Saturday, March 15, 2014

Stocks DD Opines: What Berkowitz and Ackman need to do now!


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GSE shares went down on senate proposal to "wind down" GSE. Politicians are enthusiastic to get their names behind "reforms" without clearly understanding the root cause and the option to fix the root cause. No surprise. Here is what Ralph Nader, Berkowitz and Ackman needs to do without wasting any time:

1. Why NO BIG BANG Reform is needed ? 
  1. Publicly put the ROOT Cause for the 2008 Crisis - it seems like our politicians are suffering from amnesia. The point to prove is 2008 Downturn was a ONE-TIME event created by wrong incentives where players who wrote the Mortgage never bothered about Underwriting quality and these front-end mortgage salesman were happily satiating the demand of mortgages from so-called "investment banks"(eg: Bear sterns) . These "investment banks" could magically hold these Mortgages with less than 2% capital. Here is a frontline investigative story on that. Such a dramatic housing downturn event will NOT happen as reforms have been done to fix root cause. Investment banks don't exist and now they are all bank holding companies regulated with 10% capital ratio. As the GSE's post 2009 portfolio indicates, the underwriting quality has improved by leaps and bounds and the controls(loan-to-value ratio, credit worthiness check on the borrower, etc) taken by market players will ensure it remains that way.
  2. Articulate the minimal reform needed. Publicly prove by Sensitivity Analysis that "public utility model" is sufficient to ensure GSE will not only be profitable at all times in future but soon be well capitalized. By sensitivity analysis using 30 year home price fluctuations, 30 year delinquency and 30 year foreclosure rates prove that Government's role or capital would NOT be needed and the capital generated by GSE will be self-sufficient to endure the next trough in a future housing cycle downturn. Remember the post-2009 portfolio is historically the best quality portfolio that GSE's have had and also remember the multi-decade profitability of GSE (from 1986-2008 -link). Estimate the capital that GSE would have by 2018, if the Net Sweep agreement is revoked and the taxpayers get the 10% dividend. If at all capital is needed, indicate how equity capital could be raised by issuing preferred shares without damaging existing shareholders.
  3. Any unwarranted reform - Risky and may endanger the affordability of 30 year fixed rate mortgage instrument or the instrument itself. Without the regulated public utility model and the implicit Govt backing, the agency MBS would get expensive and the 30 year rate Fixed mortgage (the most unique thing in American housing market) will get expensive. Nobody knows how MBS investors around the world would perceive if the implicit Govt backing on Agency-backed MBS no longer exists.
If the 3 points are done, I believe it may convince lawmakers to NOT act radically on GSE and endangering the affordability of 30 year mortgage and putting in something that is risky and untested.

2. What about the ownership rights of Shareholders in any restructuring ? It is very important for Ackman to articulate the equity value for Shareholders (Govt and Private) in the 'status quo' scenario that legitimately belongs to the Shareholders.

The Rule of Law in America AND the importance of Govt not changing rules midstream without consent from ALL stakeholders.
  1. The Supreme court will decide the Fairness/legitimacy of 2012 amendment a.k.a net sweep agreement at the time when GSE were already Profitable and they were in no dire straits to get capital. If they really needed capital, they could have approached the capital markets and gotten capital at much lower cost to shareholders than the draconian Aug 2012 agreement.
  2. Also, Ackman needs to point out that any Congressional reform on GSE  that is NOT in the best interests of private shareholders and turnabout from the "quasi-govt/private" nature of GSE or the status quo will also be challenged in the Courts. Lets remember this is America (Not a banana republic) and Government can't whimsically change rules midstream.

3 comments:

  1. Before Reading Above Naive Article, You Should Read Below Link !

    http://www.investorshangout.com/boards/message?id=1340651



    Happy Investing


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  2. Seems that the US Government would save a significant amount of the money of the American People (on litigation), if they could come around to recognizing key aspects of the "error in their ways" in handling the GSEs since 2008. Not holding my breath, but it could happen. Simply saying "let the courts decide" is a cop out - especially when some in Congress clearly recognize the issues exist. Common legislative folks, tone down that "righteous indignation" level Mr. Corker, and listen to your associate, Mr. Toomey....

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  3. Hello TJ, thanks for your comments. The one thing MR. Market is NOT recognizing is the following: Any restructuring that Congress tries to propose will need to consider Shareholders voice. Otherwise, it will be challenged in the Court of law. Remember Quasi-Private-Public company that GSE's are. If they restructure in a way that does NOT result in good shareholder outcome, I am very positive it will be challenged in the courts. Fiduciary Duty.. Ultimately , if Ackman has better recapitallization proposals that also insulates risk to the Govt and better returns to Shareholders, they will need to weigh in his recapitalization proposal.

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