Fannie, Freddie shares plunge after Supreme Court deals blow to investors

Fannie, Freddie shares plunge after Supreme Court deals blow to investors
Greg Stohr and Joe Light, LA Times
Wed, June 23, 2021, 9:59 AM

The Supreme Court dealt a blow to Fannie Mae and Freddie Mac investors in their challenge to the government’s collection of more than $100 billion in profits from the government-sponsored enterprises.

The justices threw out a core part of the investors’ lawsuit, rejecting claims that the Federal Housing Finance Agency exceeded its authority under federal law.

Common shares of Fannie Mae slumped as much as 42% and those of Freddie Mac plunged 44%, both posting their steepest intraday declines since October 2014. Fannie Mae was down 36% as of 11:05 a.m. in New York. Freddie Mac sank 37%.

The court said investors might be able to win damages on a separate claim that some payments under the so-called profit sweep were illegal because the FHFA director was unconstitutionally insulated from being fired by the president. But the justices said they wouldn’t use that claim to toss out the entire profit sweep.

The justices sent the case back to the lower-court level, where the investors will have a chance to show they were harmed by the lack of presidential control over FHFA directors who implemented the agreements. But it means shareholders “can’t recover the bulk of the overpayments they sought,” said Bloomberg Intelligence analyst Elliot Stein.

The decision is a setback for firms including Paulson & Co., Pershing Square Capital Management and Fairholme Funds Inc. that have sought for years to persuade the government to release Fannie and Freddie from government control, thereby earning billions of dollars on their shares.

The ruling means President Biden will be able to oust Mark Calabria, the FHFA director and an advocate for releasing the mortgage giants from government control. Biden will face pressure to remove Calabria and put in his place someone more likely to allow Fannie and Freddie to ease mortgage credit.

“This will allow the Biden administration to finally put an end to the course that Calabria has the nation’s mortgage market on, much to the relief of progressives and industry alike,” said Jim Parrott, who is a consultant for financial firms and was a senior housing advisor in the Obama White House when the net worth sweep was implemented.

The suing investors targeted the 2012 agreements that let the federal government collect more than $300 billion in profits from Fannie and Freddie. That included $124 billion the investors said was an unwarranted windfall, beyond what the Treasury would have netted under earlier accords.

Brandon Barford, a partner at policy research firm Beacon Policy Advisors, called the decision a “profound rejection” of most of the shareholders’ claims, though he expected some shareholders to continue to fight “knowing the tenacity of those who feel they’ve been wronged.”

Justice Samuel A. Alito Jr. wrote the opinion for the court, which splintered on various parts of the case.

The cases are Collins vs. Yellen and Mnuchin vs. Yellen, 19-563

Biden to Oust Fannie-Freddie Regulator After Court Ruling
Jordan Fabian
Wed, June 23, 2021, 12:21 PM

(Bloomberg) -- President Joe Biden will move immediately to replace the director of the Federal Housing Finance Agency, Mark Calabria, an appointee of former President Donald Trump with broad powers over mortgage giants Fannie Mae and Freddie Mac.

The U.S. Supreme Court opened the door for Calabria’s removal with a Wednesday ruling that made clear the president had the authority to oust the regulator. A White House official responded by saying Biden would start the process of inserting an FHFA director who supports the administration’s priorities on housing policy. The official asked not to be identified discussing Biden’s intentions.

In addition to paving the way for Calabria’s removal, the Supreme Court also dealt a crushing blow to Fannie and Freddie shareholders who are challenging the government’s collection of more than $100 billion of the companies’ profits. The justices rejected claims that the FHFA exceeded its authority under federal law, leaving investors few options to get their hands on funds they’ve been seeking for years.

Fannie and Freddie shares cratered on the high court’s decision, with each plunging the most in intraday trading since 2013.

Calabria is a libertarian economist who has long supported releasing Fannie and Freddie from federal control. He’s also sought to reduce the companies’ footprint in the mortgage market, arguing that the extent of their operations puts taxpayers at risk.

In a statement, Calabria said he respects the Supreme Court’s decision and wishes his successor all the best in fixing the remaining flaws of the U.S.’s housing finance system.

No Rush

The Biden administration may not be in any rush to free Fannie and Freddie. That’s because it’s potentially easier to make the companies extend mortgage financing to underserved communities as long as they are wards of the state. Eliminating economic inequities is a top goal for the White House. Biden would likely name an acting FHFA director before nominating a permanent replacement.

Among issues Wall Street will be focused on is whether a new FHFA head will make it easier for borrowers to refinance their loans -- something that would have implications for investors in mortgage securities issued by Fannie and Freddie, said Ajay Rajadhyaksha, head of macro research at Barclays Plc in New York. He signaled it would be a mistake for the Biden administration to dramatically overhaul housing policy because it’s such a crucial component of the U.S. economy.

“Any policy changes should be incremental in nature instead of a ‘big bang’ so as not to disturb the critically important agency mortgage market and thereby the housing economy,” Rajadhyaksha said.

Determining what to do with Fannie and Freddie is the last major policy decision remaining from the 2008 financial crisis. The companies got into trouble when the housing market tanked in the run up to the Great Recession, prompting the government to rescue them with $187.5 billion in taxpayer funds. The firms have since become profitable again, paying out billions of dollars in dividends to the Treasury.

Little Hope

Fannie and Freddie don’t make loans. Instead, they buy mortgages from lenders and package them into bonds, guaranteeing payment to investors even if homeowners default. The process is is considered essential to the $10 trillion mortgage market and in keeping borrowing rates low.

In its ruling, the Supreme Court left Fannie and Freddie shareholders with little hope of making a windfall on their holdings.

Investors, the court said, might be able to win damages on a claim that some payments Fannie and Freddie have made to the government were illegal because the FHFA director was unconstitutionally insulated from being fired by the president. But the justices said they wouldn’t use that argument to toss out the entire policy decision -- made in 2012 -- that directed the companies to send their earnings to the Treasury.

The Supreme Court sent the case back to the lower-court level, where shareholders will get the chance to show they were harmed by the lack of presidential control over the FHFA.

Fannie Mae and Freddie Mac Shareholders Lose in Court; Here's What That Means for the Stock
The litigation lottery ticket doesn't pan out.
Brent Nyitray, CFA
Jun 29, 2021 at 7:31AM

June 23 was a big day in the mortgage market as the Supreme Court decided two issues that will weigh heavily on the future of Fannie Mae (OTC:FNMA) and Freddie Mac (OTC:FMCC). The Supreme Court ruled that the president has the authority to replace the director of the Federal Housing Finance Agency (FHFA), and it rejected a shareholder lawsuit by several hedge funds that claimed the FHFA exceeded its authority in handling the two government sponsored entities (GSE). This decision basically removed the last justification for owning the stocks.

Shareholders fail to convince the Supreme Court

Fannie Mae and Freddie Mac shareholders tried to argue that the structure of the Federal Housing Finance Agency was unconstitutional, and the government had no right to institute its net profit sweep, which diverted all of Fannie and Freddie's net income to the U.S. government.

However, Justice Samuel Alito wrote in the opinion: "When the FHFA acts as a conservator, it may aim to rehabilitate the regulated entity in a way that, while not in the best interests of the regulated entity, is beneficial to the Agency and, by extension, the public it serves. This feature of an FHFA conservatorship is fatal to the shareholders' statutory claim." This means the FHFA has no fiduciary duty to Fannie Mae and Freddie Mac shareholders, and that its main concern is the broader public.

Fannie Mae and Freddie Mac both fell around 45% on the news of the decision.

The stocks shouldn't exist in the first place

When Fannie Mae and Freddie Mac failed during the financial crisis and subsequently entered into conservatorship, the government left just over 20% of both companies' stock outstanding, trading on the pink sheets. The government did this so it wouldn't be forced to consolidate the GSEs' debt onto its own balance sheet, which would have had a material impact on the United States' debt-to-GDP ratio.

Absent that consideration, Fannie and Freddie would have gone through a typical bankruptcy, where the shareholders would have been wiped out. The Obama administration was dead set against the shareholders getting anything, and that viewpoint is probably shared by the Biden administration.

With the removal of Mark Calabria as the head of the FHFA, the philosophy regarding the companies will shift as well. The Biden administration is much more interested in the GSEs helping support affordable housing goals and increasing access to credit. In the waning days of the Trump administration, Calabria put several restrictions on Fannie and Freddie that will probably get reversed. The net effect will be to increase the flow of credit and increase the GSEs' footprint in the mortgage market.

Investors hoping for a release of the GSEs from government control will probably have to wait for a new administration. Releasing Fannie and Freddie was always going to be a heavy lift, one that will involve complicated legislation and the reconciliation of stark ideological differences in Washington, D.C. Suffice it to say the appetite for releasing them simply isn't there.

Where does that leave Fannie Mae and Freddie Mac shareholders? Fannie and Freddie stock was always something of a litigation lottery ticket, and at this point, the numbers have been announced and the ticket is worthless. While Fannie Mae and Freddie Mac will undoubtedly earn a lot of money going forward, those earnings are for the benefit of the government and not stockholders. It is possible that current stockholders could participate if Fannie and Freddie are eventually released, the chance of that happening is impossible to evaluate, which makes the companies an unsuitable long-term investment. The stocks are dead money at this point.