For hedge funds, 2019 offers risks and rewards on Fannie-Freddie


For hedge funds that have been hoping the Trump administration would deliver a windfall on their investments in Fannie Mae and Freddie Mac, 2019 could be a make-or-break year.

There are reasons for cautious optimism after years of heartbreak.

President Donald Trump will finally get to replace Mel Watt, the Democratic holdover from the Obama administration who has been running Fannie and Freddie’s regulator since 2014. Trump plans to nominate Mark Calabria to lead the Federal Housing Finance Agency. The libertarian economist has criticized the government policy that denies shareholders access to the mortgage giants’ billions in profits.

Signage in front of the Fannie Mae and Freddie Mac headquarters.

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Also, Treasury Department officials have privately signaled that they are losing patience with Congress, which for nearly a decade has failed to agree on legislation that would address the future of housing finance or free Fannie and Freddie from federal control.

Many Hurdles

While there are many hurdles to Treasury taking matters into its own hands, Treasury Counselor Craig Phillips has indicated in meetings that the agency might do just that should lawmakers continue to dither, according to six people familiar with the matter. Having an FHFA chief in place would be necessary for any unilateral fix.

Phillips, a top adviser to Treasury Secretary Steven Mnuchin, has expressed interest in aspects of a plan to let Fannie and Freddie build up capital buffers and then be released from conservatorship, the people said. Hedge funds have long advocated for policy makers to recapitalize Fannie and Freddie and end the conservatorship status that the companies have operated under since the government seized control of them during the 2008 financial crisis.

Treasury didn’t respond to a request for comment.

Mnuchin hinted at the administration’s option of going it alone in a Dec. 18 interview with Bloomberg, though he said he prefers working with Congress.

“There’s obviously certain things we can do administratively at Treasury,” Mnuchin said, without offering specifics. He made clear that he’s eager to get the companies out of conservatorship, and wants to tackle the issue with lawmakers on a “bipartisan basis next year.”

Bearish Case

Still, there are strong reasons why hedge funds should be pessimistic.

Public and private remarks from Treasury officials have been vague, leaving much to interpretation. And Mnuchin has been promising to deal with Fannie and Freddie almost from the moment Trump was elected. Two years later, Treasury has yet to outline specific steps it wants to take. That’s left many lobbyists and housing-policy analysts skeptical there’s an urgency within the administration to pursue bold measures.

Calabria, who currently works for Vice President Mike Pence, could also be an obstacle to hedge funds getting what they want. He has previously called for Fannie and Freddie to be put on the path to bankruptcy through receivership. It’s unclear whether private shareholders would recoup anything from their investments under such a scenario.

Plus, Calabria has criticized the way Fannie and Freddie were run before the crisis. That makes it unlikely he would support the ideas that hedge funds have proposed for recapitalizing and releasing the companies, said the Urban Institute’s Jim Parrott.

“It is difficult to imagine that Mark would take this job to recreate the very system he’s spent an entire career criticizing relentlessly,” said Parrott, a former housing official in the Obama administration. “If indeed he winds up comfortable with some version of a privatized Fannie and Freddie, it would likely look dramatically different.”

With Trump gearing up for a re-election campaign, the White House might be hesitant to tamper with such a crucial component of the housing market. Despite handwringing over Fannie and Freddie being wards of the state, the nation’s $10 trillion mortgage market seems to be functioning effectively. Any plan could be received poorly, underscoring the fact that taking the issue on next year poses risks with questionable political upside.

“The Treasury secretary has neither the political capital, nor buy-in from the rest of the Trump administration” to end the conservatorships, analysts at Beacon Policy Advisors wrote in a note.

Shareholder Lobbying

Fannie and Freddie underpin the housing market by buying mortgages from banks, packaging them into securities and offering bond investors guarantees in case borrowers default. The companies backstop nearly $5 trillion in mortgage bonds, which keeps borrowing costs low and helps make loans readily available.

Hedge funds such as Paulson Co. and Pershing Square Capital Management have been fighting the government for years over what’s known as the net worth sweep — a 2013 decision by the Obama administration to send nearly all of Fannie and Freddie’s earnings to the Treasury. Calabria co-authored a 2015 paper, which was promoted by shareholder groups, that criticized the profit sweep.

At the same time, hedge fund lobbyists have been aggressively urging the Trump administration in recent months to release Fannie and Freddie from conservatorship without legislation. Central to their campaign is a proposal developed by investment bank Moelis Co. that calls on Treasury to sell its massive stakes in the companies.

Moelis says its plan, which is backed by Paulson and Blackstone Group LP, would raise as much as $125 billion for taxpayers. The proposal would also likely trigger big gains for hedge funds because with Treasury no longer hoarding Fannie and Freddie’s earnings, the companies’ shares would presumably surge.

Treasury’s Phillips has indicated in meetings with lobbyists, trade groups, academics and other administration officials that he would be amenable to parts of the Moelis plan, said the people who asked not to be named because his remarks weren’t public.

Temporary Leader

As a stopgap until Calabria is confirmed by the Senate, the White House announced late Thursday that Comptroller of the Currency Joseph Otting will lead the FHFA on an acting basis. Otting is close to Mnuchin, having worked with him at OneWest Bank before they joined the government. Otting will continue to run the Office of the Comptroller of the Currency while he oversees FHFA.

In the Bloomberg interview, Mnuchin did outline some elements he’d like to see in an overhaul. He said key goals are making sure taxpayers aren’t at risk if Fannie and Freddie suffer losses and ensuring the government is appropriately compensated should it provide an “explicit guarantee” of the companies’ mortgage bonds.

“I want to fix them for the next 50 years,” said Mnuchin.

Hedge funds are hoping it doesn’t take that long to mint Fannie and Freddie riches.

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