Dick Bove comments on the latest Fannie Mae developments in a note sent to clients.


An entity named InsideSources apparently obtained a Treasury memorandum sent by Undersecretary for Domestic Finance Jeffrey Goldstein to then Treasury Secretary Timothy Geithner on January 4, 2011.

This memo may have been legally required to be given to Judge Royce Lamberth prior to his making a decision in a specific court hearing relative to Fannie Mae (OTCB:FNMA) and Freddie Mac( FMCC/$2.66/Buy). Judge Lamberth did not receive the document and dismissed the case.

I have read the Treasury memo in question and it raises serious questions as to whether the Treasury is following the law and even if Judge Lamberth understands the law. The case in question is being appealed.

The memo is entitled Housing Finance Reform Plan and it refers to a discussion apparently held at the Treasury on December 23, 2010. The first point that becomes very evident is that Treasury believes it controls the conservatorship set up to operate Fannie Mae and Freddie Mac (F&F).

This is contrary to the Housing and Economic Recovery Act (HERA) of 2008 that explicitly requires a new agency called the Federal Housing Finance Agency (FHFA) to handle this function on an independent basis. It raises the issue as to whether the changes in the terms of the Senior Preferreds at F&F were really set by the FHFA or the Treasury. In theory, the Treasury was not allowed to do this.

One interesting point in the memo is that it suggests that F&F have capital ratios of 3% to 4%. This is substantially lower than current demands that they have capital ratios of 10%.

A bombshell in the report is the following statement: “Ensure $275 billion of funding capacity after 2012 is not used to pay dividends. This may require converting preferred stock into common or cutting or deferring payment of the dividend … .”

This is directly contrary to the current practice whereby the Treasury is taking all of

F&F’s profits as a dividend and driving the two companies into insolvency by doing so.

Then the memo describes Option 1 as part of the “End State Options” for F&F. The memo states: ”After becoming adequately capitalized during the Transition, the GSEs would exit the conservatorship as private companies … This is essentially the path laid out under HERA and the Paulson Treasury when the GSEs were put into conservatorship in September 2008.” This quote is basically saying that this is the law.

There is much more in this memo but it is up to Senator Grassley to pursue these issues not me. This memo should also let jurists like Judge Lamberth think about the fact that material information is being withheld by the Treasury. More importantly, whether it is the jurists’ responsibility to uphold the law or not.

Fannie Mae
Fannie Mae