Shares of Fannie Mae and Freddie Mac slumped on Friday amid disappointment over a long-awaited U.S. Treasury Department plan to begin recapitalizing the mortgage giants and return them to private control after their bailout during the 2008 financial crisis.
Preferred shares of Fannie were down 7.9% Friday early afternoon and Freddie Mac preferred slid about 8.8%, on track for their biggest daily percent slump since July 18.
The plan, released on Thursday, outlined a raft of administrative and legislative recommendations for overhauling Fannie and Freddie, which guarantee more than half of all U.S. mortgages and are known as government-sponsored entities, or GSEs.
Investors and analysts said the plan, presented in a 53-page report, left many questions unanswered, failing to provide the concrete timelines or a recapitalization plan that many had hoped for.
There was a build up of expectations that was never going to be met by this type of report, Isaac Boltansky, director of policy research at Washington-based Compass Point Research & Trading, told Reuters on Friday. Though an important first step on the long-road to overhauling Fannie and Freddie, the report "delivered less than what some investors hoped for," he added.
In March, President Donald Trump asked the Treasury to quickly develop a plan for overhauling Fannie and Freddie, the first major effort to jump-start housing finance reform after a failed 2012 attempt by the Obama administration.
Many investors had had high hopes that the plan, which has been led by Treasury Secretary Steve Mnuchin, would recommend swift and bold actions to recapitalize Fannie and Freddie, remove them from conservatorship and start delivering returns for private shareholders.
While the Treasury holds warrants representing 80% of Fannie's and Freddie's common stock, as well as senior preferred stock, a handful of hedge funds also have stakes in both classes of securities. They have lobbied the Trump administration to take up housing reform, arguing the conservatorship has allowed the Treasury to illegally seize Fannie and Freddie's profits. Some hedge funds have sued the government over the conservatorship.
Hedge fund investors in Fannie and Freddie include William Ackmans Pershing Square Capital Management, Bruce Berkowitzs Fairholme Funds Inc, and John Paulson's Paulson & Co, according to people familiar with the matter. Berkowitz wrote to his shareholders in late July, arguing, "It is now time for Fannie and Freddie ... to keep what is rightly earned, recapitalize, and exit conservatorship.
Ackman, whose fund owns both common and preferred shares, wrote to his investors last month saying he was "disappointed" by what he saw as a delay in the Treasury's plan but that he was optimistic it was still the administration's priority to end the conservatorships and recapitalize the GSEs.
None of the hedge funds were immediately available for comment on Friday, while other investors said they were still digesting the plan. Some analysts and investors were skeptical that Congress would take up the Treasury's call to undertake a comprehensive housing reform, expecting only incremental administrative changes instead.
"The equity market was clearly disappointed," said another hedge fund manager with holdings in the firms who declined to be identified. "I think the market is generally discounting parts of the report that would require legislative approval."
Many investors had hoped the Treasury would provide a clear recapitalization plan that would allow the mortgage companies to start retaining the majority of their earnings. In particular, they hoped the Treasury would recommend ending an arrangement, allowed under the preferred share agreements, whereby the Treasury sweeps Fannie and Freddie's net quarterly profits into its coffers.
The report, however, recommends only that the government "consider permitting" them to retain more than the $3 billion in capital currently allowed, adding that any capital plan will have to be carefully negotiated with the Federal Housing Finance Agency, which oversees the pair.
"On the bearish front, this report did not signal the immediate end of the net worth sweep, was purposefully amorphous regarding the recapitalization process, and left many key questions unanswered," Boltansky wrote in a note on Friday.
Despite such disappointment, the excitement generated by the administration's vow to address housing finance reform has already reaped rewards for some hedge funds, with preferred shares in Fannie and Freddie up around 67% for the year.
Ackman said in August the securities' gains this year helped fuel strong returns at Pershing Square Holdings fund, which has gained 54% this year.