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Long Road Ahead for GSE Profit Allocation Battle

In a recent Bloomberg interview [1] by Joe Light and Erik Schatzker, Fairholme Hedge Fund Manager Bruce Berkowitz said the legal battle with the U.S. government regarding Fannie Mae and Freddie Mac’s profits could last another five years.

Back in February [2], the D.C. Circuit [3] panel gave the U.S. Department of the Treasury [4] and Federal Housing Finance Agency [5] a win over the allocation of profits from Freddie Mac [6] and Fannie Mae [7] to the Treasury. This affirmed a lower court’s ruling that actions taken under the FHFA’s conservatorship of the GSEs cannot be challenged in court, however Fannie and Freddie shareholders sued the two for agreeing to the deal. When the government took over the GSEs in 2008 during the housing crisis, the Treasury had “senior” preferred shares that paid a 10 percent dividend and had warrants to acquire nearly 80 percent of the companies stock. When the company changed the terms in 2012, instead of the 10 percent dividend, the government would receive nearly all profits, but there would be no payouts if the company suffered losses. They believe the profit sweep violates the reasonable expectations that they had when they originally purchased stock in the GSEs.

The battle has already lasted more than four years, but Berkowitz said from beginning to end, it could be a 10-year process. He and several other investors were a part of the group that sued the government over its 2012 decision to seize all of Freddie and Fannie’s earnings that federal judges have so far upheld the legality of. According to Bloomberg, lawmakers in the Senate are in the early stages of developing legislation to revamp the housing-finance systems, which even if it succeeds, doesn’t give a clear ending for shareholders.

Treasury Secretary Steve Mnuchin said he prefers to work with Congress on bipartisan reform, but hasn’t ruled out taking action without lawmakers. Though Berkowitz said he hasn’t discussed Fannie and Freddie overhaul plans with Mnuchin, if the Trump administration doesn’t stop the profit sweep, Fairholme will “absolutely” go to the Supreme Court.

“When you go back and think about it, right, there are issues of breach of contract,” Berkowitz said in reference to the Federal Housing Finance Agency who oversees the GSEs. “There are constitutional issues. How do you create an agency that oversees Fannie and Freddie that doesn’t answer to any branch of government?”