabilities onto the country's balance sheet. That would add $5T to the national debt overnight, political suicide for Trump. The way politicians spin things, it won't matter than the overall net worth of the country would remain unchanged (because assets would also go up by $5T): they just focus on the debt number.

The most recent presidential budget confirms this. On page 104 (page 116 of the pdf):

Although Federally chartered to serve public-policy purposes,  GSEs are classified as non-budgetary because they are intended to be privately owned and controlled—with any public benefits accruing indirectly from the GSEs’ business transactions.

https://www.whitehouse.gov/wp-content/uploads/2018/02/spec-fy2019.pdf

[locutusoftexas]

Midas,

Thank you for your time in responding and the excellent points that you have made. I believe that you have a very good chance of being right on all counts and hope that you are. I cannot be as optimistic about what Mnuchin will do but I absolutely agree about Congress. I have also observed over many years that the federal government is very unlikely to kill a program once it starts, although every "rule" has exceptions. I further agree with your comments about the administration's reluctance to nationalize the companies and past demonstrations of this reluctance. This is why I believe that a complaint aimed at de facto nationalization in violation of the 5th Amendment is not only the most likely to succeed but also a potential trigger to action by Mnuchin or Congress. It is possible that I did not read the Mason Capital complaint closely enough and would appreciate hearing that I somehow got it wrong.

The Mason complaint is particularly ironic to me as I wrote an email to a major private shareholder suggesting exactly such a complaint two days before the Mason complaint was filed. I am sure that my email had nothing to do with it, but the filing gave me some hope that I wasn't completely off the mark. Past discussions over the years have used the term "nationalization," so this thought was new only to me.

Anyway, I don't believe that I will have much to add to the thread beyond this, but will do so if I have anything else to offer.