A Step in the Right Direction for Fannie Mae and Freddie Mac Shareholders

By Markets Fool.com

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Source: www.futureatlas.com

Recently, a bill was introduced in the House of Representatives that would overhaul the way Fannie Mae and Freddie Mac's profits are handled. While this won't directly benefit the agencies or their shareholders right away, it could go a long way toward fixing both the agencies themselves and the current status of the shareholders, which many people believe isn't exactly fair.

The bill and what it would do
Rep. Marsha Blackburn (R-Tenn.) introduced the bill in order to create a place to put Fannie and Freddie's profits until Congress figures out what to do with the two government-sponsored enterprises. Basically, all of the agencies' profits would be placed into an escrow account, rather than straight into the Treasury's pocket as they have been since Fannie and Freddie became profitable several years ago.

For one thing, the bill could protect taxpayers from the need for further bailouts should the GSEs lose money. Under the current arrangement, 100% of the agencies' profits, as well as a chunk of their reserves, are sent to the Treasury as a "dividend" payment for the bailouts they received. This is fine while the agencies are making billions of dollars, but what happens if another decline in the housing market occurs and the agencies are facing losses? Having several billion dollars in escrow could prevent the taxpayers from having to inject any more cash into Fannie and Freddie.

Why shareholders should be happy
It's important to note that this bill wouldn't actually change anything about the current state of Fannie Mae and Freddie Mac or their current conservatorship. The agencies still won't be able to keep their profits as reserves or make any distributions to shareholders.

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The newly created escrow fund wouldn't be under Fannie and Freddie's control. In fact, the bill clearly states that any reserve established under this act shall not be considered an asset of the enterprises, other than as part of a capital restoration plan once GSE reform actually takes place.

However, shareholders should still view this as a positive development. As I mentioned, all of Fannie and Freddie's profits are currently given to the Treasury -- an arrangement that many people argue is illegal. If capital were put into escrow, it could eventually be used to recapitalize the agencies and return them to an independent status.

Even under the most optimistic case for shareholders, the government has rights to about 80% of Fannie and Freddie, but 20% would certainly be better than 0%. Shareholders have made a solid argument that if the GSEs were allowed to recapitalize, shares could easily be worth 10 times what they are now.

What else needs to happen before shareholders get paid?
A creation of an escrow fund for Fannie and Freddie's profits would certainly remove one obstacle to a solution for shareholders. However, there is still a long road ahead before shareholders could potentially see any returns from their investment.

There are currently several lawsuits pending against the current arrangement, led by activist investors such as Bill Ackman and Bruce Berkowitz. A favorable outcome could change the profit-sharing arrangement, but this is an uphill battle. One judge has already dismissed several of the lawsuits, and a separate judge is set to hear arguments on several others.

Regardless of what happens, shareholders should hope this bill makes its way through Congress. If shareholders are successful in challenging the current state of the companies, having billions of dollars of capital reserves in escrow will make Fannie Mae and Freddie Mac much stronger independent entities.

The article A Step in the Right Direction for Fannie Mae and Freddie Mac Shareholders originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.