Bruce Berkowitz, who runs the mutual-fund firm Fairholme Capital Management in Miami, sent a couple of scorching letters to the boards of Fannie Mae and Freddie Mac the other day, blasting their directors for failing to protect the rights of shareholders. And here's the funny part: The companies have been warning for years that they have absolutely no interest in protecting shareholders. Berkowitz is venting furiously anyway.
Fairholme is among the owners of Fannie and Freddie preferred stock that are suing the government-controlled mortgage-finance companies and their conservator, the Federal Housing Finance Agency. The plaintiffs claim that a 2012 change in the companies' bailout terms nullified certain rights of preferred shareholders, including the right to receive dividends, in what amounted to an unconstitutional seizure of assets. Fairholme, which urged the companies to retain their earnings rather than send them to the government, bought its stakes in the two companies last year.
"Fiduciary duties do not disappear with conservatorship," Berkowitz wrote. "Members of the board are the only people with the experience and information to govern, and fiduciary duties are an inescapable consequence of custodianship. Directors must represent all owners."
He went on: "The board has a duty to the company for the benefit of all the company’s stakeholders. Treasury is but one of those stakeholders. FHFA made a deliberate choice in 2008 by maintaining Fannie Mae as a publicly traded, shareholder-owned corporation. Where the interests of Treasury conflict with those of the company, the loyalty and duty of the board is unambiguously to the company."
It's true that directors of public companies normally are supposed to work for the benefit of shareholders. However, Fannie and Freddie never were normal companies. They are creations of Congress with their own special charters and regulator. The government seized the companies in 2008 while they were in the process of collapsing, and today the Treasury Department holds 80 percent stakes in each.
The White House's longstanding position has been that the U.S. should wind down the companies, with good reason. Private-public hybrids of their sort -- which have private-sector shareholders but implicit government backing -- create untenable risks and burdens for taxpayers. Yet here we are more than five years later, and the companies are still around. Their stocks still trade. And now some large investors are suing to impose their will on taxpayers for their own benefit.
Of course, the first thing every sophisticated investor should do before buying stock in a public company is read its financial disclosures. And let's see, here is the first paragraph from Fannie's most recent annual report. This same cautionary language has appeared in the financial reports filed by Fannie and Freddie ever since they were seized:
"We have been under conservatorship, with the Federal Housing Finance Agency acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. The conservator has since delegated specified authorities to our board of directors and has delegated to management the authority to conduct our day-to-day operations. Our directors do not have any fiduciary duties to any person or entity except to the conservator and, accordingly, are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator."
That seems clear-cut, doesn't it? Seriously, what part of "all rights, titles, powers and privileges" does Berkowitz not understand?
It also mirrors what Fannie's chairman, Phil Laskawy, said in his response to Fairholme over the weekend. "As legislated by Congress, with conservatorship, the Federal Housing Finance Agency as conservator assumed by law all of the rights, powers, and privileges of the company, including those of the board of directors, which provides appropriate governance in accordance with FHFA's limited delegation of authority," he said. "I am confident that the board is doing the job it has been given."
It will be hard to feel sympathy for Fairholme and its fellow plaintiffs should they lose in court -- and not just because the companies' share prices have soared during the past year. Here you have sophisticated investors who bought stock in two companies that for years have said they owe no obligations to anyone other than their government conservator. Now Fairholme is complaining that the companies aren't doing enough to protect shareholders -- when they have been upfront for years about the fact that they have no intention of ever doing anything for shareholders. And Berkowitz acts surprised? Talk about chutzpah.
So the farce of Fannie and Freddie goes on. When they were on the verge of collapse in 2008, the government reasoned that it couldn't put them out of business because they were too weak. Now that they are showing profits and the housing market has rebounded, the rationale is that we can't wind them down because they're making too much money. Meanwhile, the longer the government keeps Fannie and Freddie around, the more it feeds a sense of entitlement among common and preferred stockholders, whose shares rightfully should have been extinguished years ago.
Fairholme knew the risks. It's no victim.
(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter at @JonathanWeil.)
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