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Bill Ackman Ignores The Warning On Fannie Mae, Freddie Mac

Tickers in this article: BX FMCC FNMA

Back in 2012, Bill Ackman had some suggestions for Federal National Mortgage Association OTCBB:FNMAaa.k.a. Fannie Mae. The hedge fund manager, known for his aggressive activism, said that Fannie Mae could do well for the housing sector if it held on to its foreclosed homes rather than selling them, he said, “ fix them up and rent them and become a residential REIT that owns homes.

Today, Ackman’s hedge fund filed two 13Ds showing nearly 10% stake in each insurer’s common stock. Pershing Square detailed in the filings that they will push the companies to follow through with a plan for restructuring the GSEs. aBill Ackman intends to engage in discussions with the government and other shareholders to achieve a favorable outcome.

No liability to shareholders

Ackman is buying shares of the two companies, which he warned investors against in a 2011 interview. While on CNBC, Ackman said “ these shares should come with a warning .” The hedge fund manager was registering his surprise after aaFannie Mae / Federal National Mortgage Association OTCBB:FNMA board member and Harvard Business School professor, Clayton Rose, told him that the board’s fiduciary duty is only to its conservator, meaning the government, and not to the shareholders. He shocked Ackman by saying that the board has no liability if it makes decisions that go against shareholder interests. It seems Ackman has now gotten over his shock and believes that he can actually turn a profit here despite the obvious risks tdue to the heavy government involvement.

Bill Ackman shorts CDS

Interestingly, Ackman’s Pershing Square was among the first hedge funds to predict the fall in the subprime mortgage market during the financial crisis. According to Pershing’s 2Q2012 letter , the fund initiated short positions inaFannie Mae / Federal National Mortgage Association OTCBB:FNMA andaFreddie Mac / Federal Home Loan Mortgage Corp OTCBB:FMCC through credit swaps in June’ 2007. It is not known whether Pershing is still hedging the risk of its new long bet by buying credit derivatives anymore or if the funds have exited the short bets.a There is more likelihood of the latter. In the second quarter letter, Ackman noted,

Two mortgage insurers, Fannie Mae and Freddie Mac, where we were correct in ouradetermination that both were insolvent, but where we did not expect that the U.S. governmentawould protect their subordinate debt which we shorted through the purchase of CDS. Despite theagovernment?s effective assumption of their debt obligations, we made multiples of our CDSainvestment on Freddie Mac and incurred only a modest loss on Fannie Mae CDS.

Fairholme proposal

Fairholme Fund holds preferred shares, worth $3.5 billion face value, of the state-controlled insurers, making it the largest stakeholder. The refinancing plan that Berkowitz has proposed includes the acquisition of the core business of the insurers in exchange forapreferred stock wortha$34.6 billion, and an additional $17.3 billion that will be raised from preferred shareholders in a rights offering. Other than Berkowitz, John Paulson, Richard Perry and The Blackstone Group L.P. , also hold prefs ofaFannie Mae / Federal National Mortgage Association OTCBB:FNMA and Freddie Mac / Federal Home Loan Mortgage Corp OTCBB:FMCC.