The US presidential elections are just days away. Vice President Kamala Harris and former President Donald Trump are tied in the polls and the election will likely be on the line.
Investors consider the outcome and try to position their portfolios for a quick gain after the results, or for creating a longer-term strategy based on which candidate will win and which party will control Congress. Billionaire investor Bill Ackman and his fund Pershing Square Holdings are among these investors, holding positions that could go one way or the other depending on whether Harris or Trump wins. Here’s Bill Ackman’s $277 million election bet.
In 2013, Pershing Square purchased an approximately 10% stake in two government-sponsored entities (GSEs): the Federal National Mortgage Association(OTC: FNMA)known as Fannie Mae, and the Federal Home Loan Mortgage Company (OTC: FMCC)known as Freddie Mac. Both Fannie and Freddie securitize mortgages and sell them to investors, providing the mortgage market with a vital source of liquidity. They allow banks and other lenders to take mortgages off their balance sheets and make more mortgages so they can always meet demand.
However, the two were caught holding too many subprime mortgages during the housing crisis of the Great Recession. The U.S. Treasury would then inject capital into both GSEs and put them into receivership. Shareholders have seen shares of Freddie and Fannie, now traded on the over-the-counter market, plummet since the Great Recession.
FNMA chart
Over the past decade, shareholders and opponents like Ackman have speculated endlessly that the government might eventually release the GSEs from receivership and recapitalize them. Since the Treasury Department injected $187 billion into the GSEs after the subprime mortgage crisis, the GSEs have returned more than $300 billion in profits through an agreement with the Treasury Department that expired in 2019. The Treasury Department also owns billions of dollars in Fannie and Freddie senior preferred stock and warrants that expire in 2028
In 2019, the GSEs were allowed to begin building capital to meet the new capital requirements needed to end the conservatorship and recapitalize. This event could lead to big gains for existing common and junior preferred shareholders. But the path forward is uncertain. Although the GSEs are rapidly building capital, they still face a large deficit made worse by the overhang of the Treasury’s senior preferred stock and warrants. The process would likely culminate in a massive initial public offering (IPO) to bridge the gap, but it is unclear how existing shareholders, the senior preferred stock and warrants would be handled in such a case.
Regardless of your political affiliation, it’s hard to argue that a Trump victory would be a major catalyst for the GSEs’ exit from conservatorship. The Trump administration began the process of removing the GSEs from conservatorship during Trump’s first term, and several reports have suggested that Trump would continue these efforts if elected. The Trump administration could accelerate the timeline and choose a new Treasury secretary who will set terms for the Treasury’s senior preferred stock and warrants that are more suitable for a recapitalization.
Trump has floated the idea of choosing billionaire hedge fund manager John Paulson as Treasury Secretary if he wins the election; that could be tricky because he reportedly has a large position in junior preferred stocks Fannie and Freddie, which poses a significant potential conflict of interest. Even if he is not elected, Paulson will likely have influence as the billionaire hedge fund manager is a longtime Trump backer.
Ackman’s fund Pershing Square also discussed the idea of a Trump presidency and its impact on the GSEs in its 2023 annual report:
The US presidential election in November 2024 could provide the opportunity for a change in the status quo. Both companies’ stock price gains in 2023 and year to date reflect optimism about a possible reprivatization should former President Trump be re-elected. The Trump administration had begun the process of releasing Fannie and Freddie from conservatorship, a process that would likely be completed in a future Trump administration.
A Harris win wouldn’t necessarily spell the end of Fannie and Freddie’s prospects of leaving conservatorship, but it would almost certainly slow them down. I would expect a Harris administration to step up to the plate on this issue.
Either way, Fannie and Freddie offer an interesting risk-return proposition for investors with a long runway. I have a small position in the Fannie Mae Junior Preferred Series S Stock. These shares are trading around $5.40 and have a fivefold upside if redeemed for $25 par value. Fannie and Freddie common stock could potentially have many multiples of upside if the two GSEs are recapitalized, but it are also the riskiest stocks, because they are lowest in the pecking order of the capital stack. It is unclear whether the two GSEs could raise enough capital to reach a settlement with the Treasury Department and existing shareholders, while also attracting sufficient interest from new shareholders.
Ultimately, Ackman’s bet is very risky and may require a lot of patience. Fannie and Freddie stocks have soared this year on hopes of a Trump victory, and I expect this trend to continue if Trump wins election night.
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Bram Berkowitz holds positions at the Federal National Mortgage Association. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Billionaire investor Bill Ackman’s $277 million bet on the US presidential election was originally published by The Motley Fool
