has provided much of the drama in the investing world for the past
five years, as he sunk stomach-churning amounts of money into one
dubious-looking asset after another. Yet the investor always seems
to greet monumental risk with perfect aplomb. Probably because he
is so well informed and his theses are so airtight that there does
not seem to be any risk involved for him at all, and once he takes
a position, he merely watches events unfold according to plan. Most
recently, he revealed an investment in another Berkowitz-esque
asset - the companies at the epicenter of the 2008 financial
crisis, housing mortgage institutions Fannie Mae and Freddie Mac.
This project also involves and largely hinges on him suing the U.S.
government. So far so good.
Berkowitz announced his
) had taken a $500 million preferred equity stake in Fannie Mae (
) and Freddie Mac in May. The crux of his strategy is that he was
able to purchase the shares at prices depressed to one-fifth of
liquidation value by the government's policy of expropriating the
Fannie Mae's three-year stock price history:
Expropriating profits did not set well with numerous investors in
the companies' preferred shares, and triggered several lawsuits,
including Berkowitz's. The plaintiffs (holders of non-cumulative
preferred stock of Fannie Mae and Freddie Mac) argue that the
government's August 2012 amendment to take 100% of the companies'
profits - just as they were returning to profitability - i.e. the
"Net Worth Sweep," deprived preferred stock holders their property
rights, violating the Fifth Amendment.
Previously, when the U.S. Treasury took Fannie Mae and Freddie Mac
into conservatorship in 2008, it create a new class of Senior
Preferred Stock which ranked senior to all other preferred stock
and held a dividend of 10% of the Treasury's outstanding
"liquidation preference" in the companies, according to court
The Net Worth Sweep prompted at least eight lawsuits since June
2013 - including one by guru
's Perry Capital. The government responded to the onslaught of
litigation by requesting a stay of "indefinite duration" in
Fairholme's case with the court until the various other actions
were resolved. The granting of a stay could have pushed Fairholme's
case back months or even years.
Fortunately for Berkowitz, on Sept. 18, the court denied the
government's motion for a stay, meaning his case can move forward.
Berkowitz explained his view of the sweep amendment in a Sept. 17
interview with CNBC:
I don't understand the 2012 amendment, the sweep amendment. The
2012 amendment was established as if we were still in 2008. The
lawsuit is about protecting our property. For all I know there
could be a typo in the third amendment. It makes no sense to me.
The government cannot unilaterally change the rules and harm
minority shareholders by privatizing losses and socializing gains.
That doesn't work in America.
But Berkowitz still faces a further challenge: legislation to
dissolve the two companies and replace them with a new government
entity, the Mortgage Insurance Corporation (FMIC), with co-sponsors
Sens. Bob Corker, R-TN, and Mark R. Warner, D-VA. The legislation,
known as the the Housing Reform and Taxpayer Protection Act of
2013, would create a new entity tp "provide a federal backstop for
investors in certain mortgages, like the GSEs currently do, but
that backstop would only be triggered after private investors had
already absorbed the first 10 percent of any potential losses,"
according to Zillow, which interviewed the senators on Sept. 19.
The bill already has bipartisan support, and several similar bills
have been introduced. President Barack Obama has also called for
the abolishing of the companies.
Berkowitz, along with other fund managers such as John Paulson of
Paulson & Co., believes that the government should instead
restructure the companies. If he is wrong and congress passes
Corker and Warner's or similar legislation, shareholders could go
Berkowitz made a fortune on a similar bet with AIG (
) during the financial crisis. Like AIG, Fannie and Freddie
required billions in Treasury funding to remain afloat ($187
billion in total), and are almost done repaying it ($131 billion so
far). Recognizing this, the market has traded up shares 246% this
year. He has a roughly 59% average gain on his AIG shares.
Berkowitz described the type of companies he looks for in his
recovery bets in a CNBC interview this year: "At Fairholme, we buy
essential, critical, systemically important companies that look
like they are down and out but franchises are still intact, they
are still absolutely essential to companies and are here to stay
and it is no different for Fannie and Freddie."
An incipient housing market recovery means that the companies are
returning to profitability.
Several housing recovery indicators:
On Aug. 8, Fannie Mae reported its sixth consecutive quarterly
profit - $10.1 billion for the second quarter. It attributed the
strong quarter to stable revenues resulting from increasing home
prices which reduced loss reserves.
As litigation and legislation move forward, it will become clearer
what chance Berkowitz stands to receive dividends on his stake in
Fannie and Freddie.
See Bruce Berkowitz's portfolio here. Undervalued StocksTop Growth
Companies High Yield stocks
If you are not a GuruFocus Premium Member, why not Take a 7-Day
Free Trial?About GuruFocus: GuruFocus.com tracks the stocks picks
and portfolio holdings of the world's best investors. This value
investing site offers stock screeners and valuation tools. And
publishes daily articles tracking the latest moves of the world's
best investors. GuruFocus also provides promising stock ideas in 3
monthly newsletters sent to