The outcome of Bruce Berkowitz's tussle with the U.S. government over the profits from Fannie Mae and Freddie Mac may depend on two women: federal claims court Judge Margaret Sweeney and Sen. Elizabeth Warren.
Berkowitz, who achieved fame picking stocks at Fairholme Capital Management, won a ruling from Sweeney last week, keeping his lawsuit against federal regulators on track after losing a similar case in district court in Washington. Warren, a Democrat from Massachusetts, has been pivotal in beating back attempts by President Obama and Republicans to wind down the two government-controlled mortgage companies, which could wipe out profits for shareholders like Berkowitz.
"We've had our ups and downs but we are making considerable progress in the court of federal claims," Berkowitz said yesterday during a conference call in which he defended his $7.9 billion Fairholme Fund's investments in Fannie Mae and Freddie Mac. "We do have reason to be optimistic."
Berkowitz, Pershing Square Capital Management's Bill Ackman and other investors have been battling the government for more than two years to recoup dividends from Fannie Mae and Freddie Mac. Returns in the Fairholme Fund, which has a 4.9% stake in Fannie Mae and 3.8% investment in Freddie Mac, dropped after Berkowitz lost in district court last year. Sweeney's ruling in the court of federal claims last week, denying the government’s request to delay the case, was a rare legal victory in the investors' campaign.
"This is a big win for shareholders," said Elliott Stein, a litigation analyst at Bloomberg Intelligence. "They have their best shot in the court of federal claims, which tends to be a little more sympathetic to investors."
Fannie Mae and Freddie Mac, which were seized by regulators in 2008 as they neared bankruptcy, package mortgages into bonds. They received $187.5 billion in taxpayer funds to stay afloat before they returned to profitability in 2012 when the housing market rebounded.
At issue in the lawsuits is a change in the bailout agreement in 2012 that sent the companies' profits to the Treasury. Bloomberg Intelligence estimates that about $150 billion in disputed payments have been swept to Treasury since then.
Fairholme's shares plunged 9.6% on Oct. 1, a day after U.S. District Judge Royce Lamberth in Washington rejected the investors' claims that there was a breach of contract and an illegal "taking" under the Fifth Amendment to the U.S. Constitution. Berkowitz's fund has fallen 8.2% over the past 12 months, trailing 99% of rivals, according to data compiled by Bloomberg.
The investors are appealing Lamberth's ruling. A similar case in Iowa was dismissed on Feb. 3.
The government in October asked Sweeney to delay the cases in her court until appeals of dismissals in the district court in Washington are resolved. Sweeney, who was appointed to the position in 2005 by President George W. Bush, said on Jan. 28 that Fairholme and other investors may continue to gather information for cases in her court while the appeals play out. Investors are seeking monetary damages in the federal claims case.
"We've very pleased that Judge Sweeney continues to hold the often expressed view that we are entitled to make our case in her courtroom," said Charles Cooper, a lawyer for Fairholme. "It was certainly a welcome decision and ended the speculation all of us had" on whether Sweeney would follow the district judge's ruling in Washington, Cooper said.
Plaintiffs are in the discovery stage, collecting documents, and preparing to identify the people they want to interview under oath, Cooper said.
Warren and fellow Senate Democrats last year blocked bipartisan legislation to replace Fannie Mae and Freddie Mac with a government insurer as part of a revamp of the housing finance system. Warren said that the proposal didn’t do enough to ensure lower-income families could still get mortgages.
Fannie Mae and Freddie Mac are required to buy loans issued to borrowers in underserved neighborhoods, a guarantee that Warren and Senator Sherrod Brown, Democrat of Ohio, want to preserve. After Warren and Brown voted against the bill in a preliminary round, Democratic leaders refused to bring it up for a vote by the Senate.
"In some weird way, this is where Elizabeth Warren could be the savior of Wall Street," said Ed Mills, a policy analyst at FBR Capital Markets Corp.
With Republicans now in control of the Senate and the House, reform of Fannie Mae and Freddie Mac has become even more difficult to achieve.
Richard Shelby, the Republican from Alabama who now chairs the Senate committee that vets housing legislation, told Bloomberg last week that he won’t move forward with a bill that includes an "explicit government guarantee" for mortgages. His counterpart in the House, Jeb Hensarling of Texas, similarly has endorsed a plan that removes most federal support for home loans outside of the Federal Housing Administration.
Democrats like Warren and President Obama, whose support would be necessary to change the law, oppose that approach.
The partisan gridlock, which preserves Fannie Mae and Freddie Mac, almost eliminates the risk that shareholders will be wiped out by Congress. And now that Fannie Mae and Freddie Mac have more than repaid their bailout to taxpayers, the Treasury may come under more pressure to stop taking all of their profits.
"The companies are essential, they have no substitute," Berkowitz said during the call. "When it comes to funding our nation's housing market, they are mission critical."
Berkowitz said the Obama administration appears "schizophrenic" by talking about making mortgages more accessible while wanting to do away with Fannie Mae and Freddie Mac.
He also said he wasn’t going to sell his investments in the two companies. Fannie Mae shares have dropped 26% over the past 12 months as Freddie Mac stock has declined 27%.
"We own them at cheap prices and look forward to staying invested in them for very long periods of time," Berkowitz said.
