Bruce Berkowitz
Image source: CNBC Video Screenshot.

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Daniel Schmerin: Let’s turn to specific positions. The most questions we received by far had to do with the two largest financial institutions in the country: Fannie Mae and Freddie Mac. Both recently reported third quarter results. Do you still find the underlying economics of their businesses attractive?

Bruce Berkowitz: Attractive? These are two of the best businesses in America. Period. Together, they earn $30 billion on a combined basis each year. $30 billion. Attractive? Attractive is an understatement. Fannie Mae’s CEO just stated that their underlying fundamentals are strong and they expect to remain
profitable for the foreseeable future.3 The average FICO score – and FICO score is a measure of borrower quality – for Fannie Mae’s single family book of business is 745, and delinquencies have dropped for 26 consecutive quarters. Really, how do you spell “pristine”? The same is true for Freddie Mac. Freddie Mac’s CEO emphasized earlier this month that the company is stronger than ever with credit quality at its best in eight years.4

Fannie Mae and Freddie Mac are insurance companies. Fannie Mae and Freddie Mac are not banks. Fannie Mae and Freddie Mac insure and ensure affordable, predictable mortgages. Fannie Mae and Freddie Mac provide a unique, vital service that enables American families to achieve the American dream. Fannie Mae and Freddie Mac are phenomenally strong and they are sustainably profitable. Their social good and economic value is world class. This is obvious to anyone who just counts the cash Fannie Mae and Freddie Mac generate.

And it’s obvious that Fannie Mae and Freddie Mac are as solid as any financial enterprise in the world, public or private. Yet, the companies are priced for less than runoff liquidation.

Daniel Schmerin: So where do we go from here?

Bruce Berkowitz: I’m going to let David Thompson of Cooper & Kirk address our progress in the courts of law. But first, I want to remind our shareholders of the following. In early 2014, I wrote that many believed Fannie Mae and Freddie Mac would be victims of a government sponsored expropriation that brings our country closer to a future such as that conceived by George Orwell in his novel, 1984. Conventional wisdom was that the companies would be liquidated. Of course, we disagreed. Our investment in Fannie Mae and Freddie Mac was predicated on a simple thesis: There are no substitutes. Fannie Mae and Freddie

Mac are the largest providers of liquidity to our mortgage markets. The financial services they provide benefit American renters, buyers, and existing homeowners in both good and bad times. Fannie Mae and Freddie Mac are the housing finance system in America, and they earn a nominal amount – less than 40 basis points – for ensuring that the venerable 30-year fixed-rate mortgage remains widely accessible and affordable, especially when every bank in the country refuses to do so without their support.

Fairholme applauds their social good, which has helped tens of millions of families have a home and build retirement nest eggs. We’re not arrogant. We’re not telling our government or the people of our country what to do. But, we do have common sense solutions that would result in big wins for the country. Fannie Mae and Freddie Mac should transform into low-risk, public utilities with regulated rates of return, just like everyone’s local electric companies.

Any intellectually honest observer will admit that the rational next step is to halt the payment of any further monies to the United States Treasury (“Treasury”), permit the companies to retain capital in order to protect tax-payers, and eventually release them from the shackles of a perpetual conservatorship.

Only the disingenuous would assert that recapitalization of these companies would take decades and come at taxpayers’ expense, as if retaining earnings precluded the ability of each company to raise equity from private investors.

Only those beholden to special interests would ignore the substantial reforms implemented at Fannie Mae and Freddie Mac over the last eight years and pretend the companies are somehow doomed to repeat the past upon release from conservatorship.

And, really, only those who oppose the dream of American homeownership would attempt to dismantle two publicly traded, shareholder-owned companies that have singlehandedly provided $7 trillion – yes, trillion – in liquidity to support America’s mortgage market since 2009.

With a new administration coming into office, we’re quite optimistic that the indispensability of these two companies to affordable homeownership eventually overpowers the taboo imposed upon them by the conventional Washington establishment.

That being said, we’re fighting in the courts to protect our shareholders’ assets. Our shareholders have paid hard earned cash in exchange for contracts executed with Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are obligated to protect the capital of all preferred shareholders, not just one of those shareholders

– the Obama Treasury. Fannie Mae and Freddie Mac are obligated to obey the laws of our great country, laws that every investor, small and large, depends on each day in our financial market.

Daniel Schmerin: David, we received many shareholder questions pertaining to our ongoing litigation, particularly what we are expecting, when we are expecting it, and the magnitude of those potential outcomes. So can you start by providing our shareholders with an update of our ongoing case in the U.S. Court of Appeals for the District of Columbia Circuit (the “D.C. Circuit”)?

David Thompson: Certainly, I’d be happy to, Dan. With respect to timing, there was an oral argument held on April 15 of this year. The D.C. Circuit has an informal term, so they hear cases from September to May. From September of 2015 through May of 2016 they heard 308 cases, and 304 of those cases have now been decided. We and three other litigants are still awaiting our decision, so we should be close. They release their opinions on Tuesdays and Fridays between 10:00 a.m. and noon.

In terms of why it’s taking so long, we think the most reasonable and plausible explanation is the fact that there’s probably a dissent being written. I think that anyone who listened to that oral argument, which is available online on the court’s website, would understand that there seemed to be a difference of
opinion.5 Fortunately, two of the judges seemed favorably inclined to our view, and, in particular, we’re really looking at six key issues. If we win on any of these six key issues, it will result in a tremendous victory for Fairholme.

Number one is the question of whether the Federal Housing Finance Agency (“FHFA”) acted as a genuine conservator. As such, the FHFA is required to preserve and conserve assets, and is required to operate the entities in a sound and solvent manner. Clearly, not having a nickel of capital on the balance sheet, sending the entirety of the net worth, quarter after quarter, to the federal Treasury, is not sound.

And, we were very gratified when Judge Douglas Ginsburg, one of the three members of the panel, said it was “clearly true” that you could not be sound and solvent if you are giving every nickel of capital away quarter after quarter. Moreover, he noted that by imposing the Net Worth Sweep, the Treasury essentially said: “We are going

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