Hedge Funds' Big Bet on Fannie and Freddie May End Up Worthless

Almost six years after bad home loans crippled the economy, Perry Capital and other big hedge funds are battling the government over the future of mortgage companies Fannie Mae and Freddie Mac, which needed taxpayer bailouts to survive. If the investors prevail in the courts or in Congress, they could enjoy one of the biggest paydays in history. And Todd Westhus, who spearheaded Perry Capital’s purchase of Fannie and Freddie preferred shares when they were trading for pennies in 2010, could join the ranks of hedge fund legends George Soros and John Paulson. The bet on the once-battered stocks is “the biggest distressed trade in history,” says David Ford, co-founder of hedge fund Latigo Partners, which owns shares in Fannie and Freddie.

Other investors getting in on the action include Bruce Berkowitz, the mutual fund manager known for big bets on financial companies. Berkowitz’s Fairholme funds own more than 37 million shares of common stock of Fannie and Freddie and more than 118 million preferred shares. Hedge fund manager Paulson, famous for making $15 billion for his firm in 2007 wagering that subprime mortgages would default, also bought preferred shares. Bill Ackman’s Pershing Square Capital Management and Ralph Nader, the consumer activist, have said they own common stock in the companies. (Preferred stockholders are paid before common stockholders if a company goes bankrupt.)