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Plan to unwind Fannie, Freddie pits taxpayers vs. shareholders

By Dina Elboghdady

WASHINGTON — The newest Senate plan to dismantle Fannie Mae and Freddie Mac omits at least one major detail: What happens to the private investors who scooped up the mortgage companies’ shares in hopes of getting a portion of their recently stellar profits?

0 Talk about it

“The answer is going to come in court rather than in Congress,” Sen. Mike Crapo, R-Idaho, told Bloomberg Television on Thursday.

Crapo joined with Sen. Tim Johnson, D-S.D., this week to unveil the broad outlines of a proposal that would wind down Fannie and Freddie, replace them with a new agency, and shift some of the risk of mortgage losses to the private sector. The lawmakers have declined to publicly discuss the details until they offer their legislation, which could possibly occur Friday.

But whether the companies are shut down or kept alive, the outcome of several investor lawsuits making their way through the courts will ultimately determine how much of the companies’ profit will go to investor groups.

“The litigation is important because it will determine who gets that money: the taxpayers or shareholders,” said Jaret Seiberg, an analyst with Guggenheim Securities.

At issue is the arrangement the government created when it took control of Fannie and Freddie at the height of the housing crisis in 2008.

Under that deal, the U.S. Treasury began injecting the companies with huge sums of cash to keep them solvent. In return, Fannie and Freddie issued “senior preferred” shares to the government that paid a 10 percent dividend. The government also acquired rights to own 79.9 percent of the companies’ common shares.

But Fannie and Freddie were losing money at the time, and they were borrowing money from the Treasury to pay the 10 percent dividend to the Treasury. In August 2012, the government directed the companies to send nearly all their profits to the Treasury in the form of dividends instead.

Fast forward to this year. Fannie and Freddie have done the unexpected: They’ve turned profits for many quarters in a row. At the end of this month, they will have sent about $203 billion in dividends to the Treasury — more than the $188 billion they received in the taxpayer-funded bailout.

But that doesn’t get them out from under the government’s thumb. As long as they’re in conservatorship, Fannie and Freddie must keep turning over their profits to the government. In essence, they can never “repay” the bailout money.

Several investor groups, such as the mutual fund firm Fairholme Capital Management and the hedge fund Perry Capital, are suing to end the Treasury’s take-all-profits approach. These investors bought shares on the cheap, betting that Fannie and Freddie would become cash cows. They say they’ve been duped.

“We were misled,” said Tim Pagliara, who invested nearly $1 billion in Freddie and Fannie securities on behalf of his clients starting in the summer of 2008. Pagliara is not involved in the lawsuits. But he said he would not have invested in the firms had he known that the Treasury would change the deal. “They pulled a switcheroo.”