Fairholme Fund (MUTF:FAIRX – NAV), the mutual fund managed by Bruce Berkowitz filed a lawsuit (full court document below) against the United Stated government in behalf of the shareholders of preferred stocks of Federal National Mortgage Association/ Fannie Mae (OTCBB:FNMA) and Federal Home Loan Mortgage Corp/Freddie Mac (OTCBB:FMCC).

Fairholme Vs Fannie Mae, Freddie Mac On ‘Net Worth Sweep’: Filing

The mutual fund is seeking just compensation for holders of preferred stocks of Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) under the Fifth Amendment of the Constitution of the United States.

According to the mutual fund, its lawsuit against does not challenge the emergency investments or bailout money provided by the government to the mortgage giants during the 2008 financial crisis, instead it is disputing the implementation of  “Net Worth Sweep” related to the Government stock documents.

See Republicans Planning To Wind Down Fannie Mae, Freddie Mac In 5 Years

Fannie Mae, Freddie Mac Net Worth Sweep

Under the “Net Worth Sweep” the 10% dividend due on Treasury’s Government stock was changed to 100% on all current and future profits of the Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) forever.

Fairholme Fund emphasized, “The result of  Net Worth Sweep circumvent the rules of priority and to expropriate for the government the value of the preferred stock  and common stock held by private investors.”

The mutual fund also cited the previous statement of the Treasury Department that the objective of the Net Worth Sweep was to ensure that every dollar earned by Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) will benefit taxpayers.

Fairholme Fund argued that the mortgage giants did not receive or any other meaningful value from the Treasury Department in exchange of the Net Worth Sweep. According to the mutual fund, the action of the government “effectively nationalized” Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC), two of the largest financial institutions in the country.

See Waterstone: Freddie Mac, Fannie Mac Common Shares ‘Worth Zero’

Bruce Berkowitz Argument Against Fannie Mae and Freddie Mac

The mutual fund noted that the mortgage giants paid huge sum of money ($66.3 billion around June 30, 2012) to the Treasury Department under the Net Worth Sweep. On other hand, without the implementation of Net Worth Sweep, Fannie Mae (OTCBB:FNMA) and Freddie Mac’s (OTCBB:FMCC) obligation to the Treasury was only $4.7 billion (10% original coupon rate on Government stock).

The Treasury does not consider the $61.7 excess as a return on capital invested instead, it is a “windfall” dividend on its Government stock. Fairholme Fund pointed out that the government’s rate of return annually under the Net Worth Sweep is not 10% but, 140%. It also anticipated that Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) will be required to pay the same large dividend to the Treasury over the next quarters.

Fairholme Fund pointed out that the Net Worth Sweep eliminated the ability of Fannie Mae (OTCBB:FNMA) and Freddie Mac (OTCBB:FMCC) to generate funds and rebuild capital reserves, to redeem Government stock held by the Treasury, or to distribute dividends to the owners of preferred stocks.

See Fannie Mae, Freddie Mac Shareholders Bitter over ‘Double Standard’

In addition, the mutual fund emphasized that the Net Worth Sweep “eliminated and destroyed the property and contractual right of holders of preferred stock to receive a liquidation preference upon the dissolution, liquidation, and winding up” of the mortgage giants.

According to Fairholme Fund, the owners of preferred stock did not received any compensation from the government for taking up their vested property rights impacted by and under the Net Worth Sweep.

Federal National Mortgage Association/Fannie Mae (OTCBB:FNMA),Federal Home Loan Mortgage Corp/Freddie Mac (OTCBB:FMCC) Filing

H/T Alison Frankel of Reuters

Fairholme Fund Fannie Mae Complaint by ValueWalk.com