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. William Ackman, managing partner, Pershing Square Capital Management, a well-known activist shareholder, has a plan to save the government sponsored entities by restructuring their debt and equity. He shared that plan on CNBC's "Squawk Box." He provided these slides to help explain the plan. For brevity, he said he is only using Fannie Mae, but the same logic applies to Freddie Mac.Disclosure: Ackman has a short position in both the junior debt and the equity of both Fannie Mae and Freddie Mac. He has no position in the senior debt of the two mortgage lenders.Read the Story Full Coverage of Fannie and Freddie

The Problem: Fannie guarantees mortgages and securitizations of mortgages, but mortgages are declining in value. That is stressing Fannie's debt obligations."There's very little cushion when you're leveraged 69 to 1," Ackman pointed out. "... 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. Jamie Dimon talks about a fortress balance sheet; we need a Fannie and Freddie with a fortress balance sheet.""I don't believe the housing market's going to stabilize where we are," said Ackman. "I think what we need is, in order to restore confidence in the financial system, you need the largest participant in the mortgage market to be extremely well capitalized, and they're far from extremely well capitalized. These two institutions were set up in a different era, and they need to be able to withstand the perfect storm. It is now the perfect storm."Read the Story

Ackman is proposing a restructuring of Fannie and Freddie in which the common and preferred equity would be extinguished and the subordinated debt exchanged for equity warrants. "What we're doing is almost like a pre-packaged restructuring for bankruptcy here," he said. In addition, the government would essentially write a 3-year put agreement for new common stock."Today, a private investor will not put money into Fannie and Freddie. The equity's too far out of the money -- there's too much debt -- and therefore, the government should not put equity into (them)," he said.Read the Story

"The problem is that the balance between debt and equity, there's too much debt and not enough equity, so what we're going to do, we're going to give the debt-holders 90 cents on the dollar in new Fannie Mae unsecured debt, so instead of $750 billion worth of debt, there will be $675 billion worth of debt. That raises equity by $75 billion. By eliminating subordinated debt of $11 billion, you're creating another $11 billion worth of equity," Ackman said.Read the Story

The new balance sheet effectively reduces Fannie's leverage."You can call it 'New Fannie Mae' or 'New Freddie,' and, by the way, if you want to sell it tomorrow, the government stands by to purchase it," Ackman said. "The beauty of a three-year standby purchase commitment on the part of the government is, no one will ever exercise it. Why? Because if it's there, it's good, it's now an explicit opportunity, it gives time for the equity value of the company to build, and there's a lot of optionality.  Every arbitrageur on Wall Street will buy the common stock, and pay a premium for the fact that you have a free put to the U.S. government, and I think over time, properly governed, the put will be so far out of the money that the government will wind up not having to buy any of this equity three years from now."Read the Story

"What's going to happen is, the senior unsecured, the holders of the Fannie Mae debt that's all around the world, they're going to get ownership of the company," Ackman said.Read the Story

Reaction: Lawrence Lindsey, former National Economic Council president, doesn't think the current government approach is valid. "I thought what Mr. Ackman said was a good start," Lindsey said. "I'm not ideologically opposed to having to do a bailout."Watch the Video

In an earlier appearance on CNBC, Jim Rogers, CEO of Rogers Holdings, argued strongly against any sort of bailout, saying it would stress already alarming public debt levels. "In two years or three years, when six or eight other people are failing, America won't have any more bullets left," Rogers said, adding that Sunday's move increased the burden of public debt and did not solve the root cause of the crisis. "The patient has cancer, Band Aids won't help."Read the Story

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