Hedge fund manager William Ackman said Tuesday mortgage companies Fannie Mae and Freddie Mac are not as well capitalized as their executives say they are.
"It doesn't matter what the rating agencies say about their capitalization," Ackman said, in an interview on CNBC. "Implicit guarantees don't work in the market that we're in now. What matters is capital. These institutions need to have a fortress balance sheet. (JPMorgan CEO) Jamie Dimon talks about a fortress balance sheet. We need a Fannie and Freddie with a fortress balance sheet."
Fannie Mae and Freddie Mac shares have been falling steadily amid doubts about two companies' capital position. A government plan, announced Sunday, has done little to alleviate these concerns.
Ackman, who runs the New York-based Pershing Square Capital Management, has a short position in both the junior debt and the equity of both Fannie Mae and Freddie Mac, and is critical of the federal plans to backstop the two companies if needed.
Ackman has no position in the senior debt of the two mortgage lenders.
With his short position, Ackman stands to benefit if the value of the Fannie and Freddie Mac stock and junior debt deteriorates.
In the CNBC interview, Ackman laid out a plan he claims will reduce leverage at the two government sponsored enterprises. (For the details of the full plan, see the videos.)
"I think the whole 'government-sponsored' nature of the entities is going to start to fade," Ackman said. "The only reason you need government sponsorship is you were levered 140 to 1. 'Heads I win, tails the taxpayer loses' is not a good structure."
Ackman is purposing a restructuring of Fannie and Freddie in which the common and preferred equity would be extinguished and the subordinated debt exchanged for equity warrants.
"Investors made a bet," Ackman said. "They received dividends, and so on...they allowed the institutions to become too levered, they chose these directors....The subordinated debt holders received an excess yield. This is not the senior debt of Fannie Mae - there is a relatively small amount of it outstanding....We believe the subordinated debt holders should get warrants."
Ackman likened this part of his plan to a prepackaged bankruptcy restructuring.
"This is a conservatorship, which is a good thing, because you can accomplish it more efficiently," Ackman said.
After tackling that phase of the plan, the next part attempts to strike a balance between the debt and equity on the companies' books.
To do this, Ackman purposes that for every $1.00 of senior unsecured debt held, a holder would receive $0.90 in new senior unsecured debt and $0.10 in value of new common equity.
According to Ackman, this would reduce Fannie's debt to $675 billion from $750 billion.
"That raises equity by $75 billion," he said. "By eliminating subordinated debt of $11 billion, you're creating another $11 billion worth of equity."
In addition, the government would make a stand-by purchase commitment for new Fannie Mae common equity at initial value for three years, and would issue subordinated debt or preferred stock if capital is needed in the future.
The same thing could be done at Freddie as well he said.
Fannie and Freddie are the dominant providers of funding for mortgage lending. They buy loans, keeping some, but packaging most of them into securities that are then resold to investors.
Since the government announced its plans to backstop Fannie and Freddie, many marketwatchers have commented on other steps that might need to be taken to shore up Fannie and Freddie.