Thanks to its conservatorship of Fannie Mae and Freddie Mac, the US Treasury paid itself the biggest dividend in history at the end of June – $66.3 billion. The resultant fury of private investors in those firms is now finally spilling over into the courts. It was always going to be a risky strategy. When hedge funds including Perry Capital, Paulson & Co, Fairholme Capital Management and Carlyle-owned Claren Road Asset Management began to build positions in the preferred stock of Fannie Mae and Freddie Mac, they probably weren’t banking on the US government changing the rules of the game.
Last year, the US Treasury enforced a third amendment to the preferred stock purchase agreements of the two GSEs, effectively diverting all quarterly profits from the two agencies to its own coffers. It replaced a 10% dividend on the preferred stock with a “sweep” of substantially all profits to itself.
Given the sums involved, it is no surprise this is now squaring up to be quite a fight. Perry Capital, the hedge fund founded by ex-Goldman Sachs banker Richard Perry, has now filed a lawsuit against the US Treasury, claiming this diversion of profits is illegal.
“The third amendment fundamentally and unfairly alters the structure and nature of the securities the Treasury purchased,” states the claim. “This blatant overreach by the federal government to seize all of the companies’ profits at the expense of the companies and all of their private investors is unlawful and must be stopped.”
Fannie and Freddie shareholders have also filed a claim in the US Court of Federal Claims claiming $41 billion in damages from the Treasury.
On July 9, the Fairholme Fund, a mutual fund managed by Fairholme Capital management, announced that it will also file suits with the United States Court of Federal Claims and the US District Court for the District of Columbia. “The Fairholme Fund is owed a contractually specified, non-cumulative dividend for its investment in these companies,” said CIO Bruce Berkowitz. “Fairholme’s objective is quite simple. The Government set the terms of their 2008 investments and should be held to their original deal.”
The future of Fannie and Freddie is set to become a battle royal as the public and private sector slug it out for the riches that the recovering US housing market can provide. The lawyers must be rubbing their hands in glee.
To read more on the GSE money machine, check out Euromoney's July issue.
