Bill Ackman and Bruce Berkowitz, two of the most successful investors of the past decade, aren’t afraid to go against the grain.
Ackman, a hedge-fund manager known for his detailed research, pushed U.S. mall owner General Growth Properties Inc. to file for bankruptcy, then helped orchestrate a rare victory for both bond and equity investors. Berkowitz scored big for his mutual funds by betting on American International Group Inc. at a time when the insurer’s future was in doubt.
Now, as they seek to make money on their holdings of Fannie Mae and Freddie Mac, the two mortgage giants at the core of the U.S. housing market, Ackman and Berkowitz are fighting another uphill battle, this time against the White House and U.S. Congress. Taking different approaches, each is angling to salvage securities valued at more than $100 billion combined before the financial crisis and which many deemed worthless when the federal government took over the companies as markets unraveled in 2008. Few on Wall Street or in Washington see how they can win.
“It’s risky as the odds are stacked against these investors in the short-term,” said Nela Richardson, senior economist with Bloomberg Government. “This is the biggest hot-button issue after Obamacare and there’s little chance of reform now. However it may pay off in the long term for the investors.”
Ackman’s $12 billion hedge-fund firm, Pershing Square Capital Management LP, said on Nov. 15 that it had bought a 9.98 percent stake in the common shares of Fannie Mae that aren’t owned by the government, as well as a 9.77 percent stake in the Freddie Mac shares available to the public. The stakes were valued at $577 million at the end of last week. The firm said it may seek talks with shareholders, management and the government, which owns almost 80 percent of the agencies since bailing them out.
The announcement was prompted by a proposal two days earlier from Berkowitz’s $10.5 billion mutual-fund firm, Fairholme Capital Management LLC, that it and other owners of the preferred shares buy the mortgage insurance business of the companies and leave common shareholders like Ackman with stakes in the legacy business that would be wound down.
The moves highlight how, in the space of two years, Fannie Mae and Freddie Mac went from taxpayer sinkholes to money makers that investment managers are fighting to privatize. Seized by the government in 2008 in a $187.5 billion bailout, both companies returned to profit in 2012, when Fannie Mae had record net income of $17.2 billion. Freddie Mac earned $11 billion last year.
The common shares of the two companies spiked this year, gaining about 12-fold, as investors piled in. Fairholme said in June that it had acquired preferred stock in the two companies with about $2.4 billion in redemption value. His firm now owns $3.5 billion to $4 billion of the preferred shares at par value.
Fannie Mae’s 8.25 percent preferred shares, which have a par value of $25, fell 1.3 percent to $9.80 at 12:54 p.m. today in New York. They rose as high as $10.50 on Nov. 14, the day after Berkowitz announced his plan. The company’s common stock declined 7.6 percent to $3.06 at 1:23 p.m.
The housing market is in the second year of a recovery from the crash as buyers, lured by historically low mortgage rates, compete for a tight supply of available homes. The S&P/Case-Shiller index of property prices in 20 U.S. cities rose 12.8 percent in August from a year earlier, the most since early 2006, and is up 23 percent from its March 2012 low. Foreclosures have fallen to the lowest level in six years as rising values make it easier for distressed homeowners to sell.
Hedge funds, private-equity firms and real estate investment trusts are pouring into the market by acquiring thousands of foreclosed houses to turn them into rentals, reducing the inventory of distressed properties. Blackstone Group LP, the biggest company in the burgeoning industry, has spent more than $7 billion to acquire about 40,000 homes.
Fannie Mae was established near the end of the Great Depression in 1938 to help boost homeownership by making mortgages more available. Along with the smaller Freddie Mac, created in 1970, the company bundles loans into mortgage-backed securities that are sold to investors with the support of the federal government. While they don’t make loans, the companies own or guarantee more than half of all U.S. mortgages and have become crucial to keeping capital flowing to lenders and borrowers.
The companies are notoriously unpopular in Washington not only for having required a bailout, but also for decades of accounting scandals and their role in helping to create the housing bubble by backing loans to borrowers with small down payments or weak credit histories. Their implicit government backing, which makes their mortgage bonds more attractive to investors, has been criticized as unfair. The Obama administration believes Fannie Mae and Freddie Mac should be wound down, the Treasury Department said last week in response to the Fairholme proposal.
That opposition is unlikely to deter Berkowitz, 55, a contrarian investor who has used phrases like “ignore the crowd” and “embrace the hated” to describe his strategy. Berkowitz, who founded Miami-based Fairholme in 1997, isn’t afraid to make large, concentrated bets and stick to them. Three holdings -- AIG, Bank of America Corp. and Sears Holding Corp. - - accounted for about two-thirds of the money in his $8.3 billion Fairholme Fund as of May 31, according to data compiled by Bloomberg.
Berkowitz along with other preferred shareholders has sued the government for taking all of the companies’ quarterly profits beyond a $3 billion net-worth cap. The money counts as a return on the U.S. investment and not as a repayment of the aid, leaving Fannie Mae and Freddie Mac without an avenue for exiting conservatorship and fueling controversy among holders of their junior-preferred and common stock.
Fannie Mae and Freddie Mac said on Nov. 8 they will return $39 billion to the Treasury out of third-quarter profits, bringing their total payments to within about $2 billion of the cash aid they got after the credit crisis.
“Every day, I put myself in the shoes of the shareholder, invest for the long run, do what I say I’m going to do and stick to it without consequence of what people may say or what the optics may look like,” Berkowitz said in an e-mailed statement last week. “That’s my job. That’s what I get paid for. And that’s what I’m going to keep doing.”
The risk and payoff of his investing philosophy were on display in his wager on AIG. He plowed money into the New York-based insurer starting in 2009 as part of a strategy to buy financial firms that he said were “priced to die” after they were recapitalized by the government following the 2008 financial crisis.
Fairholme’s investment soured in 2011 after AIG booked charges to strengthen reserves, and the government laid out plans to sell its 92 percent stake through a series of share sales. The prospect of the offerings held down the stock price because investors wagered that the U.S. would divest its holdings near its break-even on AIG’s $182.3 billion bailout. The share slide caused the Fairholme Fund to suffer its worst year ever in 2011 and prompted investors to pull their money.
Yet those who stuck by Berkowitz, named Morningstar’s domestic stock manager of the decade in 2010 for returning an average of 13 percent over that period, reaped gains. AIG last year rebounded as the government exited its stake and led the Fairholme Fund to its best performance against the Standard & Poor’s 500 Index in a decade. The fund has surged 36 percent this year to beat 97 percent of peers, according to data compiled by Bloomberg. AIG has continued to outperform the benchmark this year, climbing 40 percent.
Ackman, too, is known for making concentrated and occasionally long-shot wagers. Pershing Square had invested in seven public companies with stakes valued at a combined $8.4 billion at the end of the third quarter, according to a filing. His strategy involves intense research and pushing companies to make changes to boost the share price, a very public style of investing that backfired this year with wrong-way bets against Herbalife Ltd., a maker of nutritional supplements, and on retailer J.C. Penney Co.
“Ackman is willing make large bets that are counter to conventional thinking,” said Justin Pawl, chief investment officer of Covenant Multi Family Offices, which manages more than $1 billion out of San Antonio, Texas. “Some of these bets have paid off handsomely and others have not.” Covenant isn’t an investor Pershing Square.
Ackman, 47, declined to comment for this story.
In his General Growth wager, Ackman paid $9.3 million for 20.1 million shares at an average of 46 cents each, according to a filing at the time of his November 2008 purchase. General Growth filed for Chapter 11 protection the following year after weighing itself down with $27 billion in debt that it was unable to refinance because of the financial crisis and collapse of the commercial mortgage-backed securities market.
Berkowitz in 2010 joined Ackman and other investors including Brookfield Asset Management Inc. in a proposal to invest in General Growth to bring it out of bankruptcy. The investor group prevailed, committing more than $8 billion to bring the firm out of Chapter 11.
General Growth’s restructuring plan provided a full recovery for creditors and a recovery for shareholders, which is rare in a bankruptcy reorganization. Ackman, who started his first hedge fund at the age of 26, told Bloomberg News in 2011 that he had “turned $60 million into $1.6 billion,” and the wager helped to generate a 29 percent gain from his main fund in 2010.
Pershing Square’s main fund has returned an annual average of 20 percent since the firm’s 2004 inception. The fund has gained 8.1 percent this year through October, according to a performance update. Hedge funds have returned an average 6.9 percent, according to data compiled by Bloomberg.
While General Growth turned out to be a win for both investors, that’s not clear in the case of Fannie Mae and Freddie Mac. Ackman, who was betting against shares of the two companies in 2008, hasn’t disclosed his plans. He told CNBC last year that Fannie Mae should stop selling foreclosed assets and become a residential real estate investment trust.
Pershing Square started buying the shares Oct. 7 and accelerated purchases after Oct. 21. Ackman paid a total of $401 million for his combined holdings, meaning he already made a 44 percent return. The firm said it disclosed its stakes “in light of the proposed Fairholme transaction.”
Under Fairholme’s proposal, the preferred shares would be exchanged at their full par value of $34.6 billion for shares in a new mortgage insurer. The preferred shares currently trade at about 40 cents on the dollar. Holders of common shares would get no stake in the new business unless they want to purchase the shares.
Some significant investors in Fannie Mae and Freddie Mac preferred shares weren’t aware of the details of Fairholme’s proposal and his plan to publicize it, though they would probably be interested in participating if it’s accepted, according to people familiar with discussions among shareholders.
So far, the chances of that happening appear slim, as policy makers have shown little interest in the Fairholme proposal. Senator Bob Corker of Tennessee, a Republican, and Virginia Democrat Mark Warner, who have co-authored a bill before the Senate that would overhaul housing finance and wind down Fannie and Freddie, last week rejected Berkowitz’s proposal.
“An offer of this nature would not be in the public interest,” Corker said in an e-mailed statement about the Berkowitz proposal. “Without meaningful legislative reform we would still have dominant entities owned by the private sector but operating with an implied government guarantee, leaving taxpayers at great risk.”