Peekaboo Fannie Mae, Freddie Mac Accounting May Have Helped Circumvent Fifth Amendment by Glen Bradford. The author has a long position in the companies.

Fannie Mae and Freddie Mac are run like they are government agencies. Overseen by the Federal Housing Finance Agency who have put them into conservatorship, these government sponsored enterprises historically support American home affordability. After writing about the GSEs and owning the common securities for over a year I have instead moved into preferred shares and this article is an explanation why.

According to the FHFA and US Treasury, the government all but owns the companies. With the third amendment net worth sweep in place since 2012 the net worth of Fannie Mae and Freddie Mac belongs to US Treasury and FHFA runs them. Even though the government runs them and they take all their money forever, but they are still private shareholder owned companies. Yes, you read that right.

US Constitution – Amendment V

Below is the fifth amendment of the US Constitution. I’ve bolded the portion of interest for your convenience:

No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a grand jury, except in cases arising in the land or naval forces, or in the militia, when in actual service in time of war or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.

Fairholme has recently asked 16 questions that sure make it sound like they and other shareholders have had private property taken for public use. The crux is that the government has figured out a loophole. Look at how Fannie Mae made $85.5B of cash money during the time period that the government says they were failing:

Fannie Mae Freddie Mac Accounting

The best price to buy something at is $0. Frankly, if privately owned companies didn’t have limited liability this would be a lot more interesting because the government could have gone beyond just taking all of the money from the company forever, the government could have taken all of the money from all of the banks and private shareholders that own the securities. With this in mind, the government isn’t in a position to eliminate the risk of Fannie Mae and Freddie Mac from its mind completely and it chooses to frame this risk in the context of broken business models. The genius behind this is that admittedly broken business models aren’t worth anything, price tag $0. That’s the formula at work.

If the government wants to have something without paying, all they have to do is declare it’s worth $0. Then, they can pay $0 to take it. Put simply, the government doesn’t have to pay anything for worthless companies:

“We need to reconstruct the record,” Jester announced about the Federal Housing Finance Agency letters.

This is a lesson in how the government can get out of paying for something that the rest of us would have to pay for. You can’t beat the price of free for two business making billions every year. The secret sauce is in the Enron style off-balance sheet accounting but don’t let yourself be fooled. The government has figured out that if they mark the assets of a business to $0 they don’t have to pay for the privilege of taking them.

Conservatorship Gives Government GSE Accounting Authority

Chapter 11 was off the table because Fannie Mae and Freddie Mac had their highest levels of capital in history. Conservatorship was chosen specifically because it provided FHFA control over the accounting. Nationalizing companies without compensation through conservatorships is made possible by employing government directed accounting that triggers the government to be given unrepayable yield bearing securities from companies at the discretion of the government. In this case FHFA directed the accounting and US Treasury was given unrepayable yield bearing securities at FHFA’s discretion, working with Treasury.

Considering that both of Fannie and Freddie’s preferred securities purchase agreements are identical in form, the preferred securities purchase agreement is the only agreement in US history that causes a private company to borrow money from the government based on accounting statements directed by the government. In good faith, the government negotiated with itself that on top of being able to determine how much money Fannie and Freddie needed to borrow from the government at 10%, it would also be fair for the government to take 79.9% warrant coverage which in this case is the right to purchase 79.9% of the companies at as close to a price of $0 as one could get while not being $0. The good faith negotiations regarding the PSPA and the warrants happened between the FHFA and US Treasury, both of which are parts of the government.

Once the conservatorship commenced, FHFA took complete control over the GSEs accounting. This led to some challenges for the CFO of Freddie Mac around the time the conservatorship started:

The challenges included a disagreement with the company’s regulator over disclosing certain information to investors.

These disagreements were serious enough for the CFO to hire a security detail to guard his house. Combined Fannie and Freddie have around $5T of assets. The government can take control of those assets without paying for them if no one disagrees that the businesses that own them are worthless. Since that has been public record so far, the government looks like it is doing Americans and the world a favor by preventing a collapse by stabilizing two failed business models that are hemorrhaging billions of dollars. This is what the FHFA website says their role is:

Fannie Mae Freddie Mac Accounting

As you’ll note, key snippets on Treasury’s website paint a different picture where perhaps the conservator’s mission is to wind them down and prevent them from retaining profits or building capital:

Fannie Mae Freddie Mac Accounting

Forensic Accounting Analysis: FHFA’s Accounting Authority Forced GSEs To Borrow Money They Never Needed

A forensic accounting analysis has been produced that graphically depicts what I call peekaboo accounting. Transparency Reporter for MarketWatch Francine McKenna corroborates Adam Spittler’s accounting. For three years massive net losses were reported by FHFA triggering the creation of long-term massive streams of cash flow for the government while both Fannie and Freddie kept making billions:

Fannie Mae Freddie Mac Accounting

Make sure that you read that chart right. The companies are reporting massive net losses at the same time they are making massive amounts of cash money. I’m not saying that there is accounting fraud here. I’m saying that there might be some interesting conversations that have happened between the companies and auditors where I would have liked to have been a fly on the wall.

At present there is no one officially disputing the accounting employed by FHFA in a court of law. Perhaps the question that should be asked is whether or not the FHFA is obligated hand over the companies to

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