A group of hedge funds and private equity companies is preparing a proposal to take over large parts of Fannie Mae and Freddie Mac, in an attempt to end a bitter dispute with the Treasury, which has controlled the US housing finance agencies for five years.
The plan is being pitched as a way to bring tens of billions of dollars of private capital into the US mortgage market and to speed housing finance reforms that remain bogged down in Congress.
The investor group includes holders of more than half the $34.6 billion of preferred shares in Fannie and Freddie, who have been fighting to restore some value to the shares after the terms of the government conservatorship rendered them worthless.
Mishandling the future of the two agencies, one of Washington's biggest pieces of unfinished business from the 2008 credit crisis, could jeopardize America's housing recovery and rattle the wider economy as they guarantee 85 per cent of US mortgages.
Numerous plans to reform Fannie and Freddie have circulated among politicians, investors and academics but the latest proposal is likely to spur intense debate.
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Their plan will face several hurdles including widespread political hostility to keeping Fannie and Freddie alive, Washington's suspicion of Wall Street and the Treasury's reluctance to surrender what has become a valuable source of cash.
Holders of the preferred shares include Claren Road Asset Management, Fairholme Funds, Blackstone's GSO arm, Paulson & Co and Perry Capital, according to people familiar with the matter.
The group is soliciting others to join them, including private equity firms such as Carlyle and KKR. They have recruited Wall Street groups including Barclays Capital to drum up support.
The deal would see the investor group take control of Fannie and Freddie's core businesses of guaranteeing mortgage-backed securities, in two newly-capitalized insurance companies.
Fannie and Freddie's portfolio of previously-written guarantees and mortgage holdings would stay in government hands to be wound down, potentially at considerable profit to taxpayers. A common securitization platform, used to standardize mortgage-backed securities, would also stay in public hands.
"It will be the largest ever restructuring and show how to reform these agencies using private capital," said one member of the investment group. "We will buy the platform and step in with new capital."
The group proposes to capitalize the new insurers by converting their preferred securities into common equity and then carrying out a $17.3 billion rights issue, according to a presentation document seen by the Financial Times.
Details remain fluid, with various iterations of the core plan circulating, including a proposal calling for private equity or other investors to inject a further $7.5 billion into the new insurers, and perhaps asking the government to put up a further $2.5 billion.
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The government took control of Fannie and Freddie in 2008 and injected $187 billion to keep them afloat, but the housing market turnround has seen them produce billions of dollars in profit – a turnround that seemed inconceivable a few years ago.
Politicians have vowed to wind the agencies down, but there remains little agreement about whether to continue to offer the government guarantees against defaults which have subsidized US mortgage rates for generations.
A Treasury spokesman declined to comment on the litigation.