Fairholme Capital Management revealed an ambitious plan to transform the insurance businesses of Fannie Mae and Freddie Mac by acquiring the units and forming two new state-regulated private insurance companies.
The solution is coming at a time when analysts are suggesting it would be impossible to end the now-profitable GSEs, which continue to drive a majority of the U.S. mortgage market.
But Fairholme Capital’s plan is rather specific – and includes not only a plan to recapitalize the new insurance units with $34.6 billion in capital in exchange for preferred stock in the entities – it also would raise $17.3 billion in new capital from preferred stockholders in a rights offering.
Investors would take on the risk, allowing for the liquidation of Fannie and Freddie, virtually ending the GSEs’ federal charters and special status while maintaining the value of the assets that support the U.S. mortgage market, the company said.
The firms would enact a business plan regulated not by the Federal Housing Finance Agency, but by state insurance authorities and a few applicable federal agencies.
Any new capital received from the conversion of preferred stock in the GSEs would be held by the new companies along with attributable profits as locked-in capital for five years to maintains the units as they write new business.
No dividends would be paid out during the initial five-year period, Fairholme said.
Essentially, private investors would be acquiring the MBS insurance businesses tied to Fannie and Freddie, bringing $52 billion in private capital to support the credit risk for more than $1 trillion new mortgages without undoing the entire mortgage market, Fairholme Capital contends.
The plan also would preserve government affordability options and housing initiatives using tools outside of Fannie and Freddie while ending the federal conservatorship altogether.
The GSEs’ legacy book of investments and insurance already in existence would be wound down over a period of time, the company said in a press statement. Proceeds would then be used to repay the Treasury for investments in the companies.
"The new companies could be cornerstone participants in a reinsurance program along the lines contemplated by proposals under discussion in the Senate, if that is the result of the legislative process now underway," Fairholme said in its press release.
"Alternatively, the new companies could serve as cornerstone participants in a new, competitive market with less Federal involvement, such as proposals being contemplated in the House, putting their private capital at risk to achieve the best possible pricing and availability for mortgage borrowers under those parameters."
Fairholme's confidence in the plan comes at a time when GSE analysts are not so sure reform is possible in the near future. Brian Harris, the main GSE analyst at Moody's Investors Service, says there are three steps the FHFA can use to reduce the GSEs' footprint, but they are under-using those tools.
The three-pronged approach includes private risk-sharing deals, increasing guarantee fees and reducing the conforming loan limit. But there are pros and cons to each, making it difficult for reforms to gain traction.
This recent analysis prompted Harris to suggest substantial GSE reform is not going to take place within the next few years.