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Fannie and Freddie will test Trump's ties to Wall Street

Rick Newman
Columnist

Banks and energy firms have been big winners since Donald Trump stunned the world with his surprise victory in the US presidential election on Nov. 8. Stocks in those two sectors are up around 10% since Election Day, as investors anticipate new Trump policies favorable toward each industry.

But that’s a trifle compared with the rally in shares of Fannie Mae (FNMA) and Freddie Mac (FMCC), the housing finance agencies now run by the federal government. Fannie is up 92% since Election Day; Freddie, 99%. Investors, who own a minority of shares not controlled by Washington, are betting that Trump will free the two agencies from government control and begin sending their considerable profits back to private-sector shareholders.

If that were to happen, the biggest winners would be a handful of hedge funds that have placed risky wagers on Fannie and Freddie during the last few years. The top shareholder is Pershing Square Capital Management, run by billionaire Bill Ackman, which bought a large stake in both firms in 2013. Ackman owns 116 million shares of Fannie and 64 million shares of Freddie, and his stake has gained about $272 million in value since Election Day. Ackman had been underwater on the investments, since the share prices had fallen well below what he paid for them in 2013. But Trump’s election and the improved prospects for the two firms have put Ackman in the black.

Ackman is not an active Trump supporter, but another Fannie and Freddie investor is. Hedge fund billionaire John Paulson owns 1.33 million shares of Freddie, with his holdings gaining about $2 million in value since the election. Paulson supported Jeb Bush and Scott Walker early in the presidential race, but signed on with the Trump campaign once Trump became the Republican nominee. Eventually, he became one of Trump’s top economic advisors. The huge jump in Fannie and Freddie shares could be due in part to the perception that Paulson could persuade the future president to steer the two firms back toward private ownership.

Other investing firms holding a stake in Fannie or Fredde include Ruane, Cunniff & Goldfarb, Third Avenue Management and William Harris Investors. While their stakes are small, they could win big if either agency is freed from government control. Both stocks traded above $60 prior to the housing bust, then plunged almost all the way to zero as they collapsed and the government rescued them. Each now trades around $3 per share. Ackman has argued that the shares could go as high as $50 if the government gets out of the way, which would make those returns since Election Day look like peanuts.

But traders betting on a second act for Fannie and Freddie may be banking too heavily on Trump, who has not taken a public stance on the fate of the two agencies. “There have been false dawns before with the Fannie and Freddie trade,” says Michael Bright of the nonprofit Milken Institute’s Center for Financial Markets. “There’s a lot of rumor and speculation, but no one is getting involved in these things based on the underlying fundamentals of the company. The question is whether Congress will deal on a payout for the owners of Fannie and Freddie.”

There have been several attempts in Washington to enact housing finance reform that would settle the fate of the two firms—with virtually no progress. The government bailout cost taxpayers $187.5 billion, with the government taking a 79.9% ownership stake in each company. Fannie and Freddie have since paid back the bailout money, with interest. But the original bailout legislation left unanswered the question of what to do with the zombie firms after that. The two firms still back roughly two-thirds of all new mortgages, making them essential to the housing market and impossible to liquidate without a detailed backup plan.

In 2012, the Obama administration changed its policies and announced a “quarterly sweep of every dollar of profit that each firm earns going forward.” That means the two firms’ profits go straight back to the Treasury, making them highly unusual government-operated corporations with a smidgen of public ownership. The two organizations have been profitable since 2012, and they’ve funneled more than $240 billion in profits back to the government since then. But remitting all their profits means they can’t build capital, invest like a normal company or plan for the future. Ackman and other investors sued to challenge that move, with the suits still winding through the courts.

Various reform proposals run the gamut from shutting down Fannie and Freddie completely and replacing them with a new federal agency, to privatizing them fully and regulating them like a big Wall Street bank. A Milken Institute blueprint would convert the two agencies into a sort of insurance company owned not by the government or individual shareholders, but by banks and other lenders that issue mortgages. “I think what will happen is they’ll be kept around in some form with a smaller footprint, and the door to competition in the mortgage space will be opened a bit,” says Bright.

What investors like Ackman and Paulson care about is what happens to current shareholders whenever the feds decide what to do. The government could wipe them out completely, compensate them at some fixed rate or engineer an outcome that generates billions of dollars worth of profit for shareholders. And Trump will have a lot to say about it. If Wall Street ends up feasting on Fannie and Freddie, they’ll have the next president to thank.

Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman.