In an unusual turn of events, a group of hedge funds and private equity companies have recently expressed their willingness to provide the U.S. mortgage market with tens of billions of dollars. The funds, however, are dependent on the acceptance of a particularly sensitive proposal. Respective investors have suggested a takeover of both Freddie Mac and Fannie Mae, effectively relinquishing them from government control almost entirely. The infusion of private money into the U.S. mortgage market is expected to speed up housing finance reforms that have recently been subjected to the rigors of Congress.
Proponents of the investor group make up more than half of the $34.6 billion of preferred shares in each respective government agency. As government conservatorship has rendered their shares worthless, many of the investors have been fighting tirelessly to restore value. This proposed course of action may be what they need to do so.
Holders of the preferred shares include Claren Road Asset Management, Fairholme Funds, Blackstone’s GSO arm, Paulson & Co and Perry Capital.
Of particular concern, however, is the condition in which these institutional investors would leave the two agencies. Their current state is already volatile to say the least. Any mishandling or improper treatment of Fannie and Freddie could result in severe consequences for both the recovery and the housing sector. The two agencies are responsible for 85% of U.S. mortgages and any disruption would be catastrophic.
Numerous plans to reform Fannie and Freddie have circulated among politicians, investors and academics. However, the latest proposal involving a partial takeover is starting to gain traction. Proponents are rallying more investors. Their prospecting has generated interest from influential private equity firms like Carlyle and KKR. However, they have already succeeded in recruiting Barclays Capital and similar Wall Street groups. Each addition of a group of this magnitude only serves to better their cause going forward.
Despite the momentum the proposal is gaining, there is still a great deal of uncertainty. There remains little in agreement as to whether or not the government should continue to guarantee against default. This should continue to serve as a difficult hurdle for the foreseeable future.
The proposal, should it pass, would permit these investors to take control of Fannie and Freddie’s practices in mortgage-backed securities. While the groups would maintain control of core businesses, previously written guarantees and mortgage holdings would stay in the hands of the government. A common securitization platform, used to standardize mortgage-backed securities, would also stay in public hands.
“It will be the largest ever restructuring and show how to reform these agencies using private capital,” said one member of the investment group. “We will buy the platform and step in with new capital.”
The investment group looking to take control intends to capitalize the new insurers. According to a presentation document witnessed by the Financial Times, their plan will involve the conversion of preferred securities into common equity. In addition, the group will carry out a $17.3 billion rights issue. Despite the ambiguity of the current takeover, various iterations of the core proposal continue to circulate. One such variation of the proposal even suggests the injection of an additional $7.5 billion on behalf of the investment group and $2.5 billion from the government.
While the takeover does not appear imminent, it is not inconceivable. Both Fannie Mae and Freddie Mac were not under government control as early as 2008. However, that same year the government injected $187 billion into the agencies to prevent their collapse. Furthermore, politicians have acknowledged that they intend to relinquish control over the agencies eventually.