Immediately following President Trump’s election, Fannie Mae and Freddie Mac’s future generated renewed and robust interest. The Government Sponsored Entities’ (GSE) shares rallied on expectations that the Trump administration would take both entities out of conservatorship in a manner that rewarded all shareholders, including hedge-fund speculators. In the intervening two years, however, those expectations faded and shares in the GSEs underwent a slow decline.

That changed last month when President Trump announced that he would appoint Comptroller of the Currency, Joseph Otting, to serve as Acting Director of the Federal Housing Finance Agency (FHFA). Since that announcement, shares in Fannie Mae had risen 165 percent as of the market’s close on January 28), with a similar increase in the value of shares in Freddie Mac. Less than two weeks after taking office on January 7, 2019, Otting had already made clear that investors’ confidence has not been misplaced; in a January 17 meeting, Otting told FHFA employees that the administration would release a plan in the coming weeks to take the GSEs out of conservatorship.   

Attention to the Trump administration’s numerous conflicts of interest regarding Fannie Mae and Freddie Mac’s futures dissipated as it became clear that housing reform was not a top priority for the administration. With the shares’ rally and Otting’s recent statements, however, we think it is important to revisit the conflicts represented by revolving door bankers turned Trump Administration policymakers.  The following annotated stock chart illustrates the nature of our concern, which is not dependent on any fixed notion of housing policy but rather our aversion to the possibility that public policy is being driven by private interests.


Movements in Fannie Mae’s Stock Price Since President Trump’s Election

Movements in Fannie Mae’s Stock Price Since President Trump’s Election

Background

In 2008, when Fannie Mae and Freddie Mac were on the verge of collapse, the Federal Housing Finance Agency took control of the corporations, putting them into conservatorship. Under the terms of the agreement, the Treasury Department would infuse the GSEs with much needed cash by purchasing “Senior Preferred Stock” which would then pay a dividend.  

As these entities’ value collapsed, several mutual funds and hedge funds took up positions in their nearly worthless shares over the course of the following years, on the assumption that the government would eventually release them from conservatorship and their value would rebound. Among these funds were John Paulson’s Paulson & Co., Bruce Berkowitz’s Fairholme Fund, and Bill Ackman’s Pershing Square. Activist investor Carl Icahn also took up a position in the GSEs in 2014.

In 2012, the Treasury department altered the terms of its agreement with the GSEs. Instead of only receiving quarterly dividends on the “Senior Preferred Stock,” it now claimed all of the GSEs’ profits. Several investors, including Berkowitz, sued, claiming that the government’s actions were illegal.

As these cases slowly worked their way through the courts, the federal government continued to collect the GSEs’ profits and the entities’ shares remained nearly worthless. In 2016, however, another route to recovering the value of these investments opened up.

Trump’s campaign came to be closely tied with some of the investors who were seeking to recover the dividends to which they considered themselves entitled. Trump, along with his campaign finance chair, Steven Mnuchin, had millions invested with Paulson & Co. Mnuchin and Paulson had also both been a part of the group of investors that had purchased failed lender Indymac and created OneWest bank.

Given these close connections, it may come as little surprise that John Paulson was one of Trump’s earliest Wall Street backers and a major donor. For instance, Paulson organized a fundraising event where donors paid $250,000 to attend — a success for Mnuchin, the National Finance Chairman for Trump’s 2016 presidential campaign. In August, Trump announced that both Paulson and Mnuchin would serve on his economic advisory team.

Carl Icahn was another of Trump’s early supporters, backing him as early as the fall of 2015. Icahn donated generously to Trump’s campaign and was rewarded with a role as a special advisor on regulatory policies, a position that offered him wide reaching influence without much scrutiny (because he was not a government employee, Icahn did not need to turn over his financial records or divest from his positions).

Over time, other GSE investors followed the lead of Mnuchin, Paulson, and Icahn and joined Trump’s team. By September, Bruce Berkowitz was also expressing tentative support for Trump’s candidacy. Reports from late 2016 show that he donated $100,000 to Trump Victory. Although Pershing Square’s Bill Ackman did not express support for Trump’s candidacy, he made clear in statements immediately following the election that he “was extremely bullish on Trump.”

Paulson, Berkowitz, and Ackman, despite having once been financial sector stars, were all experiencing sustained losses. Fairholme Funds had lost nearly 50 percent of its value the year before and had yet to meaningfully recover. Paulson & Co. had been struggling since 2011 and was in the midst of a major decline. 2016 had been particularly painful, at least partially due to a bad bet on Valeant Pharmaceuticals and Allergan.

Investing in Trump’s candidacy was a potential path out of the free fall and towards sizeable gains. When Trump was elected, Fannie and Freddie’s shares rallied. This rally was reinforced when Trump announced that he would nominate Mnuchin for Secretary of the Treasury. Immediately following the announcement, Mnuchin went on Fox Business to state that privatizing Fannie Mae and Freddie Mac was a priority for the administration. These gains helped push Fairholme Fund to a positive quarter, despite simultaneously sustaining major losses in Sears (ironically, Mnuchin had served on Sears’ Board for more than a decade alongside Sears’ failed CEO and Mnuchin’s former college roommate, Eddie Lampert). While the rally was not able to bring Paulson above water, it did help him to regain some traction after major losses.

Details of Trump’s relationship with Berkowitz, Ackman, and other investors in Fannie and Freddie are not clear, but we know that Paulson was a close associate throughout the presidential campaign and beyond and that he remains an outspoken supporter. We also know that Icahn was able to exercise a great deal of influence over the administration’s environmental regulatory policy in his eight months as an advisor to President Trump. These ties, along with Trump and Mnuchin’s personal investments in Paulson & Co., raise questions about the motivations behind the administration’s stance on the GSEs, regardless of one’s position on the GSEs or broader issues of federal housing policy.

These ethical questions faded into the background, however, as the administration’s previous promises failed to materialize. While investors temporarily benefited, they did not get the big payout that they were seemingly counting on. Over the course of the next two years their gains would disappear and their positions would fall below their early 2016 levels.

With no movement on GSE reform on the horizon, other concerns surrounding the administration’s policies and myriad conflicts of interest in other arenas understandably took center stage. Now that the administration is moving aggressively on this issue again, however, Trump and his team’s ties to GSE hedge fund investors are in desperate need of greater attention.


Recent Developments

On January 7, controversial Trump Comptroller of the Currency, Joseph Otting, assumed the role of Acting Director of the FHFA, which he will occupy until the Senate confirms the administration’s nominee Mark Calabria. Otting’s assumption of this role appears to have been the impetus for a rally in Fannie and Freddie’s stock, which has helped the same investors who had benefited from the 2016 rally.

In the last month, Fairholme Funds has been able to recover nearly half of the 25 percent loss that it sustained over the course of the previous year. Prospects for Paulson’s hedge fund have been looking even bleaker of late; in early 2018 he cut large parts of the fund’s staff. Paulson has been discussing shuttering his hedge fund entirely; a major change to the GSEs could represent a significant reversal in his fortunes.

It is not clear, however, why stocks rallied with Otting’s announced appointment. The value of shares, in contrast, had not risen when the administration announced Calabria’s nomination on December 12.

There is no record of Otting making public statements about his stance on Fannie and Freddie prior to his appointment. Commentators have speculated that Otting would push GSE reform because of his close relationship with Mnuchin (the two worked together at OneWest bank, an enterprise in which Paulson’s fund received a roughly $1 billion return on its 24.9 percent stake). Commentators also speculated that the administration’s decision to appoint Otting to the role, rather than the vastly more legally grounded path of promoting temporarily an FHFA Deputy Director, indicated that it was preparing to push “reform.”

Nonetheless, this speculation hardly seems sufficient to drive a rally. Did some concerned parties know more about the administration’s intentions than what was available to the wider public?

In the backdrop to this rally, Calabria’s nomination appears to be moving surprisingly slowly. While William Barr, Trump’s pick for Attorney General, had a confirmation hearing almost two weeks ago, no hearing has been scheduled for Calabria. This delay is particularly puzzling because Calabria is likely to be confirmed with very little resistance. Former congressional staffers tend to sail through the confirmation process, and although Calabria has been described as an ideologue, he has earned respect for being both knowledgeable and principled.

While Calabria supports GSE reform, the type of “reform” that he would advocate is less clear — including whether it would benefit hedge fund holders of Fannie and Freddie stock. Furthermore, numerous commentators expressed skepticism that Calabria would move forward with radical reforms once he was appointed. This is all the more reason to be concerned that Trump might be trying to prolong Otting’s tenure to push through controversial GSE actions and deliver big payouts to some of his wealthiest supporters.

However, we do not claim to know with any confidence what is driving these recent developments. Nonetheless, we believe that the Trump administration’s actions regarding GSE reform, both in 2016 and in the last month, represent cause for concern. The ability of people like Otting and Mnuchin to put aside their indebtedness to their past investor John Paulson is uncertain. Close relationships between members of the administration and individuals with large stakes in the future of GSE reform, in concert with numerous irregularities in the administration’s conduct and the dubious nature of Otting’s temporary appointment, warrant further investigation.

Unfortunately, the SEC, which monitors and punishes insider trading, puts much more emphasis on disciplining insider trading in public companies than from the halls of government. Recent experience suggests that it should consider putting government officials under greater scrutiny. The consequences of political insider trading have the potential to erode public faith in both securities markets and government.