Bruce Berkowitz rolling dice on bailout babies — again

Bruce Berkowitz has had some success investing in companies bailed out by U.S. taxpayers — think American International Group Inc. But his latest bet on bailed-out outfits looks like a long shot for the controversial manager of the Fairholme Fund.

Based on June 30 disclosures, Mr. Berkowitz has invested 7% of his Fairholme Fund in the preferred shares of beleaguered housing lenders Fannie Mae and Freddie Mac. That stake works about to about $560 million.

On Tuesday, the Fairholme Funds Inc., on behalf of itself and nine insurance companies, filed two complaints against the Federal Housing Finance Agency, the acting director of the agency and the Treasury Department, essentially demanding a reinstatement of dividends on the companies’ preferred shares.

“Once the government has recouped its investment, The Fairholme Fund — on behalf of our shareholders, who are predominantly individual Americans with an average investment in the fund of $43,000 — is owed a contractually specified, noncumulative dividend for its investment in these companies. As solvent, highly profitable companies, Fannie and Freddie should honor all outstanding obligations to their investors,” the company said in a statement.

The complaint is the third filed so far against the government over Fannie and Freddie, both of which placed in conservatorship by the government in 2008 and received $188 billion in government aid to help bolster the collapsing mortgage market. The companies’ preferred and common shares came to life this year after languishing at less than $1 for most of the past few years.

With the housing market recovering and the two government-sponsored enterprises now showing substantial profits, hedge funds and other institutional investors such as Mr. Berkowitz have been investing predominantly in the companies’ preferred shares in hopes that the government will reinstate the dividends on the securities after it is repaid the full amount of the bailout.

“I think these complaints are really reaching,” said Bert Ely, a consultant and long-time follower of Fannie and Freddie. “I expect the government will file motions to dismiss them and wouldn’t be surprised to see them thrown out.” If the suits are dismissed, Mr. Ely also expects that the prices of both the preferred and common shares of the two companies will collapse.

Fairholme’s complaint specifically challenges changes made to the government bailout plan last summer, when the government forced the two companies to pay all their profits as dividends to the Treasury Department and specified that the payments would not be treated as a repayment of the bailout funds.

The litigation comes as Republican members of Congress ready legislation to wind down the two companies over the next five years and leave any mortgage-guaranteeing business to the private sector. Democrats are unlikely to support shutting down the two entities, but both sides of the political aisle in Washington are loath to restore them as publicly owned companies.
Mr. Ely suggests that the complaints filed by Fairholme and other shareholders in Fannie Mae and Freddie Mac have little chance of succeeding, given that the two companies would have collapsed had the government not stepped in. “In my opinion, these companies were insolvent when they were taken over, and in bankruptcy situations, shareholders and creditors get wiped out all the time,” he said. “I’m not a lawyer, but I’m highly skeptical that these suits will succeed.”

Related Topics: Mortgages