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Hedge Funds Hit With Right Hook on Fannie-Freddie Ruling

Hedge Funds Hit With Right Hook on Fannie-Freddie Ruling

The collapse of securities tied to Fannie Mae and Freddie Mac punished some of Wall Street’s best known money managers, with star investor Bruce Berkowitz’s main mutual fund losing more than $600 million.

The value of the $8 billion Fairholme Fund’s stakes in preferred and common shares of the U.S. mortgage-finance firms slid to less than $550 million today, from $1.2 billion at yesterday’s close, based on holdings disclosed as of May 31.

Berkowitz’s Fairholme Capital Management LLC lost a legal bid yesterday to force the bailed-out companies to share profits with private stockholders. Investors had sued the U.S. for breach of contract over allegedly promised dividends and liquidation preferences.

All told, investors today saw the market value of their preferred securities tumble by more than $6 billion, with the value of the common stock held by private investors losing more than $1.5 billion, according to data compiled by Bloomberg.

Common shares of Fannie Mae fell 37 percent to $1.70 in New York trading, and Freddie Mac dropped 38 percent to $1.65. Investors that have bet on the common or preferred equity have included Bill Ackman’s Pershing Square Capital Management LP, Perry Capital LLC, Paulson & Co. and Owl Creek Asset Management LP and units of private-equity firms Blackstone Group LP and Carlyle Group LP.

The court delivered a “right hook” to investors’ hopes, said Jeffrey Lewis, a senior portfolio manager at hedge-fund manager TIG Advisors LLC, which has invested in the preferred shares. He wouldn’t say whether his firm owns them now.

Being Aggressive

“He clearly went out of his way in terms of being aggressive in his language and in dismissing it now,” Lewis said about the judge who issued the ruling. “I don’t really understand how somebody could be in yesterday understanding what the process is, and out today. It’s not that people didn’t think there would be setbacks. A lot of people always thought this would be a question for the Supreme Court. The change in the probabilities are not commensurate with the change in values.”

Some Fannie Mae and Freddie Mac preferred securities tumbled by more than half. Berkowitz’s investments are focused on the preferreds. In a letter to investors dated July 29, Berkowitz said bets on Fannie Mae and Freddie Mac accounted for about 15 percent of the Fairholme Fund’s portfolio.

Piled In

Pershing Square was the largest private holder of the common shares as of March 31, according to data compiled by Bloomberg. In May, Ackman said Fannie Mae could be worth $23 to $47 a share over time.

Ackman’s lost more than $150 million today, according to data compiled by Bloomberg, based on his most recently disclosed stake of common shares. Carolyn Sargent, a spokeswoman for Pershing Square, declined to comment.

His firm in August also sued in a separate court, where Fairholme has a different case where the pretrial sharing of information has begun.

Other hedge funds including Perry, Paulson, Owl Creek and units of Blackstone and Carlyle had piled into the companies, with some lobbying lawmakers and regulators in Washington in a bid to have them shape the future of the $10 trillion mortgage-finance system in a way that would allow Fannie Mae and Freddie Mac to survive.

It’s unclear which firms still hold the securities. Spokesmen for Perry, Blackstone and Paulson declined to immediately comment or didn’t return a call and e-mail seeking a comment. Spokesman for Carlyle and Owl Creek declined to comment.

Billionaire hedge-fund manager David Tepper said he doesn’t hold a big position in Fannie Mae or Freddie Mac.

More Research

“I wish I didn’t have an investment,” Tepper said in an interview today on Bloomberg Television. “We’re going to do a little more research and see where we stand in different courts. You know there is a process for different lawsuits. You are done with this particular court, you have other courts you are involved in. You can appeal the last decision. That will go on and you want to see what exactly happened in this judge’s opinion right here.”

He added that “we may get a little more interested but we really do not have a position big enough to get involved in that fashion.”

U.S. District Judge Royce Lamberth rejected Berkowitz’s claims, finding that the government is allowed under a 2012 amendment to the companies’ bailout agreements to sweep “nearly all” profits from Fannie Mae and Freddie Mac to the U.S. Treasury.

‘True Gripe’

“The plaintiffs’ true gripe is with the language of a statute that enabled FHFA and, consequently, Treasury, to take unprecedented steps to salvage the largest players in the mortgage finance industry before their looming collapse triggered a systemic panic,” Lamberth wrote, referring to the Federal Housing Finance Agency.

Berkowitz, who was named Morningstar Inc.’s domestic stock manager of the decade for the 2000s, has profited by buying disliked and bailed-out firms. He accumulated the largest stake in American International Group Inc. after the U.S., when the insurer was rescued, and also wagered on Citigroup Inc. and Bank of America Corp.

“Our inclination remains to run from the popular and embrace the hated where prices tend to reflect such mistrust,” Berkowitz wrote in a 2011 report to investors. “Often, we are ahead of the crowd, too early, and appear wrong for a time.”

Volatile Returns

That’s made performance volatile at his Fairholme Fund. It’s returned an average 11.6 percent annually over the past five years before today, better than about three quarters of rivals. So far this year, Berkowitz’s fund is up 2.6 percent, trailing the Standard & Poor’s 500 Index.

“He’s still a very talented investor,” said Kevin McDevitt, an analyst at Morningstar Inc. “You make these kinds of bets and some of them aren’t going to work out.”

Today, Fairholme Capital affirmed its commitment to winning private shareholders’ rights to profits from Fannie Mae and Freddie Mac after losing the legal challenge.

“Litigation is a lengthy process,” Berkowitz’s firm said today in a statement through Sard Verbinnen & Co. “On behalf of hundreds of thousands of Fairholme Funds shareholders, we will vigorously pursue the enforcement of existing contractual claims and our inalienable rights of property ownership as guaranteed by the U.S. Constitution.”

(Updates shares in the fifth paragraph, adds analyst’s comment in the third-to-last.)