Fannie Mae: Discovery Awarded; Now, Will Treasury Comply?

net worth sweep Fannie Mae Freddie MacBy User:AgnosticPreachersKid (Own work) [CC BY-SA 3.0], via Wikimedia Commons

Rafferty Capital Markets analyst Richard X. Bove looks at the recent court decision ordering the Treasury to turn over documentation, noting that it’s not clear if the Treasury will actually comply with the ruling.

Judge Margaret Sweeney of the U.S. Court of Federal Claims has ruled that Fairholme’s request for discovery in its suit against the Treasury Department should be honored.

Federal National Mortgage Association in Washington DC – Quarterly Earnings Per Share | FindTheBest

This means that the U.S. Treasury will be required to provide the documentation surrounding the Treasury’s decision to put in place its Third Amendment. This is the amendment that requires Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) to: a) provide all of its profits to the Treasury; b) take its capital down to zero; and c) bring its owned portfolio down to $250 billion. It is the Amendment that in effect disenfranchises the private stock holders of the company.

Will Treasury obey the court?

The Treasury has asked that the Fairholme suit be dismissed without allowing Fairholme to see any of the documentation that supports the Treasury’s demand for dismissal. This now changes and, at least, the Court is requiring the Treasury to provide the appropriate documentation to Fairholme.

It is not clear to me that the Treasury will obey the Court. In recent years, the Treasury has acted as if it was not restrained by the laws of the land because: a) it is a sovereign power with sovereign rights; and b) it acted in the best interest of the nation at a time of great stress. Moreover in the WinTrust cases the Treasury ignored a Supreme Court ruling.

However, if discovery is provided, it is my view that it will demonstrate two critical factors. The first is that the Treasury knew that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA)’s earnings had turned around and the company’s profits would now rise appreciably. Second, that the Treasury did not want private shareholders to obtain their share of these profits because the Treasury had saved the institutions from bankruptcy.

HERA laws would apply to Fannie Mae if Third Amendment found lacking

If my view is correct the reasons that the Treasury gave the court for instituting the Third Amendment are fallacious. The Third Amendment is in question. If it is ultimately discovered that the Third Amendment was not appropriate, the laws established under HERA would apply and Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) would be returned to stockholder ownership.

The Buy Recommendation on the stock is based on the view that this will happen. The earnings estimates on the company are being shown in two forms. The first estimate assumes that the Treasury wins and private shareholders are disenfranchised. The value of the stock is zero.

The second estimate is based on the assumption that the Treasury loses and stockholders get their company back. In that case the stock could reach $9 per share in the next 12 months and $18 per share by 2017.

This is a high risk recommendation and should only be implemented by the investment institutions with the appropriate risk appetites.

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