Feb 2024 ### A Saga of Uncertainty and Opportunity For over 16 years, the fate of **Fannie Mae (FNMA) and Freddie Mac (FMCC)** has been a contentious issue in U.S. financial markets. Originally chartered to stabilize and expand the mortgage market, these government-sponsored enterprises (GSEs) became **too big to fail** in the 2008 financial crisis. The federal government bailed them out, placing them into conservatorship under the **Federal Housing Finance Agency (FHFA)**. The core question facing investors today is: **Can these institutions successfully exit conservatorship and deliver substantial returns to shareholders?** ### Summary Fannie Mae and Freddie Mac are **the backbone of the U.S. mortgage market**, collectively guaranteeing over **$7.6 trillion in mortgage-backed securities (MBS)**. Their future hinges on government decisions, recapitalization efforts, and broader housing market trends. ### **Key Developments:** - **Privatization Plans**: The U.S. government is exploring pathways for re-privatization by 2026-2027, requiring substantial capital raises and restructuring. - **Financial Turnaround**: After years of losses post-2008, both GSEs have returned to **consistent profitability**. - **Legal and Political Uncertainty**: Investors are closely watching lawsuits and legislative proposals that could reshape the conservatorship exit. - **Pershing Square’s Bet**: Hedge fund manager **Bill Ackman has been vocal about the investment case**, arguing that Fannie and Freddie have overpaid the government and should be released into the private sector. ## **Strategic Rationale** ### 1. Focused Strategy: Mortgage Market Stabilization - The GSEs provide **30-year fixed-rate mortgages** at rates close to Treasury bonds, ensuring home affordability. - They have **refocused on prime mortgage guarantees**, distancing themselves from the riskier subprime lending practices that contributed to the 2008 collapse. ### 2. Innovation & Technology - **Risk-Based Pricing Models**: Implementing AI-driven underwriting systems to improve credit assessment. - **Credit Risk Transfer (CRT) Programs**: Reducing taxpayer exposure by transferring mortgage credit risk to private investors. - **Digital Mortgage Solutions**: Streamlining loan processing through fintech partnerships. ### 3. Market Potential: Addressing a Multi-Trillion-Dollar Opportunity - The U.S. homeownership rate remains **~65%**, with trillions in mortgage originations annually. - **Fannie and Freddie’s implicit government backing** has historically allowed them to **offer the lowest guarantee fees (G-fees) in the industry**. - **Expansion of private capital participation** could enhance their balance sheets while maintaining housing affordability. ## **Financials & Valuation** ### **Key Metrics (Projected for 2027 IPO)** | Metric | Fannie Mae | Freddie Mac | | --------------------------------------- | ---------- | ----------- | | **Total Assets** | $4.3T | $3.34T | | **Total Liabilities** | $4.2T | $3.29T | | **Current Shareholders’ Equity** | $90.5B | $56B | | **Government Claims (Preferred Stock)** | $212B | $129B | | **Ackman’s Proposed Fair Value** | ~$34/share | ~$39/share | | **Current Share Price (2024)** | ~$6.21 | ~$5.66 | ### **Market Sentiment** - **Bullish**: If the government acknowledges that past payments should count toward repaying Treasury, common shareholders could see **5-6x returns**. - **Bearish**: If no deal is reached, the GSEs may remain in conservatorship indefinitely, limiting upside potential. ## **Risks** ### **1. Operational Risks** - **Uncertain Path to Privatization**: A failed or delayed capital raise could prolong conservatorship. - **Regulatory Hurdles**: The FHFA and Congress must agree on the framework for release. ### **2. Market Risks** - **Housing Market Sensitivity**: A downturn could reduce mortgage volumes and increase defaults. - **Emerging Competition**: Private-label mortgage-backed securities (PLS) could erode Fannie and Freddie’s market share. ### **3. Financial Risks** - **Massive Capital Needs**: Analysts estimate that Fannie and Freddie must raise **$30-$50 billion in equity** to meet capital requirements before exiting conservatorship. - **Government Overhang**: The Treasury still holds **79.9% of the common equity**, creating uncertainty around future ownership dynamics. ## **Potential Scenarios: Base / Bull / Bear** | | | | | ------------- | ----------------------------------------------------------- | ----------------------------------------- | | Scenario | Key Assumptions | Investment Return (for $1,000 investment) | | **Base Case** | GSEs exit conservatorship by 2027; stable mortgage growth | ~$5,000 (IPO price ~$35/share) | | **Bull Case** | Accelerated privatization, favorable accounting adjustments | ~$6,500+ (Stock rallies to ~$45/share) | | **Bear Case** | Political gridlock; conservatorship extended indefinitely | ~$1,000-$2,000 (Minimal upside) | ## **Linchpins: Core Strengths** - **Essential to U.S. Housing Market**: Their role in mortgage financing is irreplaceable. - **Government-Regulated but Profitable**: Unique status allows consistent earnings with lower credit risk. - **Strong Balance Sheets**: Despite past challenges, both GSEs have accumulated significant capital buffers. ## **Conclusion: A High-Risk, High-Reward Trade** Fannie Mae and Freddie Mac present a **rare deep-value investment with asymmetric upside**. While political and regulatory risks persist, the possibility of privatization could unlock **multi-bagger returns**. Investors should monitor government actions and legal proceedings closely while considering position sizing and risk tolerance. **Key Catalysts to Watch:** - FHFA and Treasury announcements on recapitalization plans. - Court rulings on shareholder lawsuits. - Legislative developments regarding the GSEs’ future structure. - Market appetite for a potential 2026-2027 IPO. For investors willing to navigate the volatility, **Fannie and Freddie may offer one of the most compelling investment opportunities of the decade.** ### Deep Dive References 1. [Art of the Deal - Pershing Square](https://pscmevents.com/wp-content/uploads/2025/01/Fannie-Mae-Freddie-Mac-01-16-2025-Presentation.pdf)