Swinging for the fences, Berkowitz bets on Fannie, Freddie

Betting on Congress to do anything is about as risky a bet as you can make. But Bruce Berkowitz is willing to make it.
Last week, his firm, Fairholme Capital Management LLC, disclosed that it owned $2.4 billion of the junior preferred stock of both Fannie Mae and Freddie Mac. While the well-known money manager posted a 36% return in his flagship Fairholme Fund last year and is up another 20% through the end of May, he is only now recovering from the huge 32% loss he suffered in 2011 — largely due to his very large and early bet on the banking sector.
Mr. Berkowitz is swinging for the fences again with Fannie Mae and Freddie Mac — the two government-sponsored enterprises whose ownership structure is still in limbo. Preferred shares in both firms, which pay no dividends, have skyrocketed this year as hedge funds such as Paulson & Co. and now mutual funds like Mr. Berkowitz’ are betting they can convince the government to let the companies pay off their $187 billion debt to taxpayers and emerge again as investor-owned companies. Fannie Mae’s 5.375% non-cumulative preferred Series 1, for example, topped $11 last month, rising from about $3 in March. The shares have a par value of $25 and currently trade at just over $9.
In a statement last week, Fairholme said it was “ready to help with a restructuring that accelerates the return of meaningful investment to the secondary mortgage market.” It continued: “Privately-owned Fannie and Freddie are critical to our nation’s economic security, lowering the cost and increasing the availability of homeownership.”
Optimism about a restructuring of the two lenders has been fueled by the continuing recovery in the housing market and increasing profitability for both companies. The recent suggestion by Jim Millstein, the former Treasury Department official who oversaw the rescue and reorganization of American International Group Inc., that Fannie and Freddie could and should be restructured, likely has helped as well. The government made a profit of more than $20 billion on the AIG restructuring.
The problem is that neither Republicans nor Democrats appear willing to release the companies from government conservatorship, or to allow them to pay off the government’s preferred position, with its increasingly large dividend payments.
A draft bill written by Sen. Bob Corker, R-Tenn., and Sen. Mark Warner, D-Va., would replace Fannie and Freddie with another government entity. The draft, which has not been formally proposed, gives no indication of expectations that there will be any value left over for shareholders — preferred or common.
“We are not in the habit of or in a position to give any investment advice whatsoever, but our bill — when finished — will make every effort to ensure that taxpayers get all of the upside that comes with the risks they were asked to assume in 2008,” Mr. Corker said in a statement last week.
Jaret Seiberg, a policy analyst with Guggenheim Securities LLC, sees the chances of Fannie and Freddie surviving intact as slim. “The overwhelming view in Washington on both sides of the aisle is that any changes in housing and finance have to involve liquidating Fannie and Freddie,” he said.
If that’s the case, Mr. Berkowitz and other investors in the two companies could be left holding the bag.