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Fund Offers to Buy GSEs’ Ongoing Business

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A preferred investor in Fannie Mae and Freddie Mac that has sued the government over unpaid dividends now seeks to pick up some of their assets while liquidating the rest.

The proposal came from Fairholme Capital Management LLC, an investment fund manager founded in 1997 by Bruce R. Berkowitz.

One of the funds managed by the firm, The Fairholme fund, reports a 180 percent cumulative return over the past 10 years. The fund has 85 percent of its investments tied up in AIG, Bank of America Corp. and other financial services firms devastated by the financial crisis.

Most recently, The Fairholme Fund invested in preferred shares of Fannie and Freddie at a discount of around 80 percent, “a significant bargain thanks to market predictions of U.S. Government agencies expropriating their assets,” according to a first-half 2013 portfolio manager’s report.

“We see them differently,” the manager’s report stated. “Fannie and Freddie are successful, publicly traded, shareholder-owned companies just like AIG and Bank of America. Shifting political winds can change their futures, but not alter their pasts.”

Fairholme filed lawsuits in U.S. District Court for the District of Columbia and U.S. Court of Federal Claims seeking the payment of dividends to preferred shareholders of Fannie and Freddie.

“Our arguments are based on fundamental principles. In America, property ownership is a sacrosanct freedom, guaranteed by our Constitution. In America, we follow the rule of law, not the rule of the crowd. In America, profitable companies honor contracts,” the company stated in the manager’s report.

The Miami-based firm laid out its plan for Fannie and Freddie in a letter to “relevant federal government officials,” according to an announcement Wednesday.

The proposal calls for private investors to purchase the two firms’ mortgage-backed securities insurance businesses while allowing for an orderly liquidation of their historical assets.

Such a move would answer bipartisan call for significantly more private capital in the mortgage market and “facilitate legislative reform of any political stripe,” according to the statement.

Around $52 billion in private capital would be utilized to support credit risk on more than $1 trillion in new mortgages without disrupting the market. Almost $35 billion would come from an exchange for Fannie’s and Freddie’s preferred stock, which would be retained for at least five years, while more than $17 billion would be raised in a new preferred offering.

However, much of the $35 billion appears to be just the difference between the discounted price of the preferred shares purchased by Fairholme and the face value.

No government subsidies or support would be required for the new companies, though their business models would be compatible with a federal reinsurance program or federal intervention in the market.

Fannie’s and Freddie’s federal charters and conservatorships would be ended, and they would be liquidated.

Fairholme says that by separating new underwriting from legacy investments, systemic risk would be reduced.

“The centerpiece of the proposal is the establishment of two new, state-regulated private insurance companies to purchase, recapitalize, and operate the insurance businesses of Fannie and Freddie,” Fairholme said. “The new companies would have no federal charter or special status, and the names ‘Fannie’ and ‘Freddie’ would be retired and never used again.”

The Department of the Treasury’s investments in the pair of companies would be fully paid from proceeds from legacy investments and insurance. Fairholme claims that such a strategy would result in a “fair profit” for the Treasury Department.

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