Questions remain about what the Biden administration will do with Fannie Mae and Freddie Mac. However, a new report from the Brookings Institution’s Economic Studies Group offers insight into what could happen to the government-sponsored enterprises. It suggests that Fannie Mae and Freddie Mac be used to drive more racial equality in the housing industry, something the Biden administration could get behind.
Highlighting value in Fannie Mae for the Biden administration
In a new report, analyst Dick Bove of Odeon Capital noted that the Brookings Institution’s report indicates that at least one group sees value in the GSEs. The authors want to use that value to help low-income housing and reduce racial inequalities in the housing industry.
Bove believes that if the Biden administration takes up their views, there is a good chance Fannie Mae and Freddie Mac will be released from their conservatorships. That would mark a major shift in strategy because many assumed President Joe Biden would rather leave the GSEs in conservatorship forever. Bove also thinks the holders of the junior preferred shares would be paid if the Biden administration adopts the views of the Brookings Institution.
Of course, the timing of anything happening is unknown, but Bove notes that the Brookings Institution’s study acknowledges the value in the GSEs’ capital structure. He agrees with that view and that the current valuation of the preferred shares is “well below what they are actually worth.”
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No movement during the Trump administration
During the Trump administration, Treasury Secretary Steven Mnuchin and Federal Housing Finance Agency Director Mark Calabria both said they would get Fannie Mae and Freddie Mac released from their conservatorships. However, that didn’t happen because they waited too long and ran out of time to get it done.
Bove and many investors expected Mnuchin and Calabria to make good on their statements about the GSEs. When they didn’t, many of them dumped the preferred and common shares in the two firms. Bove argues that Mnuchin and Calabria made it more difficult for Fannie and Freddie to be reprivatized through the language of the Fourth Amendment to the senior preferreds.
The Fourth Amendment
According to Bove, the Fourth Amendment makes it appear that the net worth sweep has been eliminated, although it has not been. The amendment states that the dividend on the senior preferred shares will be the lower of 10% or 100% of their profits or the same amount as the increase in their net worth.
However, instead of receiving these dividends in cash, the government gets them as senior liquidation preference certificates with the same dividends as the actual senior preferred shares. The amendment also allows Fannie and Freddie to increase their capital to 3% of their assets or about $243 billion by ignoring the senior liquidation preference shares.
“This was a clever way of lobbying the Supreme Court in the Collins Case,” Bove argued. “In essence, the government was saying you do not have to find that the Senior Preferred dividend, or the so-called net worth sweep, as illegal because we have eliminated it.”
What will the Biden administration do about Fannie Mae?
Bove explained that the Brookings Institution’s report on the GSEs changes the narrative in the discussion. Instead of focusing on the need to recapitalize and release them from conservatorship, it describes the housing problems faced by low-income households.
The Brookings Institution accuses the government of not living up to its concepts of equality and participating in discriminatory behavior in housing. It goes on to suggest that Fannie Mae and Freddie Mac are the tools the Biden administration needs to right the wrongs perpetrated by the government. The authors say the GSEs can change the outlook for the future by providing the funds required to house low-income families.
How the Biden administration could unlock value with Fannie Mae
They explain that the $48 billion to $98 billion in stock interests the government has received from its ownership of the warrants in the GSEs is the key to unlocking value in them. The authors of the Brookings Institution report want to use the money to establish a unit in Fannie and Freddie that the FHFA will run to help low-income families.
“It is clear that the value of these warrants and the senior preferred with all of its liquidation preference shares can only be realized if there is a healthy private market for the shares of Fannie Mae and Freddie Mac stock,” Bove argued. “That can only occur if there is no litigation, no capital shortages, and no outstanding debts due to the junior preferred shareholders.”
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