US Economy

Fannie, Freddie bill leaves status of private shareholders to courts

The bill, written by Democrat Tim Johnson and Republican Mike Crapo, would replace the companies with a new industry-financed agency.
Andrew Harrer | Bloomberg | Getty Images

A draft bill to wind down government-run mortgage financiers Fannie Mae and Freddie Mac, released by two leading U.S. senators on Sunday, would leave a decision on how to treat their private shareholders to the courts.

The 442-page draft from the Democratic chairman of the Senate Banking Committee and the panel's top Republican would keep in place current terms of the government's bailout of the two companies that require them to sweep all their profits into the U.S. Treasury.

It is silent on whether or not private shareholders should share in any proceeds when the companies are liquidated.

Fannie Mae and Freddie Mac, the two leading sources of U.S. mortgage funds, were seized by the government during the financial crisis in 2008 and propped up with $187.5 billion in taxpayer funds. In return, the government got a controlling stake in the companies.

They have since returned to profitability and by the end of March will have sent the Treasury $202.9 billion in dividends.

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Private investors, including Perry Capital and Fairholme Capital Management, have sued over the bailout terms. They argue they should stand to benefit from the profits given that the companies soon will have paid more in dividends to taxpayers than they received in aid.

Fannie Mae and Freddie Mac help ensure the mortgage market stays liquid by buying loans from lenders and repackaging them as securities that they sell to investors with a guarantee. Since the government seized the firms, that guarantee has explicit government backing.

The bill, written by Democrat Tim Johnson and Republican Mike Crapo, would replace the companies with a new industry-financed agency. The agency would provide a government backstop, but it would only kick in after private creditors took a hit.

(Read more: Efforts to kill Fannie-Freddie may already be dead)

It would aim to shutter the companies over five years, although that deadline could be extended multiple times if a replacement system was not ready.

"This proposal includes an explicit government guarantee in order to add stability to the economy, keep costs reasonable for borrowers and renters, and ensure fair access to the secondary market for all lenders," said Johnson.

The plan to replace Fannie Mae & Freddie Mac

The absence of any provision to compensate private investors shows both a reluctance to interfere with the existing litigation and a concern over the potential for introducing provisions that could be subject to legal challenges.

The shares of the two so-called government-sponsored enterprises went on a two-day downward slide after Johnson and Crapo announced on Tuesday they had reached a deal on a bill. They recovered some of those losses later in the week.

"In a liquidation of any big corporation you would always pay out debt-holders and shareholders with any leftover proceeds," said Tim Pagliara, chief executive officer of CapWealth Advisors, a wealth management firm whose clients own some 8 million shares. "This (bill) attempts to legislate what happens to Fannie, Freddie shareholders."

Uncertain prospects

The two senators labored intensively to produce a bill that could be enacted this year. But the odds of the legislation clearing Congress are slim, even if they can get the bill through their committee, which itself is uncertain.

With mid-term elections approaching in November, lawmakers are likely to turn their attention to the campaign trail within a few months, leaving little time to deal with the complex issue of revamping the U.S. housing finance system.

In addition, Senate Majority Leader Harry Reid, who controls the agenda in the chamber, appears cool to the legislation.

"It's not a thing that Reid wants to do," said a Senate Democratic aide familiar with the issue. "A lot of Democrats disagree with the content of the proposal."

The plan would set up a new federal regulator, called the Federal Mortgage Insurance Corporation, to provide the mortgage guarantee and help regulate the housing system.

(Read more: Hedge funds still hope for big Fannie-Freddie win)

While the bill would abolish affordable housing goals Congress set for Fannie Mae and Freddie Mac, it would establish funds to finance rental properties and provide incentives for lenders to serve lower-income borrowers. The funds would be financed by industry fees.

It would create a single platform for the securitization of mortgages, and establish a system to ensure small mortgage lenders are not shut out by larger competitors.

Some of the banking panel's more liberal members have yet to sign off on the framework of the bill. Without their support, Reid would be even more hesitant to bring it up for a vote.

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Even if it did clear the Senate, prospects for passage in the Republican-controlled House of Representatives are slim.

Representative Jeb Hensarling, the Texas Republican who leads the House Financial Services Committee, has spearheaded work on a separate bill that would more sharply reduce the government's role.

—By Reuters