Yet Another Value Podcast - Net Interest's Marc Rubinstein on "The Trump Trade" + deep dive on $FNMA

Episode Date: July 22, 2024

Marc Rubinstein, Founder and Editor of the Net Interest Newsletter (link to substack below), is back on the podcast to discuss his article titled, "The Trump Trade" and deep dive on Fannie Mae $FNMA. For more information about Marc Rubinstein, please visit: https://www.netinterest.co/ Article on Trump Trade: https://www.netinterest.co/p/the-trump-trade Chapters: [0:00] Introduction + Episode sponsor: Daloopa [1:40] Background and history of $FNMA [17:07] Turning point in 2012 (background cont'd.) [20:19] $FNMA privatization argument from last 10 years [29:54] "The Trump Trade" and $FNMA [42:03] Why didn't Trump privatize in first term / if Trump wins 2nd term, what happens if he's going to pursue a privatization plan? / what is the most likely scenario [53:50] Final thoughts This episode is sponsored by our friends at Daloopa Hey there, fundamental analysts - Are you tired of the endless grind of updating financial models, scrubbing documents, and hard coding? Let’s talk about something that could transform your workflow—Daloopa. Daloopa delivers perfect historicals for thousands of public companies. That means every KPI, operating data, financial metric, adjustment, and guidance—all at your fingertips. And here’s the best part: Daloopa updates your models in near real-time, which is especially important during earnings season, tailored to your modeling format and style. Imagine never having to update your models again. With Daloopa, you can reclaim your time and focus on what really matters—analysis and research. Want to learn more? Create a FREE account at Daloopa.com/YAV

Are you tired of the endless grind of updating financial models, scrubbing documents, and hard coding? Let's talk about something that could transform your workflow, Delupa. Delupa delivers perfect historicals for thousands of public companies. That means every KPI, operating data, financial metric, adjustment, and guidance, all at your fingertips. And here's the best part. Delupa updates your models in near real time, which is especially important during earnings season, and it's tailored to your modeling format and style. Imagine never having to update your models again.

With DeLUPA, you can re-clean your time and focus on what really matters, analysis and research. Want to learn more? Create a free account at dilupa.com slash y-A-V. That's Delupa, D-A-L-O-O-P-A- dot com slash Y-A-V. All right, hello, and welcome to see another value podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot if you could rate, subscribe, review wherever you're watching or listening to it.

With me today, I'm happy to have one. Mark, it's the third time, Mark Rubenstein from net interest. Mark, how's it going? Yeah, very good. No, it's great to be back. Always a pleasure, Andrew. Thank you. Look, I'm super excited to have me back.

I've completely forgotten about we did Capital One and Silicon Valley Bank. about a year ago. Time kind of flies because I thought it had been just a few days ago. Anyway, we're having you on I'll talk about why in a second. I'll just do two things. First, quick disclaimer, remind everyone, nothing on this podcast and investing advice. Always true, particularly

true today. We're going to be talking about the Trump trade, as Mark so eloquently put it. That means we're probably going to be talking about Fannie and Freddie in the legal situation there. Neither of us are lawyers. Mark's actually coming all the way from the UK and talking about a legal process over in the U.S. I'll remind everyone, please consult a fight.

financial advisor, extra risk, do your own work, all that. And second, I just will give a quick plug for Mark. I don't do this a lot at the start of the podcast, but net interest is one of my most read, one of my most read publications. That's why Mark comes on once or a year or so, because they're all interesting. But every now and then, there's just one so interesting or that's something that I'm researching, like, Mark, come on, pop on. This would be a great topic. So I would say I probably read 75% of them, which if you don't do emails, you might be like, oh, that's kind of low. That's actually like really, really high for somebody who does emails and stuff. So I love Nettingress. I've been a happy subscriber almost from day one. So

anyway, Mark, you two weeks ago, you sent out a newsletter called The Trump Trade. I immediately emailed you and said, hey, on the heels of the debate, I've been looking at this. I'd love to have you on the podcast. The Trump trade, you really talked about Fannie and Freddie, and that's one to dive into, but why don't I just toss it over to you and we can talk about any aspects of it? Yeah, no, I think, I think the, my, my angle My is Fanny and Freddie. I've been following these companies for 15 years, as you highlighted in the intro, and as listeners can understand from my accent, I'm not an American. I think, you know, we can argue whether it gives me an advantage or a disadvantage. We'll go on and talk about Fannie and Freddie, but they're very politicised stocks. Everyone has a view, either as a taxpayer, as a mortgage owner, as an MBS holder, I'm none of those things. So I come at it entirely from the outside, look at these entities as businesses, and look at their securities as securities, and for my view purely around

what I see as an outsider. But then, I think, to understand why don't we just, I think, to understand why the Fannies and Freddie's are, you know, the Trump trade, and you're not alone, right? Bill Ackman, has been hammering this point. Now, he's been in these for a long time, but as last summer, when the preferrers were around like $2, he was saying, hey, if you think Donald Trump's going to get elected, there's nothing like Fannie's and Freddy's with leverage the Trump trade. We can talk about why they're the Trump trade in a second, but I think we do need to go back and talk about just kind of how we ended up in this situation. So do you want to rewind about 20 years and kind of talk about how we got here? Yeah, so, I mean, I can rewind even

further. We can start in the 1930s. But, but the, this. There's a very peculiar mortgage structure in the United States, which revolves around the fixed-rate, long-term mortgage. Doesn't exist anywhere else in the world outside of Denmark, actually. And for consumers, it's a phenomenal product, because, as you know, it allows you to borrow with visibility going way out into the future as to what your monthly payments will be. yet retain a option to remortgage should rates go down. And right now in the US, 50% of mortgage is outstanding have a rate attached to them below 3.5% even though the spot rate, if you like,

for a new mortgage is double that. So very, very valuable for the consumer. First question. You're in the UK. If I was in the UK and I wanted to buy, I guess, a flat or a home there, you know, what's the most standard way you would kind of finance buying a home or flat in the UK? You can, so you can either go completely floating or if you want some kind of security, you might go two year or five year fixed. At a premium to what the floating rate would be, but you wouldn't get more than five years. Yeah, so the government just, what I would look at is,

the government backing here allows the U.S. consumer, you know, it is a subsidy to the consumer, right, allows them to borrow this great piece of paper, 30-year fixed rate, you get all the optionality on your side, and that's in part thanks to the government being here. Okay, perfect. Yeah, I think that's right. And I'm saying a family and family were created in order to support that product, to provide the backstop for the lenders, as I was saying, For the consumers is a great product. For the lenders, it's not so good because no lender wants to hold 30-year fixed-rate paper. And so Fannie and Freddie were introduced to backstop that risk.

And they've done it very successfully. And in the run-up to the financial crisis 2007, they actually saw a decline in their market share in the immediate run-up to 2007 as private label securitization structure. took market share. That's one of the stories of the financial crisis. But kind of in any competitive environment, it was difficult for Fannie and Freddie. I will talk actually later as well

about their structure with one foot in public markets and one foot as kind of quasi-government institutions. But with that one-foot in public markets, they saw the competition, and like any business, they wanted to react. And so they accumulated on their balance sheet a lot of that private label paper, which proved disastrous in 2007, 2008, and generated for them quite material losses. So, I mean, look, they have always been quasi-public private companies, right?

And you can go back, like, in the, I believe Vinny and Freddie, the IP in the early 90s, and if I'm doing this from memory, but Buffett, he buys them on the IPOs, takes huge stakes, does great. And he said, look, these are, they're very unique businesses, which is always good to look at. Like, I love looking at unique business models and ends of one. They were very unique businesses with a very unique moat. But he sells out, if I remember correctly, in the early 2000s because he kind of sees this coming, right? He sees, hey, you've got this great business, but like all great businesses, the temptation is to step a little bit further. Like, keep pushing the envelope. They're taking extra risks and everything. And obviously that comes

to heal in the financial crisis where homes are blowing up. They've probably gotten a lot laxer with their underwriting. And they've also taken their profits and they're balance sheet and invested into a lot of toxic stuff. You had this great chart. I think it was taken from Fannie's website, but you had this great chart that shows defaults of Fannie backed securities. And it's like 2007, 16% of them end up deal with outing. 2006, 12%, 2005, 8%. And, and it's, and it's like 2007. And And in no wonder, in most of the years, it's like one to two percent is just crazy. Anyway, I rambled there about how we, the lead up to the crisis. Anything else you want to add there?

Well, no, I mean, so you can look at them as businesses. And clearly Buffett did that, as you highlighted, when they initially came to the market. And as businesses, they tip all of Buffett's criteria. They are, they're a duopoly. they they there's a kind of branding associated with them they set the rules for what a conforming mortgage is they will only guarantee conforming mortgages and therefore they almost define the product characteristics for a u.s mortgage so a bit like a bit like moody's a bit like um um mc i they in the mortgage field, they create the specifications, they create the benchmark for what a

mortgage is, and that's hugely powerful. So they take that box. And also, again, back to Buffett, they are fundamental insurance companies with flows. Because in order to secure the credit guarantee, which is just to be absolutely clear, that's their core product. What what they provide is a credit guarantee. To secure that credit guarantee, they take a premium which the mortgage borrower pays through the interest rate. So off the top of that interest rate, a certain fee goes to Fannie and Freddie as insurers, but they only pay out in the event of a claim to use the analogy in a default situation, which

will be further down the line. And as you pointed out, most of the time, defaults are very low. And there's clear reasons why they're low, because loan to values are set sufficiently and so on and so forth. But they're typically very low. And so the cash flow characteristics to use the insurance analogy very, very similar. The money's coming in, but a float gets built up, which Fannie and Freddie can invest. They did that very badly in the run-up to the financial crisis, but the insurance analogy still, still, still assists.

It's very similar in people who did the financial crisis, or even now, MBI, AMBC, a shared guarantee actually still operates. But you know, these were, Fannie and Freddie are doing the residential mortgages. All these guys were mainly, not exclusively, but mainly doing municipal bonds, right? But you can see the advantage of it, right? Who wants to go through, you know, a hundred million homes in the U.S. and underwrite each one and guarantee, like if Fannie and Friday are providing that guarantee, it becomes a super liquid piece of paper, it's got the government backing, from the government standpoint, having a liquid mortgage market encourages homeownerships, like there's all sorts of benefit, but then you can

also see like, hey, it's kind of weird to take all these mortgages or an MBI in AGO's case and take all these small municipal departments that would be, you know, single a rated if they just getting rated and guarantee them at AAA and say, hey, you know, you pay us a fee, we'll make you AAA, we'll split the difference. Like, it is a very weird thing. And in this case, like, it's a lot of it's rushing on continued American prosperity. Obviously, there's LTV and underweight, but it's just, it is a strange creature. Anyway, we get to the financial crisis.

I don't think we need to belabor this. People know. Things go bad. The balance sheets get terrible. It gets wrecked. And this is where the government steps in. So do you want to take it up from there? Yeah, so Labor Day 2007, they, so actually they raised some capital, they raised some prefs.

So the capital was being depleted because of losses that were being incurred. In July of 2007, they actually raised some capital. They raised some preferred stock in July 2007. But by the beginning, by the end of August 2008, sorry, 2008, it becomes apparent that they are going to needs another capital injection. And there's a whole discussion around this, but to cut to about whether it was necessary or not, but to cut to the chase, the government decided to,

the government decided they needed to nationalize these entities. And this comes back to a kind of, you know, kind of Schrodinger characteristic about them anyway. Were they government, you know, you, you, you, you, you, you, said very clearly they had government backing. That was never explicit, but it was assumed. And so I remember, because this was right when I was in college and finance classes, they'd be like, hey, Fannie bonds trade like 10 basis point wide of treasuries and a little bit of that liquidity, but part of it was like, it was always implicit, but was never explicit that

they had government backing. So it was like, hey, you're kind of getting 10 basis points extra because you're betting on that implicit. It hasn't been explicit. So you get a little bit of extra. reward for just betting on that. Yeah. So, and the market called a bluff in August, beginning of September 2008, and the government decided they had to make it explicit and the way to do that was to nationalize. The problem with nationalizing was the balance sheet of these businesses was too large to sit on the government budget.

Actually, the reason why they became private, why, why they became private companies in the first place was the inverse of that problem. They needed to be removed from the government's balance sheet. And so they came up with another solution, which was conservatorship. So September 2008, they're placed into conservatorship. It's kind of like nationalization, but not. So rather than fully nationalizing these companies, they left the equity out there. Government took 79.9% They took warrants on 79.9% of the equity for both of them. And they backstop them saying that we will provide sufficient capital as to absorb any losses.

So they backstop the balance sheet of both Fannie and Freddie. The cost for which, and they agreed to do up to $200 billion each, the cost for which was a 10% coupon. Now, if you remember, lots of other financial institutions would go on and structure similar deals. Bank of America, Buffett famously took Bank of America preffs on similar terms. Goldman as well. Yeah. On similar terms.

Yeah, exactly. So issuing prefs, this was slightly different because it was on a needed basis. So it wasn't pre-funded, but whenever they suffered a loss, government would come in with seemingly a preferred capital out of the interest rate of 10%. And that's what they did. And that was the situation from 2008 up until 2012. Are you tired of the endless grind of updating financial models, scrubbing documents, and hard coding? Let's talk about something that could transform your workflow, Dulupa.

Delupa delivers perfect historicals for thousands of public companies. That means every KPI, operating data, financial metric, adjustment, and guidance, all at your fingertips. And here's the best part. DeLUPA updates your models in near real time, which is especially important during earnings season, and it's tailored to your modeling format and style. Imagine never having to update your models again. With DeLupa, you can re-fling your time and focus on what really matters, analysis and research. Want to learn more? Create a free account at dilupa.com slash Y-A-V. That's Delupa, D-A-L-O-O-O-P-A-V. Yep, perfect. So goes into distress. You know, they're going under the balance sheets of disaster.

Government has to inject huge amounts of capital. They fund them. I think that takes this nice, you know, 2010, 2011 is like kind of the bottom for these guys. 2012. Why don't we just go right into what happens to 2012? Because that's where the story really starts to play out. Yes, by 2012, it was becoming, by 2012, one argument, there are two arguments here. One argument is that Fannie and Freddie found themselves in the catch-22,

that they drawn down by then $190 billion between them of government funding. The 10% coupon on that was very difficult for them to, was a huge burden on their, on their, was it was a huge burden on them. And so the government in August of 2012 decided to rewrite the terms of those senior preferreds and introduce what's known as a net worth sweep. And what they said was, okay, forget about the 10% instead, just pay us all of your profits. So again, you know, the analogy really here is nationalisation. kind of just pairs all your profits, we have absolute claim on all the profitability of Fannie

and Freddie. Now, by then, as you say, the bottom was in for credit losses. They'd also been raising and they would continue to raise the fee, the premium that they take every year for guaranteeing mortgages. At the time, 2009, they were charging like 20 basis points. today were closer to 50 basis points. So core profitability was going up. Losses had peaked. And so for the government, this was a pot of gold. And the other argument is that

there's been a number of court cases, we may go on and talk about those, but in discovery it's emerged that certain elements within the establishment, establishment kind of knew that they understood that and that for the for the government this would be the upside here would be would be enormous and actually so they'd so in august 2012 they revised the terms over history the government through dividends initially and then through just a full retention of profit has taken out over 300 billion dollars so from the government

budgetary perspective, hugely valuable. They put in 190, they're taking out to $300 billion, very, very valuable. I can't remember, I think it's towards the end of the Obama administration, but it might be towards the end of the Trump administration. There are even emails from government employees who are like, hey, like Fannie and Freddie, they've been helpful for just deficit purposes, right? Like, if you think about it right now, I don't have the exact numbers, but they're generating $20 to $30 billion per year in profit. Like, if the government gets all that net worth sweep, guess what? That's $20 or $30 billion of profit that the government gets that they can reallocate to choose whatever you want, right? Choose your own adventure. That's just

straight on to the bounce sheet. So I think that's a nice place to stop. Right now, we're kind of, we're at August 2012 right now when this net worth sweep gets to play. And obviously we're talking in July, 2012, a lot's happened since then. But that actually does lay the state of play for the next 10 years. This is like even before we have the Trump trade today. For the next 10 years, this is going to become one of the most popular plays in event-driven slash legal land. I remember when Donald Trump gets elected the first time in 2016, there were rumors like, hey, Paulson's got a call. Paulson is really in the Fannie and Freddy's and Paulson is really connected with the Trump circle. That Paulson connection is going to spur a

privatization, all the sort of stuff. So I guess before we get to the Trump trade, let's just start, what is the argument for the past 10 years that has got an investor so bold up? What, you know, What is the privatization argument? What are they playing for here? Well, so firstly, to lay the groundwork, we've got a lot of securities here. We've got, we've got common stock in each of them, but we've also got prefs that they issued both in July of 2008 and prior to that. So there's the privately hold prefts that sit below the government prefs, and then there's common that sits beneath that. The Prefs back in 2008, they're non-cumulative, and they have their dividends turned off. And so they represented, as you say, over the past 10 years throughout this process,

they've represented a kind of a residual claim that if the government could be paid off, they are next in line and there's some value there. And their par is 20, their par, there's a whole number of series out there, but mostly their par is $25. They traded as low as $2 and as high as $10 plus dollars at, out of $25. Now, there's been two tracks over the past 10 years to recapture value. One is the political, which involves Trump. You've alluded to it. The second actually was litigation that a number of attempts were made, about two dozen different

attempts were made by investors. Big one was spearheaded by Perry. Paulson was involved. I don't think Ackman was directly involved in litigation, but he's been an investor. I think Tepper was an investor. There's been a whole number of litigation attempts. trying to prove that in some cases, 2008 was illegal, but that 2012 in particular, that net worth sweep, hence the emergence in discovery of some of this commentary about what the government knew at the time was kind of illegal. It was basically a requisition. I mean, one of the discovery 2012 Fannie CFO at the time says, like when they're putting the network sweep, our projections should. show, I'm looking at your article, our projection show and I believe that we were on a path for sustained profitability, right? So exactly what you're saying, hey, you have this bailout,

you have this bailout, and you changed the terms in 2012 when it became clear that there was going to be enough money and more to pay off all the bailouts and kind of get back to the shareholder base. And so these cases were knocking around the various courts, eliminated in summer of 21 in the Supreme Court, who decided that the government or the FHFA, which is the regulatory entity, which acted as the arm of the government, in this case, acted illegally. And you pull up a chart of the securities, and you can see that in the chart. They fell back as that litigation arm was closed off. I'm looking at the chart right now.

you can see the exact day. It's June 22nd. I'm looking at the FNMA, I believe it's A's, the eight and two quarters. They go from $6.25 to $2 overnight, right, like as this evaporate. So this is just a disaster, just a disaster for these. So the litigation route gets closed off. Actually, in summer of 23, just last summer, there is another court case. which, uh, in which damages are, about 600 million agreed, but it's small. Um, and it's being appealed and, and, and, it's just so funny. The scale of this is so enormous, right? Like, we were saying 190 billion. They've done 300. I say 600 million and you say it's small. And you are right. Like, this is small. But this is, I haven't looked at a balance sheet recently, but Fannie, I believe is bigger than like Bank of America, J.P. Morgan. I could be off on that.

But, I mean, we're just talking, even if it's not them, the assets here are just so enormous and mind-boggling. It's just crazy. You can say $600 million. That's a nothing burger, you know? Yeah, that's right. So just to give you them, so, yeah, Fannie's balance sheet, $4.3 trillion. And, yeah, and Freddie's not much, 3.3.

So, yeah. So in 2012 to, you know, up until basically 2021, there are two plays, right? There is a, hey, maybe these will get reprioritized and, you know, you're looking at a, if I just use the Fannie 80 and quarters that I was talking about, they're trading for $5. The par there is 25. These pay an eight and a quarter dividends. So, you know, I can't do the math deck within my head, but about $2 per share in dividends if they got turned back on, $2 per year. They're not key in those, so you're not going to get 15 years worth of mixed. But you would imagine they trade a little higher than five if they were paying $2 per year

dividends. So if we went back to 2020, 2015, there was a hope that maybe the government would be forced from this legal situation to overturn this whole thing. That's gone. Now the path is privatization, and that is the Trump trade. So why don't you walk me through? What is the Trump trade people are putting on where they say, hey, if Trump is elected, these fannies, Freddy's, maybe the equity kicks in, these prefers are going to show it. Like, how does this play out? What are people betting here? So Trump has always been clear as far back as 2016 that the current situation is not sustainable, that these entities need to be returned to the private markets, and that various alternatives that may have been proposed prior to that. And even frankly, in 2016, which was a long time ago, right?

Even frankly, in 2016, they haven't come to pass. So one proposal was that some other kind of structure could emerge, some private sector solution could emerge, which would make Fannie and Freddie redundant, and they could be wound down over time. So, and that's not the case. And the mortgage system is more reliant on Fannie and Freddie now than it was, than it ever was. two-thirds of the mortgage market is now touched by, by Fannie and Freddie, and then there's another GSE, which takes up most of the rest, Genie Mae. So, so, so, so, so, so, so, so, so, so, so, so, so, so, so, so, so, so is untenable need to be returned to, uh, uh, private markets. Uh, incidentally, one thing we didn't mention is that net

worth sweep actually got, it kind of, so that net worth sweep got turned off. So the government isn't even any more benefiting directly from all of the profit sweep that family and Freddie are generating. Now, that's not necessarily to the benefit of the other stakeholders because what the government did instead is it said, okay, you don't have to pay us out from profits, but what you do do is those profits become a liquidation preference, that sits on top of our senior preferred.

So they haven't had to put any more money in since 2012, but the liquidation preference value of their senior preferred has been going up as a result of this tweak, which happened in 2019. So Trump's saying it's not sustainable. You know, government's not actually getting any kind of cash out. They're not going to cash out anymore to the extent that they were. there are no alternatives that have emerged.

Politically, he is of the view, as was expressed in 2016, not going to be an alternative. And then, just to make it absolutely clear, in 2021, he fired off a letter to Rand Paul, basically saying that if he had his time again, and there are various reasons why he couldn't do it at the time, But if he had a time again, he would fully prioritize them. And the government would make money in that process.

Because, oh, I want to go to that letter, but I just want to drive home the point. Like, I look at these balance sheets and everything. I see these pars trading at five, right? And I just wonder, if I'm Trump, if I'm the government, whatever, why, you know, I've got this huge asset. There's billions and billions and billions and billion dollars of equity. I can kind of do what I want with this since the Supreme Court ruling. Maybe not, but I've got a lot of assets. I've got a lot of flexibility here.

What are people playing for? Like the Trump trade? Why is buying the fanning's a Trump trade? Because yes, he's going to privatize them. But why are the prefs or why are the equities going to be the ones to benefit here? Like how is he going to structure it that I buy the prefs and I'm going to make money on this? Well, so that's the big question. Okay, so that's the big question. So, so, so one argument is that we've already quoted the numbers here.

The government has taken out $301 billion. They put in $191 billion. And therefore, one one perspective is the government has been repaid. But let me push back on that because this is a bailout, right? This company has gone without Fannie and Freddie. Go to Buffett's bailing out gold, or Bank of America or whatever you want. Like, when you put in bailout money, when you save a company, like less than a double over 15 years, which is, it's more than that at this point. Like, that's actually not a lot for bailout money, right?

Like, if it's a successful bailout, most people would kind of play for like a 4X over five years, maybe more. So I hear what you're saying, and it's the government, which makes people's minds explode. But when you say, hey, 300 billion, again, the numbers here are staggering. When you say, hey, they've got 300 billion off the 190. I say, yeah, but, you know, they could have invested in their own bonds and kind of gotten something like that. So why is that a fair way to frame it? Well, that's one perspective.

So, okay, so there are two extremes. One extreme is they've been fully, one extreme is the most optimistic for private securities holders is the government turns around and says, we've been repaid. We've taken out 301 billion, having put in 190 billion, we've been fully repaid. That's it. You know, we've got no more, we've got no more claim. We've got no more claim. They start doing that. And they also say, hey, we like, we know a lot of hedge funds own this.

We're going to get a lot of capital gains taxes if we privatize this and everything. That's one extreme. The other extreme is that actually, is that actually no. We still owed, you know, the 300 dividends, we still owed 191. And actually, because the revision in the profit sweep since 2019, the a liquidation preference of another 135 on top of that. And so we're owed, we're owed all of that. We're owed, you know, we're owed another 300.

So we've taken out 300. We're owed another 300, which and we've got the, and we've got warrants on 80% of the common as well. Now, having said that, but the warrants create a, the warrants complicated because I guess there's two ways the government could get money out. They could get money out through the preferreds or through the common, through the preferreds completely, or through the common, it's very difficult to do both. You know, by exercising their claim on the entirety of that preferred, they would wipe out the common.

But, and this is kind of I think what Trump was alluding to in that letter, they could compromise somehow on the preferred and instead extract value by exercising the warrants and taking a stake in a pair of ongoing businesses that make $28 billion a year going forward. For all the reasons we've discussed, the operation operating leverage is very high. Guarantee fees have gone up, all those reasons. And so that's the trade almost. It's kind of, it's do they, you know, and there are people in Washington who there's a lot of debate around how this will play out. Clearly that's reflected in the prices of these securities, particularly the prefs where you can kind of impute a probability,

which is now entirely political because the litigation route has been closed. as that's the cool. No, look, it's interesting because the first thing is, you know, I personally think a second Trump administration would have a lot of a lot of payoffs for friends, let's say, and this is one very easy way, right? A lot of the supporters are very long on fanning's, and I also think there is a piece of, hey, let's not let the government, let's like return this to the profit. So I guess what I'm saying is I would not be surprised to see a privatization that sees the prefs reinstated and everything.

And, you know, as you said, the press are at five right now, right? My math is kind of if these are reinstated, do they trade up to par? They probably deserve to trade to par, which is 25. They might trade a little below par just because there's a little sink. But, you know, even with interest rates where they are 8.5% from a government guarantee business making this much money, like if they would trade to 2250 like you're still talking about a four bagger from here so you're still not putting like crazy high odds on you need two things to happen right you need first trump to get elected and then trump to decide kind of privatize instead of put the screws

to fannies and freddie it's still not a huge odds especially you know they'll probably have one or two dollars per share of if nothing plays out like just tail value at the bottom but it is hard for me to say as you said if they just exercise the liquidation preperts of over 300 billion, the preps are probably wiped out the commons, definitely wiped out. Why would you choose to exercise the warrants and take your value through the warrants and share with the publicly traded preps above that instead of just taking it all at the top end with like the government press with everything? It could be payout. It could be because you legally feel crazy. It does seem like the warrant route is the way they want to go, but it's just, it's strange to

me. Yeah, I guess, I guess, yeah, I mean, right, I guess, you know, through the warrant route, they're getting capitalized value rather than, rather than a repayment of what they are put in already. So, you know, we have to ask two more questions then. We have to ask question one is how much capital do these entities need to operate? And that's not obvious. And then question two is what kind of multiple would you put on these businesses in which in what in a kind of an ongoing environment and everything we've discussed you would think I mean maybe I guess there would be a discount because of government involvement

that still be some kind there still be highly highly regulated entities and therefore they would merit some kind of discount. but they've proven, we talked about it already, but the asset quality is superb, there are a duopoly, the guarantee fees are very high. You could argue the multiple here could be quite high. I mean, you say the government's going to be involved and they should get a discount, and I would tend to agree with you, but you could counter and say, hey, now these are going to be so highly regulated, why wouldn't you look at them like a utility, right, like a regulated utility? And if that's the case, regulated utilities go for, you know, they trade for basically

a hundred or sorry 20 times three cash flow because they basically trade as bond proxies right why shouldn't this be a bond proxy now there's cyclicality and i think you would be worried about tail risk and government meddling and everything but you could go either way and argue this deserves a higher the normal multiple instead of a lower than normal multiple yeah you yeah you could the other thing that occurred to me more recently is that pre financial crisis they were distinct within financial services because of the government involvement very clear man Government defined mandate that they had to promote home ownership. I think since the financial crisis, we've learned that the entire financial system,

there is government intervention in the entire financial system. We learn that. You know, we learn that through the pandemic. You know, just every year now they need to seek government. You know, when I think about the role of a CEO of any company, it's capital allocation. and the financial banks, regulated banks, are highly restricted in their capital allocation decisions. They need to seek permission to do dividends, to do buybacks.

They need to seek permission even to appoint a CEO and board members. Much more visibly regulated than was the case, and therefore the gap to Fania Freddie isn't as great as it probably was. you know the only other thing i just want to mention this is in your article and look i haven't like pulled up the fanny and freddy balance sheets and like really dug into them and their capital stress tests in a while but you know the other thing that jumps out to me that's so unique about them is uh they you've got a line saying hey if they hold three percent set one then that actually appears too high for them just given the quality of their asset base and everything and it's just crazy to think about that because from the top of my head i mean i think jp morgan runs with like a

low to mid teens set one, right? So normal banks and obviously different asset quality and everything, but it is just crazy to think you could say, I mean, a normal bank, even a small community bank, if they ran with a set one of three, they're, they're seized, right? They're done. They're over. Six is the minimum. But these guys, they're so high quality. It just shows, yes, government is intervening a lot of pieces of the financial markets, but these guys certainly operate a very unique, a unique place where you could with a straight face say, hey, 3% set one might be too draconian for these guys. Yeah, because you're punishing them twice. Well, punishing is the wrong word, but you're requiring them. They already have, they already have protection through

their underwriting. So over 90% of homes are now owner occupied. Before the financial crisis, there was a lot of, a lot of investor homes. The average FICO is over 750. And, And then they have, importantly, loan to value. So the loan to value at origination is about 70%. But given seasoning, on Fannie's, this is Fannie's. On Fannie's book, the loan to value right now is 50%. So, you know, you made the point earlier. The losses are just way for them, that they have capital,

In addition to that underwriting practice is Bradrickoni. You think about those people who are like, hey, I've got a three or four percent mortgage and good for them, but they're in a house and they bought in, you know, 18, 19, 20, 21. They'd like to go to a bigger house for like, I just can't, even though my home's appreciated because this mortgage is so good. And, you know, that's a really interesting dilemma. As you said, I think Denmark has a way to port your mortgage from one home to another. It's a really interesting dilemma that the United States is unique and facing because of the

unique mortgage structure, but you also think about, hey, that mortgage is probably on Freddie Freddie's book in some way, shape, or form. And that is, you know, yeah, it's under market on interest rate, but my God, is that good, a good piece of paper. Like, the Holmes appreciated probably 30% since they bought it. They've paid it down a little bit with the amortization. Like, it's just a very good piece of paper. Right. Yeah, precisely. Precisely. So, okay, Trump's elected to inaugurated 2025, right? How do you think this would, like, He sent the letter to, I believe it was Rain Paul, that said, hey, I would have. Actually, let's go back. One pushback I would always have in 2019, 2020, when people are like Donald Trump's going to privatize these guys, I'd always be like, if he was going to privatize, he's the President of the United States. Why hasn't he already started this process? Why don't we have the ball rolling? Why do we need a second Trump term instead of, why didn't this get done in the first Trump term? So he claims in that letter that he couldn't because the head of the FHA when he took over, FHFA when he took over, Mel Watt was appointed by Obama and he didn't, even as president of the United States, didn't have authority to fire him.

This was, this went to the Supreme Court. It was resolved in summer of 2021. The Supreme Court ruled, yeah, you know, whatever was written in the rules, that the guy was unfairable, was unconscionable. constitutional and he can be fired and he was fired. His replacement, and again, this is kind of Trump's argument, didn't have enough time to resolve this situation because he came in at the beginning, came in April 29, Mark Calabria, came in April 29, sorry, April, came in April 2019 and then nine months later, you had the pandemic,

which was a big strain on Fannie and Freddie because of the impact it had on the housing market. And clearly, you know, for various reasons, the timing wasn't right. And so he missed his opportunity, right? There are two other arguments. So that's the kind of political argument. There are two. So the political argument is, and this is all exactly correct. Hey, I couldn't, I didn't have my guy at the FHAFA.

That's been resolved. Day one, I'm installed. I can fire the old FHA guy and put whoever I want in charge, and they're going to agree with my vision on what happens here. I think the two more realistic arguments, that's the political argument. Two more realistic arguments.

One, they weren't sufficiently capitalized. So that net worth sweep was only revoked in 2019. And in fact, in my piece, I show a chart of Fanny's net worth going right back to pre-crisis. And you can see they were running at kind of zero net worth.

up until 2019, and they were only been able to recapitalize since then. And that's important because clearly for them to be palatable for private markets, they need to have sufficient capital. We kind of talked about this. It's not clear. Still raises the question how much capital they need, whether they've got enough, what form it takes, but certainly in 2019 they didn't have enough capital. And then in addition, it wasn't, it wasn't, actually 20, sorry, 2016, it was all about 2016.

And in 2016, the other issue was, the other issue was, that there may have been an alternative. And now, eight years later, we've talked about this, it's very, very clear that there is no other game in town. That these, that this is, this is the way. There's no innovative new way. There's no disruptor here. This is, this is it. Put the mortgage guarantees on the blockchain or something. So Trump comes in January 2025.

What do you think happens if he's going to pursue a privatization plan here? So I don't know. So the first thing to look out for is, well, the first thing to look out for is who is going to be his appointee as Treasury Secretary. that's hugely important then and we probably won't get wind of this then who is going to be put in charge of the FHFA it's so funny because there will be

a lot of hedge fund and special such type who all they're going to care about is who the FHFA head is going to be but that is not like I doubt the New York Times is going to break in with breaking news like here's the next head of the FHFA but it's all people are going to care about and they're going to be parsing every statement they've ever made on Fannie and Freddie privatization.

Yeah. Yeah. And you've got, and then within that, it's very noisy. This is a very noisy issue, as you've alluded to. You know, what are the potential candidates for Treasury Secretary is Paulson, who you mentioned, right? So there are people with a direct interest in this trade who are either candidates for the role or close to candidates for the role.

And so seeing understanding those networks also is important when we kind of... If I just put my trader hat on for a second year, right? That's why like a Pulsin, who I don't know how much of the Fannie and Freddie season, but he's been pounding the table on them for a long time. Pershing, which has like a, what, they've got 20 billion in assets and I think they have a one or two percent position in the Fannie Freddie. So let's just round and say 300 million, right? Like one of the reasons why I said, hey, I think a second in Trump administration will

have a lot of like kind of favors. If you're atman, if you donated, just yesterday it came out, Elon Musk was going to donate $45 million per month to a Trump super PAC, right? But if you're admin, if you donate $10 million to Donald Trump, or let's go to Paulson, $10 million, and he put you you for Treasury, and now there's all sorts of ethical rules around blind trust and everything, but you can kind of wink, wink at your guy and be like, hey, I'm putting all my current stock holdings, don't sell any of them until blind trust. You did that and you took a $300 million fanny position and quadrupled it, right? So you're going to make $900 million. It's literally going to be the best $10 million you've ever spent. And like that's one of the reason you hear all

these people like administration people floating around in the Trump orbit. I'm just like there's too many people who have said we want fanny privatized and have meaningful stakes in it. I'm just kind like Trump has said he would he would have wanted this privatized. Every person he's doing seems like they're willing to bet on it. And if they're not, when Trump comes, his company's to office, they might just go buy fanny preferreds before they get put in and like benefit finding it just seems like the ball is rolling where a lot of people are really going to want this i don't know kind of where i'm going with that but does that make sense it does make sense what it doesn't answer is the structure um which you know we there are so many permutations still

the uh kind of surface area of possibilities for how fanny and friday look and how it structured uh is still undetermined now what do you think the most likely for appointing firms. I think it might have been Morgan Stanley, but certainly Trump alluded in a public statement to appointing Wall Street firms to look at it.

And there were various proposals that were still floating around that were various white papers, various proposals authored by all sorts of people as to what structure, what form these private identities take. When I was a, what structure

Or do you think just based on the white papers you've seen or what you've, what do you think would make the most sense for the second Trump administration with all the variables that we're talking, which do you think they would pursue? I, so I think that the government needs. So I think, I think, I think certainly the, the senior preferred that was put in prior to 2012 in that bailout period needs to be paid back. So, so, you know, the 300 billion has been written off, that's that, that's kind of been spent. Government took that out, that's gone. But I, but I suspect the, the, the, the, the hundred and I need to be paid back. What's less clear is the liquidation preference on top, 135 billion, that they, that has been accumulated since 2019. I think some solution, I don't think, I think that satisfies the point you made earlier. You know, this was a bailout.

We can almost reverse engineer. What's the appropriate return on bailout funds? And cap it at that. And that way, actually, the optics can be, you know, the optics can be very favorable. You know, we have made X on the bailout and we're going to make, you know, a little bit more by exercising our warrants. and privatizing these things. Are you tired of the endless grind of updating financial models, scrubbing documents, and hard coding? Let's talk about something that could transform your workflow, Delupa.

Delupa delivers perfect historicals for thousands of public companies. That means every KPI, operating data, financial metric, adjustment, and guidance, all at your fingertips. And here's the best part. Delupa updates your models in near real time, which is especially important during earnings season, and it's tailored to your modeling format and style. Imagine never having to update your models again. With DeLUPA, you can re-clean your time and focus on what really matters, analysis and research.

Want to learn more? Create a free account at dilupa.com slash Y-A-V. That's DeL-O-O-O-P-A-D-A-O-P-A-V. See, my only worry there, and as you say it, I pulled up the Fannie 10-K, so I'm just kind of trying to do the math in my head. My only worry there is, like, again, if you did the bailout math or the cost of funds for a, a bailout, you know, like if you did that math, I think it would suggest that, and I'm speaking as somebody who's interested in the preferreds and probably needs to ramp up a lot more on them, but who's just always followed it loosely through everybody talks to the Trump trade or

the legal. My worry there is if you said, hey, a bailout fund requires a 15% IRA plus we need to get paid ongoing for the government guarantee. I don't think there would be anything actually left for the equity and the preferred. Now, the other interesting angle is, the government writes the rules, right? And they've already gotten a lot of money out. And I could very much see a world where Trump goes and holds a, you know, Trump wipes away the liquidation compounding. The government gets their 190 back.

And then they do a big IPO and Trump goes and holds a press conference. He says, look what a business genius I am, right? Like we are IPOing and the government's going to get $20 billion from the sale of its common stock. It's the biggest common stock sale of all time. The government's getting $20 billion that's coming right into the government. I can announce a variety, $20 billion funds a lot of bridges. Like I can announce a variety of projects. I can build a wall, whatever I want to do.

So even though, like, in that scenario, I would argue the government kind of gave away $100 billion. It's such a political win and such an easy selling point. And, you know, I think a lot of people would argue ethically, this is how it should have been done from the beginning or something. Like, I could see it playing out in that direction. I kind of rambled it a little bit there. I don't know if you want to comment on any of that. No, I think you're right. I think a lot of it is optics and the way it's presented and what precisely.

I think that's right. Cool, cool. Well, Mark, we've been going for about an hour. I think we've hit most of my notes and stuff. I'll include a link to the net interest, the Trump trade piece in the in the show notes. But anything else about the Trump trade, about Phammy and Freddie? Anything else you want to chat about before we kind of brought this up? I mean, the other thing I would say is anyone is interested in this.

There's a lot of resource out there. There's a former CFO of Fanny, Tim Howard, who writes a blog on this stuff, obviously very well-informed. There's a lot of resource out there. So, I don't know, you could drop that in the show notes. You could drop some of the other resources in there as well. But there's a lot of stuff out there. Hopefully we do it before then, but if we were doing, let's say we were doing our fourth podcast and we were doing it an 18 months. So December 2025 and let's assume Trump gets elected, December 2025, do you think we, do you think, I think it would be too tight for the full privatization to happen, but we could have the balls really in motion there.

Do you think the balls are really in motion there if Trump's elected or do you think, but do you think it's still a little too early? Back in, you know, Manuchin said in 2016, he said this was a top 10. This was this was a top 10 thing to do, you know, as soon as the, at the beginning of the administration, it didn't happen for reasons we've discussed. But a lot of the groundwork, you know, talked about these white papers, the Wall Street firms that have been, can, have already done work on this. The ground, a lot of the groundwork has been done. So, yeah.

Okay. Last one, and I'm sorry, I realize I'm putting you a bit more on the spot with this one, but if I look at the betting markets, and there are lots of issues with the betting markets, they've got Trump at about two-thirds chance to win the presidency right now. And if I look at the Fannie Preffs, they're at about $5 per share. Do you think the prefs are like kind of under, if I just gave you those two numbers, do you think the press are under or overpricing Trump kind of getting elected and following this path? well they've been high right you go back to you can trace them right back to but that was when you saw the legal argument for all of this getting over turn right sure that that that that that that's right but they've been yeah sure that's right so you eliminate the but even but they seem to react they seem to react more favorably prior to the 2016 election uh which is which is curious it is because prior to the 2016 as you said like look you could just make the argument hey we're going to light all the government's money on fire and just give it to private citizens. But the Fannie and

Ferdier just so much better capitalized and so much more profitable now, I actually think you see a better path. You know, I would just, I'll give you my answer. When I run, and I've got this really huge probability table on all this, when I run it, I see that the prefs, and you know, you have to, it's chance of Trump winning and then transit of them privatizing and chance of them giving to the press. But I've got the prefs at like the mid, implying a mid-fifference. 50s chance of Trump wins with all of my different assumptions. Now, it is a little bit garbage in, garbage out, because you assume 90% chance Trump privacy dies and said 80% or something and the numbers go crazy. But I've got them slightly under where the market is pricing in,

but probably enough to say we're splitting the hair too thin. And your downside is limited, right? I mean, you're not getting paid. You're not getting paid to wait. But you're, but you can, the downside is actually easier to dimension than the upside. well so the downside i just run it to a dollar right where i'm like hey trump loses or trump says i'm not going to do it the press aren't fanny's not going to zero the press aren't going to zero so you know somebody probably just buys himself four more years and we'll have a new administration and let's see if they want to give us this gift so well mark this is been great mark's net interest again i it's one of my most frequently read things i i'm pretty religious about reading it's fantastic

i'll include a link in the show to notes both to mark's substack net interest and to the trump trade piece that he did. Mark, thanks so much for coming on. I'm looking forward to having you on for a fourth time. No, thanks, Andrew. Thanks. A quick disclaimer. Nothing on this podcast should be considered an investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.