Short-Seller Ackman's Plan Renews Fears For Freddie,Fannie Shares

July 15, 2008: 04:25 PM EST


By Aparajita Saha-Bubna and Joseph Checkler

Of DOW JONES NEWSWIRES

NEW YORK -(Dow Jones)- A well-known investor suggested Tuesday a rescue plan for Freddie Mac (FRE) and Fannie Mae (FNM) that would render the mortgage giants' shares worthless - and, at the same time, garner him a tidy profit.

The proposal by hedge fund manager William Ackman - accompanied by a disclosure that he would gain by a drop in the value of the stocks - exacerbated the uncertainty already swirling among investors around the value of their shares.

Freddie shares closed down 26% at $5.26 but are up to $5.34 in recent late trading. Shares of Fannie slid 27.3% to close at $7.07 and recently traded at $ 7.16.

In dumping their shares, investors appeared to shrug off the obvious conflict of interest that Ackman has - his proposed restructuring plan for government- sponsored enterprises renders worthless Freddie and Fannie stock. At the same time, with his fund's current trading position of being short the companies' stock, Ackman benefits from a fall in their stock prices.

By 2 p.m. EDT Tuesday, Ackman, who oversees $6 billion at hedge fund Pershing Square Capital Management, had already made a profit on his trading position as the companies' stocks had fallen by more than 20%.

The stocks' move comes on the back of federal support for the government- sponsored companies and after a statement Friday from Treasury Secretary Henry Paulson that the government's focus was on supporting Fannie and Freddie "in their current form."

"You'd think a statement from the Treasury secretary would have more credibility than from someone who's short the stock," said Richard Pzena, head of Pzena Investment Management LLC. In the first quarter this year, the money manager had increased its stock holdings in the two companies slightly, holding 23.83 million shares in Fannie and 31.24 million shares in Freddie, according to FactSet data.

The two companies, chartered by Congress to promote homeownership, are the dominant providers of funding to the U.S. housing market, owning or guaranteeing about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding. Therefore, their financial well-being is vital to the economy.

The Short (and Long) Of It

Ackman said in an interview Tuesday morning with CNBC television that he was betting the stock prices of Freddie and Fannie would fall. At the same time, he unveiled his restructuring plan that advocates writing off the companies' preferred and common shares.

In the interview, Ackman proposed giving holders of senior Fannie debt new debt worth 90 cents for each dollar as well as 10 cents of equity in the new company.

Under his plan - outlined in a presentation entitled "How to Save Fannie and Freddie" and sent to Dow Jones Newswires - holders of junior Fannie debt would get warrants, while common and preferred shareholders would get nothing.

"The same logic applies to Freddie," noted one slide in the presentation. Ackman wasn't available for comment.

"I would again reiterate that Freddie has strong liquidity and is well- capitalized. We would like to remind people that we continue to be in the market every day buying billions of dollars in mortgages from lenders and enjoy access to world's capital markets," said company spokeswoman Sharon McHale. "It is important for people to remember the facts and not the fear."

A Fannie spokesperson wasn't available for comment.

In the CNBC interview, Ackman said one of the advantages of the plan is that it would likely not cost the government anything. However, he suggested that the government agree to buy back the new Fannie equity at cost for three years. Ackman said he had spoken to senators as well as Treasury and Federal Reserve officials. Spokespersons from the Treasury and the Fed weren't available for comment.

Ackman told CNBC he began betting earlier this month that the stocks of the two companies would fall further.

"I'm hoping people see his motive, that he has an incentive for equity holders to get nothing," said one person familiar with the companies.

Ackman, 42 years old, is known for his activist campaigns involving several high-profile companies whose stocks he owned, including McDonald's Corp. (MCD) and Wendy's (WEN). He also garnered a lot of attention when he publicly denounced bond insurer MBIA Inc. (MBI), a company whose stock he was shorting. That position turned out to be a profitable one.

Besides buying and shorting equities, Ackman is known for limiting his risk by trading large quantities of options in the companies he invests in. His portfolio is extremely concentrated: According to his fund's most recent filings, he only has 10 long positions. Typically, investors are not required to disclose their short positions.

Ackman's plan, "though unlikely to be implemented, again brought to the forefront shareholders' concerns about what the equity is worth" in Freddie and Fannie, said one investor.

Separately, U.S. securities regulators said Tuesday they are putting new restrictions in place to prevent short-selling abuses involving shares of Freddie and Fannie.

Securities and Exchange Commission Chairman Christopher Cox told the Senate Banking Committee that the SEC will require short-sellers to pre-borrow shares before engaging in short sales of Fannie or Freddie. Cox said the new restrictions are called for under an emergency order.

Short sellers borrow shares for sale in hopes of profiting by replacing the borrowed shares at a lower price. "Naked" short sellers don't borrow shares in advance of short sales, a practice that critics say can have punishing effects on a stock's price.

As of June 30, the date of the most recent data from the New York Stock Exchange, 82.8 million of Freddie's 646.1 million shares were being shorted, and 138.7 million of Fannie's 982.3 million shares were being shorted.

"As a society we need to be careful that people who are proposing solutions don't unfairly benefit from it," said Ganesh Mani, an adjunct professor at Carnegie Mellon University.

-By Aparajita Saha-Bubna, Dow Jones Newswires; 201-938-2137; aparajita.saha- bubna@dowjones.com

-By Joseph Checkler, Dow Jones Newswires; 201-938-4297

(Judith Burns contributed to this report.)