The Trump administration's plan to release Fannie Mae and Freddie Mac from their government shackles laid out a vision that could eventually lead to hedge fund managers minting riches on their investments in the mortgage giants.
But the Treasury Department's proposal left much to be ironed out, signaling there might not be a windfall unless President Donald Trump wins re-election in 2020. That sentiment was palpable in early Wall Street trading Friday with Fannie and Freddie seeing their biggest one-day drops since January.
Treasury officials themselves acknowledged that their recommendations could take years to implement — a timetable that would extend beyond Mr. Trump's first term. And the report, released late Thursday, left it to a politically divided Congress to handle some of the most sweeping changes.
In the months before a presidential election, legislative action typically slows to a crawl. If Mr. Trump loses, an administration led by Wall Street scourge Elizabeth Warren or even Joe Biden would probably scrap ideas that came from Treasury Secretary Steven Mnuchin.
"Post-election, the odds get a lot more complicated," said Jim Parrott, a former housing official during the Obama administration. "If you're an investor, you've got to hope Trump wins and that Mnuchin, or someone like-minded, remains at Treasury. A Democratic administration will never support a plan that enriches a few hedge funds to the tune of billions of dollars."
The good news for Paulson & Co., Pershing Square Capital Management LP and other hedge funds that own Fannie and Freddie shares is that Treasury made it crystal clear that it wants the companies to build up their capital buffers and exit the government's grip.
That scenario sounds a lot like something known as recap and release that hedge funds have spent millions of dollars lobbying on in Washington for years. That's because it would likely lead to stock sales that enrich existing investors.
Yet Treasury's plan calls for another, separate plan that would actually hash out the details of how Fannie and Freddie would boost capital. Also, Treasury indicated it wants to let lawmakers take a crack at figuring out a fix before it and the companies' regulator, the Federal Housing Finance Agency, do anything bold. Taken together, the statements suggest the process will be slow-moving.
"The report raises as many questions as it answers," said Jaret Seiberg, an analyst at Cowen & Co. LLC. "The next six months will be key as FHFA and Treasury negotiate."
Fannie fell 13% to $2.59 in New York trading as of 10:18 a.m. EDT, the biggest decline since January. Freddie slumped 11% to $2.48.
Fannie and Freddie don't make loans. Instead, they purchase mortgages from banks and other lenders and package them into securities. Those securities have guarantees that protect investors from the risk of homeowners defaulting. The process is central to the mortgage market.
Fannie and Freddie got into trouble when the housing market crashed in 2008, with the companies being taken over and eventually receiving $191 billion in taxpayer funds to keep them afloat. They have since become profitable again, paying out more than $300 billion in dividends to the Treasury.
The Trump administration wants the conservatorships to end because it believes the companies' insufficient capital and market dominance mean taxpayers are at risk as long as the government has such a big footprint in the housing sector.
There is plenty for shareholders to like about the Treasury report.
Fannie and Freddie are currently limited to holding more than $3 billion in capital apiece to protect the companies from another housing crash.
The plan calls for increasing those buffers, which could be seen as a step toward ending what's known as the net worth sweep — a controversial policy implemented during the Obama administration that forced Fannie and Freddie to send nearly all their earnings to the Treasury. Hedge funds, in unsuccessful lawsuits thus far, have sued over the profit sweep because they want to redirect at least some of those dividend payments to themselves.
In a bad sign for shareholders, the Treasury report ponders at least one method for bolstering Fannie and Freddie's capital that hedge funds probably won't like: putting the companies in receivership. Such a tactic, which is a form of bankruptcy, could wipe out existing shareholders, depending how it's done.
The report is already dividing politicians on Capitol Hill, not a promising sign for quick legislation.
Sen. Sherrod Brown, the top Democrat on the Senate Banking Committee, blasted the plan, warning its proposals would hurt the economy and shut lower-income borrowers out of the mortgage market. Senate Banking Committee Chairman Mike Crapo, an Idaho Republican, said he prefers that Congress fix Fannie and Freddie, though he added that the Trump administration should start moving forward on "administrative reforms."
The politics surrounding housing finance will be on display Sept. 10 when Mr. Mnuchin, FHFA Director Mark Calabria and Housing and Urban Development Director Ben Carson testify before the banking panel.
Whatever happens, the silver lining for hedge funds is that they've already benefited from the Trump administration's push on Fannie and Freddie. This year alone, the companies' share prices have more than doubled on expectations that the conservatorships will eventually end.
That's been especially good for Paulson & Co.'s John Paulson, who has a long history with Mr. Mnuchin. In 2008, they joined forces to buy troubled mortgage lender OneWest, a deal that proved lucrative for both of them.