Deep Dive: Fannie Mae & Freddie Mac

$FNMA $FMCC

Few U.S. equities are more misunderstood—or more reflexive—than Fannie Mae and Freddie Mac. Nearly two decades into conservatorship, these GSEs remain the linchpin of American housing finance, their destiny bound to Washington politics and Wall Street risk appetite.

This memo is for those ready to cut through the illusion: to parse the capital stack, map the legal minefield, and model what most won’t. We treat FNMA and FMCC as potential capital pivots—if, and only if, the politics and math finally align.

The goal: distill signal from noise, clarity from complexity, and conviction in a trade the market long ago wrote off as unsolvable.

Executive Summary

Figure: Treasury Draws vs. Dividends: Since 2008, Fannie Mae has drawn $119.8 billion from the U.S. Treasury but paid $181.4 billion in dividends, an excess of ~$62 billion (an >11% ROI for taxpayers through 2019). Freddie Mac similarly paid $119.7 billion vs. $71.6 billion drawn. Both GSEs have rebuilt significant net worth (Fannie $98.3 billion, Freddie $62.4 billion as of Q1 2025) through retained earnings, yet remain undercapitalized relative to new regulatory requirements.

Key Financial Metrics (Q1 2025): Fannie Mae earned $3.7 billion and Freddie Mac $2.8 billion in quarterly net income, reflecting steady guaranty fee revenues on their $4.1 trillion and $3.6 trillion mortgage credit books, respectively. Net worth has grown ~20% year-on-year for each GSE (Fannie $98.3 billion; Freddie $62.4 billion). Credit quality remains strong (average loan-to-value ~50% for Fannie’s single-family loans, 0.56% serious delinquency).

However, regulatory capital shortfalls persist – combined Tier 1 capital of ~$147 billion vs. a required ~$328 billion (including buffers) as of Q3 2024. The Treasury’s senior preferred stock claims continue to grow with retained earnings (now $216.2 billion for Fannie, $132.2 billion for Freddie in liquidation preference), and the government still holds warrants for 79.9% of common shares. Common and junior preferred shares trade at a fraction of par value, reflecting these claims and policy uncertainty.

Capital Structure & Warrants: There are 1.16 billion Fannie Mae common shares and 0.65 billion Freddie Mac common shares outstanding. The U.S. Treasury holds senior preferred stock (with a combined $348 billion liquidation preference) and warrants to purchase ~80% of each GSE’s common stock for a nominal price.

Valuation Scenarios: We outline two dominant scenarios – Recap & Release vs. Status Quo – along with variant outcomes. Below is a high-level risk/reward matrix:

Risk/Reward Summary: The common stock is a high-volatility, binary bet on political outcomes. It could multi-bag (5–10× over time) if a shareholder-friendly recapitalization occurs under the current administration, but also carries a real risk of near-total loss or reversion to penny-stock status if reform stalls. Preferred shares offer a relatively safer claim in a successful recap (more likely to be honored near par value) but still face political risk (they could be left in limbo or restructured in less favorable ways). Current pricing of junior prefs (~40¢ on the dollar) reflects both significant upside in a settlement and ongoing uncertainty. The Treasury’s warrants and senior preferred stake virtually guarantee dilution for common shareholders in any outcome, but also represent the government’s incentive to execute a value-unlocking privatization (the Treasury could net >$250 billion from selling its stakes). We assign roughly even odds to an attempted “recap and release” in the next 1–2 years versus a continued holding pattern, and a smaller probability to alternative resolutions (utility model or congressional action). Investors should size positions accordingly, prepare for binary outcomes, and monitor key catalysts closely.

GSE Background

Mandate & Business Model: Fannie Mae (Federal National Mortgage Assoc.) and Freddie Mac (Federal Home Loan Mortgage Corp.) are government-sponsored enterprises (GSEs) chartered to provide liquidity and stability to U.S. housing finance. They purchase residential mortgages from lenders and guarantee securitizations (Agency MBS), ensuring the flow of credit in the mortgage market. In simpler terms, the GSEs operate a guaranty fee model – they earn steady fees (average ~50 basis points of loan balance) for assuming credit risk on ~$7.7 trillion in mortgages. This marks a shift from the pre-2008 era when they also held large portfolios of mortgages and MBS for investment; today, ~80% of revenues derive from the guaranty business (versus <25% in 2011) as they have de-risked and shrunk retained portfolios. The core franchises are (1) Single-Family credit guarantee (the bulk of business, ~$3.6 trillion Fannie / $3.1 trillion Freddie single-family loans, supporting ~50% of all U.S. mortgages), and (2) Multifamily housing finance (apartment loan guarantees, ~$0.5 trillion each). These enterprises operate with a thin capital base (historically <1% of assets) under an implicit government backing.

Capital Structure (Pre-2008 vs. Now): Fannie and Freddie historically issued common stock and various series of non-cumulative preferred stock to private investors, supplementing modest retained earnings to support their guarantees. In September 2008, amid the housing crash, both were placed into conservatorship under the newly created FHFA (Federal Housing Finance Agency). Treasury rescued the GSEs via the Senior Preferred Stock Purchase Agreements (PSPAs): Treasury committed to cover net worth deficits up to $445 billion combined, ultimately investing $189 billion by 2012 ($119.8 B Fannie, $71.6 B Freddie). In return, Treasury received senior preferred shares (initial liquidation preference equal to the amount invested) accruing a 10% dividend, plus warrants for 79.9% of each company’s common stock (strike price $0.00001). These terms effectively gave the government nearly all future economic upside while diluting existing shareholders.

Conservatorship Era (2008–2019): From 2008–2011, Treasury’s infusions shored up the GSEs’ balance sheets as credit losses mounted. By 2012, as housing stabilized, Fannie and Freddie returned to profitability. Rather than allow recapitalization, the Net Worth Sweep (Third Amendment, Aug 2012) redirected 100% of their net profits to Treasury as dividends, beyond the 10% originally required. This meant any earnings did not rebuild equity for public shareholders – a controversial move later judged in court to have “arbitrarily and unreasonably” violated shareholder rights (see Legal Overhang). Through 2019, all GSE profits were swept quarterly, which led to cumulative Treasury dividends of about $300 billion (Fannie ~$181 B, Freddie ~$119 B) against the $189 B invested. As a result, by 2018 the GSEs had essentially no capital buffer (net worth near zero, aside from small reserve allowances) and remained entirely dependent on Treasury’s backing to avoid insolvency.

2019–Present (Retained Earnings and ERCF): In late 2019, under the Trump administration, Treasury and FHFA amended the PSPA to allow Fannie and Freddie to retain earnings and rebuild capital up to certain limits. The GSEs have since produced consistent profits (29 consecutive quarters of net income through Q1 2025 for Fannie) and have rebuilt a combined $160+ billion in net worth. However, the PSPA changes also stipulated that Treasury’s liquidation preference increases by the amount of retained earnings – effectively accounting for those forgone dividends. This has grown Treasury’s senior pref claims to ~$340 B by Q3 2024 (and ~$348 B by Q1 2025). In parallel, FHFA under Director Mark Calabria (2019–2021) implemented a new Enterprise Regulatory Capital Framework (ERCF) in 2020, requiring bank-like capital levels (~4% of assets plus buffers). As of Q1 2025, the capital requirements are roughly $187 B for Fannie and $141 B for Freddie (risk-based, including buffers) – far above their current equity. This underscores that, despite improved balance sheets, the GSEs are still leveraged ~140:1 assets-to-common equity (or ~20:1 against total capital including Treasury’s stake). They cannot exit conservatorship until they meet these capital thresholds or have a credible plan to do so.

Policy Context: Since 2008 the GSEs have remained in limbo – private corporations with public charters, under government control. The conservator (FHFA) wields broad power to direct their operations and even disregard shareholder interests (as seen with the net worth sweep). The U.S. government – via FHFA and Treasury – effectively controls all material decisions: capital allocations, dividend policies (currently suspended), and strategic initiatives. The implicit federal backing means Fannie and Freddie’s MBS carry near-sovereign credit perception, which has been critical to housing market stability. Yet, this arrangement was always intended as temporary. Policymakers have long debated options: recapitalize and release the GSEs as private entities (preserving their role with safeguards), versus comprehensive housing finance reform (which could replace or heavily restrict them). Over 2008–2023, multiple legislative attempts to replace the GSEs (e.g. Corker-Warner, Johnson-Crapo bills) failed to pass. Thus, into 2025, Fannie and Freddie remain in conservatorship, 16+ years on, with their future dependent on administrative action or new laws. Their current condition is one of robust profitability and improved risk management, but constrained by the lack of capital freedom and the overhang of government’s senior claims.

Timeline 2008–2025 (Highlights):

• 2008: FHFA placed GSEs in conservatorship; Treasury PSPA executed (funding commitment up to $445 B, 10% dividend + warrants).

• 2009–2011: Treasury support used ($189 B drawn by 2012). GSEs delisted from NYSE (now trade OTC). Portfolio reduction and credit reforms begin.

• 2012: Net Worth Sweep implemented – ending predictable 10% dividend in favor of sweeping all quarterly profits to Treasury.

• 2013–2016: GSEs turn enormously profitable as housing recovers, but all earnings paid to Treasury. Shareholders sue over NWS (beginning decade-long litigation).

• 2017–2018: Legislative reform efforts (U.S. Congress) stagnate. Trump officials signal desire to end conservatorship administratively.

• 2019: FHFA (Calabria) and Treasury agree to allow earnings retention. Fannie/Freddie resume building capital after a decade of zero net worth.

• 2020: FHFA issues new capital rule (ERCF) mandating ~$280–300 B combined capital. COVID mortgage forbearance programs launch, with GSEs supporting market through interventions.

• 2021: Supreme Court Collins v. Yellen decision – upholds legality of NWS (no damages for past sweeps) but strikes FHFA director’s insulation (President can fire FHFA head at will). Biden replaces Calabria with Sandra Thompson. Treasury suspends some PSPA restrictions (like limits on certain loan acquisitions).

• 2022: Sandra Thompson implements minor ERCF tweaks (e.g. removing planned “countercyclical buffer” reduction, effectively keeping capital requirements high). GSEs continue accumulating capital, no major policy shifts.

• 2023: Court developments (see Legal Overhang) – jury awards shareholders $612 M in NWS damages. Little movement on legislative reform; focus shifts to 2024 election.

• 2024: GSEs’ retained earnings push net worth near $160 B combined. U.S. presidential campaign brings GSE future back to spotlight (with Republican candidates signaling privatization leanings).

• 2025: Political regime change – President Donald Trump (re-elected) prioritizes ending the conservatorships. A new FHFA Director, Bill Pulte (confirmed March 2025), rapidly moves to restructure the agencies’ leadership and plans (see Recent Developments). By May 2025, markets anticipate an imminent push to “recap and release”, fueling a speculative surge in GSE equity prices.

In sum, Fannie and Freddie sit at the nexus of public policy and private capital. Their dual role – maximizing shareholder value vs. serving a public mission – has been unresolved since 2008. This backdrop sets the stage for the latest chapter of potential reform, which will determine the fate of common shareholders (who currently own a highly diluted claim on a future recapitalization) and preferred shareholders (who hold contractual rights to dividends that have been suspended since 2008).

Recent Developments (Past 12–18 Months)

Political Reset and New FHFA Leadership: The most consequential recent development is the outcome of the 2024 U.S. elections. President Trump’s return to office in January 2025 fundamentally shifted GSE policy expectations. In March 2025, Trump installed Bill Pulte as the new FHFA Director (after dismissing former Director Thompson). Pulte, a housing investor and vocal critic of GSE bureaucracy, wasted no time initiating an overhaul. Within weeks:

• Agency Shake-Up: Pulte placed 35 FHFA employees on administrative leave and forced out several senior executives, including Freddie Mac’s CEO (Mike DeVito). He also reportedly shuttered two divisions of FHFA, cutting ~10% of staff, in an effort to “streamline” the regulator. These actions, made with little warning, caused internal upheaval and drew scrutiny from lawmakers concerned about stability.

• Board and Management Changes: FHFA under Pulte overhauled the boards of Fannie and Freddie, installing new members aligned with administration priorities (including, controversially, an official from the Department of Government Efficiency on Fannie Mae’s board). The implication is tighter government oversight of management decisions. Freddie Mac’s CEO was fired in March 2025; interim leadership was put in place pending a search for new CEOs committed to executing the privatization agenda. (Fannie Mae’s CEO as of early 2025, Priscilla Almodovar, has so far remained in her position, but further leadership churn is possible.)

• Policy Directives: Via tweets and public statements, Director Pulte signaled intentions to “strip away unnecessary bureaucracy” and reduce GSE operating costs. He also suspended or rolled back certain mission-oriented programs initiated under the prior regime – for example, affordable housing initiatives like Special Purpose Credit Programs were ordered terminated in March 2025. The new FHFA leadership emphasizes refocusing on core business and prepping the GSEs for life outside government control, aligning with a broader Trump administration theme of reducing federal role in housing.

These moves, while dramatic, underscore the administration’s seriousness about GSE reform. However, they have introduced operational risk and uncertainty in the short run (staff morale, potential legal challenges from ousted personnel, etc.). Congressional oversight hearings have been hinted – e.g. Senators sent letters to Director Pulte in March 2025 demanding clarity on his actions and conservatorship plans. The political tension between an executive branch eager to act and legislators worried about mortgage market disruption is a defining feature of the current context.

Administrative Signals: President Trump himself has directly weighed in. On May 22, 2025, he posted on social media that he is giving “very serious consideration” to spinning off Fannie and Freddie as private entities and will decide soon, in consultation with Treasury Secretary Scott Bessent, Commerce Secretary Howard Lutnick, FHFA’s Pulte, and others. This explicit public signal – essentially confirming that privatization is on the near-term agenda – sparked a major rally in GSE securities. Fannie’s OTC stock jumped 33% in a day (to ~$9.94), and Freddie’s 27% (to ~$7.15), reaching their highest levels since 2008. The market is clearly pricing in a significant chance of action.

Treasury Secretary Bessent (a hedge fund veteran) and other Trump officials have echoed that recap and release is a priority. Informally, there is talk of using executive authority to end the conservatorships without new legislation – likely by amending the PSPAs to restructure Treasury’s stake and raising capital from private markets. Key policy proposals being floated include: converting some or all of Treasury’s senior preferred into common equity (or subordinated debt), exercising the warrants and then selling the government’s common shares gradually to investors, and possibly offering current preferred shareholders a deal (conversion to common or cash settlement) to clean up the capital structure. While formal term sheets have not been released, the administration’s public comments have emboldened investors that historic progress may finally be imminent.

Legislative Developments: In contrast to the flurry of administrative activity, Congress has not yet advanced any GSE reform legislation in the past year. The issue remains contentious and, with split party control (assume Republicans hold the House in 2025, Democrats narrowly hold the Senate), significant housing finance bills face steep hurdles. Notably, some Democratic lawmakers have raised alarms about the administration’s unilateral approach – emphasizing concerns that privatization could raise mortgage costs or reduce affordable housing efforts. They argue that Congressional approval should be required for major changes to the GSEs’ status. However, absent a specific bill, this opposition so far has taken the form of oversight (letters, hearings) rather than actionable law. The House Financial Services Committee (now Republican-led) has generally been supportive of reducing government involvement in the GSEs; we may see hearings framing privatization as long-overdue free-market reform. Meanwhile, the Senate Banking Committee (Democratic chair) is likely to scrutinize any administration steps and could introduce messaging legislation to protect affordable housing mandates or even limit FHFA’s authority – but such bills would probably not become law in the near term. In summary, no new laws have been passed; the heavy lifting is being done via executive action under existing authority.

Regulatory & Credit Updates: Over the last 12–18 months, aside from the seismic leadership changes, there have been incremental regulatory developments:

• Capital Rules: In late 2022 and into 2023, FHFA made technical adjustments to the ERCF. For instance, it removed the planned “countercyclical adjustment” that would have temporarily lowered capital requirements in periods of rapid house price growth, effectively keeping required capital higher. Under Director Thompson, FHFA maintained a conservative stance on capital, which the new regime may revisit (expect possible future rule changes to ease capital requirements for certain low-risk assets or recognize credit risk transfer more favorably).

• Pricing and Credit Policy: FHFA in 2023 implemented changes to the GSEs’ Loan-Level Price Adjustments (LLPAs – fees charged based on borrower credit characteristics). A controversial adjustment in early 2023 slightly increased fees for higher-credit-score borrowers and lowered fees for riskier loans (to promote equity), prompting political backlash. FHFA later rescinded a planned debt-to-income ratio LLPA due to industry pushback. These pricing moves were modest, but they became a talking point about GSE mission vs. safety: the new FHFA leadership has frozen any further such “social policy” pricing tweaks. We anticipate a return to purely risk-based pricing.

• Credit Risk Transfer (CRT): Both GSEs ramped up CRT issuance in 2023–2024 as a capital management tool (Freddie transferred credit on $63 B UPB in Q1 2025 alone). FHFA has generally supported CRT, though under Thompson it reduced capital relief credit given for CRT exposures. Pulte’s FHFA may restore more favorable treatment to encourage shedding credit risk to private investors, aligning with a privatization narrative.

• New Products/Programs: The GSEs continued initiatives like expanded credit scoring models (moving beyond classic FICO to incorporate newer scores) and Duty-to-Serve affordable housing efforts through 2024. In late 2024, they started rolling out acceptance of alternative credit scores (FICO 10T, VantageScore) and new equity-sharing mortgage pilots. These were mandated by prior FHFA policy. Under Pulte, some of these efforts are paused or under review, but many are in flight and supported by lenders. We may see a slowdown in any new pilots that are not strictly aligned with core business.

• Market Conditions: Over the past year, rising mortgage rates (peaking ~7% in late 2024) led to lower refinance volumes but stable purchase mortgage demand. Both GSEs maintained profitability despite reduced new business volume, thanks to strong guarantee fees and stable credit performance. House prices nationally were roughly flat to +3% year-over-year through early 2025, avoiding a severe correction and thus keeping credit losses low. This benign credit environment has helped ease immediate conservatorship concerns (no new Treasury draws needed, etc.). It also sets a favorable stage for raising equity capital (investors are more receptive when loan books are performing well).

In summary, the last 12–18 months transformed the outlook: political winds have shifted decisively towards action. An administration openly committed to ending the status quo is in charge, and early steps have been taken to pave the way (albeit contentiously). No major legislative or negative credit events have impeded this trajectory. The key development to watch now is the expected administrative blueprint for recapitalization – which could emerge via a Treasury/FHFA plan announcement or term sheet in the coming months. Meanwhile, day-to-day GSE operations and financial performance remain solid, even as the institutions brace for potentially the biggest transition in their history.

Legal and Litigation Overhang

For over a decade, Fannie Mae and Freddie Mac’s equity has been clouded by shareholder lawsuits challenging the terms of conservatorship – particularly the 2012 Net Worth Sweep (NWS). While many claims have been resolved (largely in the government’s favor), some legal overhang remains. Here are the major cases and their status:

• Collins v. Yellen (Supreme Court 2021): This was a pivotal case by shareholders arguing that FHFA exceeded its authority with the NWS and that FHFA’s structure was unconstitutional. In June 2021, the Supreme Court delivered a split decision. It upheld the NWS (denying relief on the claim that sweeping all profits was illegal under FHFA’s conservator powers) – effectively ending hopes that courts would unwind the NWS or return past dividends. However, the Court found the FHFA Director’s insulation from presidential removal to be unconstitutional (a separation-of-powers issue). The remedy was limited: it allowed the President to remove the FHFA head at will (which had already occurred when President Biden replaced Director Calabria). Crucially, SCOTUS did not invalidate any past actions (Treasury kept the ~$300B in swept dividends). Collins thus eliminated most legal avenues to overturn the PSPA terms. On remand, claims that shareholders might be owed damages for the unconstitutional removal provision have made little headway – it’s challenging to show specific harm from that provision once the NWS itself was deemed within FHFA’s statutory power.

• Lamberth Contract Claims (Fairholme class action, D.C. District Court): Shareholders pursued an alternative theory: that the NWS breached the implied covenant of good faith in the stock purchase agreements (essentially a contractual claim, not barred by sovereign immunity). In a landmark jury trial in Washington D.C. (August 2023), jurors sided with shareholders. They found FHFA’s 2012 profit sweep “arbitrarily and unreasonably” violated shareholders’ reasonable expectations, awarding $612.4 million in damages. This sum is to compensate junior preferred and common shareholders for the diminution in value caused by the sweep. In October 2023, Judge Lamberth upheld the verdict and added ~$170 million in prejudgment interest, bringing the total judgment to ~$782 million. This was a rare courtroom win for GSE shareholders. The government (FHFA and Treasury) has appealed the verdict to the D.C. Circuit, where it remains pending as of May 2025. Impact: If the verdict stands through appeals (a process that could extend into 2025–2026), shareholders would receive a cash payout (e.g. class members might recoup a few dollars per share). More broadly, the finding underscored that FHFA’s action “violated the contractual rights” of shareholders, which is a moral victory. However, the remedy is purely financial; it does not unwind the NWS or restore dividend rights going forward. The precedent might deter similarly extreme actions by FHFA in future, but FHFA’s conservatorship powers remain largely intact. This case slightly improves the negotiating leverage of preferred shareholders in any settlement discussions – showing that the government’s conduct wasn’t beyond legal reproach, hence perhaps warranting compromise.

• Takings Claims (Court of Federal Claims): Another set of lawsuits (led by hedge funds like Fairholme) argued that the NWS and the ongoing conservatorship effects constituted an unconstitutional taking of private property under the Fifth Amendment, for which compensation is due. These cases proceeded in the Court of Federal Claims. In 2022, the U.S. Court of Appeals for the Federal Circuit effectively rejected the takings claims, concluding that shareholders do not have a property right to GSE dividends or to the value of their shares independent of the conservatorship’s terms (partly because the PSPA and HERA gave FHFA broad powers). The Supreme Court declined to review that decision. Thus, takings claims have hit a dead-end, removing what was once a significant legal threat to the government.

• Other Litigation: A few miscellaneous cases are on the radar:

  • Class Action in Delaware (and Virginia) – Shareholders filed in GSE charter states arguing the NWS violated state corporate law (exceeding authority of preferred stock provisions). These were effectively shut down after Collins/SCOTUS and other rulings that federal law (HERA) preempts such claims.

  • Accounting Fraud Allegations – Earlier suits claimed the government forced excessive loss provisioning in 2008–2011 to justify the conservatorship. Courts have dismissed these as speculative and time-barred.

  • Preferred Shareholder Contract Claims (pre-2012) – Some claims that suspension of preferred dividends since conservatorship was a breach. FHFA’s position as conservator allows it to suspend dividends, and courts have not contradicted that.

At this stage, the legal overhang is notably lighter than a few years ago. The Supreme Court essentially closed the door on reversing the conservatorship or the PSPA financial arrangements via judiciary. The one material ongoing case is the Lamberth $612M jury award, which, if upheld, results in a one-time payment to shareholders (likely easily absorbed by the GSEs or Treasury). The award is substantial for investors (nearly the current market cap of some junior pref classes) but not life-changing for the GSEs’ balance sheets. It does not force any structural change.

From an equity valuation perspective: earlier speculative hopes that a court might cancel Treasury’s stake or invalidate the government’s 79.9% warrants have not materialized. Instead, what remains is largely a political and administrative question. Investors can no longer pin their thesis on a judicial “bailout.” The path to value realization must come through negotiation or policy (or an unlikely act of Congress), not courtroom victory. The relative win in the contract case may encourage the administration to settle with junior preferred holders rather than continue protracted litigation – a factor possibly in favor of pref share recovery. But importantly, FHFA as conservator still has sweeping power under HERA to act in “best interest” of the GSE or public, which courts have upheld even when it disadvantages shareholders.

One additional legal consideration: Statute of limitations and the mere passage of time. The conservatorship has lasted so long that most legal challenges to its imposition or early actions are time-barred or moot. Conversely, if the current administration moves to end the conservatorship, it will likely seek releases or settlements of any remaining claims to clear the path. We may see, for example, in a recapitalization transaction, an exchange offer to preferred shareholders that is coupled with a legal release of claims.

Bottom Line: The legal sword of Damocles that once hung over the GSEs (the possibility that courts could upend the profit sweep or force a recompense far larger than $612M) has largely been removed. There remains a modest litigation overhang – primarily the outcome of the $612M judgment on appeal – but this is not thesis-changing for equity holders. If anything, the resolution of key cases has clarified that ultimate value will be determined by policy choices, not a deus ex machina from the judiciary. Equity investors should thus focus on political/regulatory developments, treating legal outcomes as secondary and mostly already baked into prices.

Exit Pathways & Scenario Analysis

After 16 years of conservatorship, the potential exit pathways for Fannie Mae and Freddie Mac can be grouped into two broad routes: administrative action by the executive branch (FHFA and Treasury) or legislative reform by Congress. We evaluate each, along with likely scenarios, timing, and impacts on the capital stack.

1. Administrative Recap and Release: This is the scenario currently in play under the Trump/Pulte plan. FHFA as conservator has legal authority to end the conservatorship when the GSEs are deemed stable and solvent, and can implement restructuring via amendments to the PSPA with Treasury (no new law needed). The government would use its existing powers to recapitalize and release the GSEs roughly as follows:

• Step 1: PSPA Amendment: Treasury and FHFA negotiate a new amendment to remove or revise the profit sweep and other covenants. This could include cancelling the remaining commitment (turning off Treasury’s backstop in exchange for a one-time exercise of warrants or conversion of the senior preferred). More likely, the commitment (currently $256 B unused combined) might be left in place initially to reassure MBS investors, but terms adjusted.

• Step 2: Capital Restructuring: Addressing the $340+ B senior preferred liquidation preference is key. Options:

  • Convert a large portion of the senior preferred into common equity. For example, Treasury could convert enough of its $216 B (Fannie) and $132 B (Freddie) claims such that each GSE’s book equity meets or nears ERCF requirements. This would immediately create an immense number of new common shares owned by Treasury (diluting existing common roughly 5:1, since Treasury would get ~4.6 billion new FNMA shares if fully exercised/converted vs 1.16 billion current).

  • Alternately, Treasury could write down some of the pref in exchange for other consideration (e.g., an upfront payment from new capital raised or a fee). A full write-off is politically unlikely (optics of a “gift” to shareholders), but a partial reduction might be justified to facilitate private investment.

  • Maintain part of Treasury stake as debt or preferred in new capital structure – e.g., convert senior pref into a long-term subordinated note, so it’s not equity (for capital ratio purposes) but Treasury still has a claim. This might ease meeting ERCF ratios by removing it from equity.

• Step 3: Public Capital Raise: The GSEs likely need additional external equity capital on top of retained earnings to hit required levels quickly. This means one or more secondary offerings/IPO of new common stock to investors. The scale could be on the order of $50–100 B (some estimates even higher) across both enterprises to fill the shortfall. Given market conditions, a staged approach is possible: e.g., an initial raise of ~$20 B (enough to boost capital and demonstrate viability), followed by follow-on offerings over time. The Treasury could coordinate large institutional investors or sovereign wealth funds to take cornerstone stakes. Pricing these offerings will depend on investors’ confidence in a post-conservatorship GSE earnings stream and the resolution of government claims.

• Step 4: Warrant Exercise: Treasury exercising the 79.9% warrants is a near certainty in an admin exit – it’s how taxpayers capture upside. Treasury would then hold the vast majority of common shares post-exercise (before any new issuance). One could imagine Treasury exercising and simultaneously selling a portion via the public offering to provide float (similar to how AIG’s recap was handled). The timing is delicate: exercising all at once could crater the stock, so it might be done in tranches or via an agreement to not flood the market.

• Step 5: Preferred Stock Settlement: Junior preferreds must be dealt with to have a clean capital structure. The administration could offer to convert preferred shares into common at some ratio or do a cash tender. For example, each $25 par preferred might be converted into common shares worth, say, $20 (an implicit 20% haircut) – current pref investors might accept this, as $20 is ~2× the recent market price. Alternatively, if sufficient new capital is raised, they could redeem preferreds for cash at a negotiated discount. The exact approach will depend on negotiation and avoiding legal disputes – remember, these prefs have contractual rights that could complicate a straight wipeout. A voluntary exchange offer is the likely path.

• Step 6: Release and Ongoing Supervision: Once recapitalized (or on a clear path), FHFA would release the GSEs from conservatorship. They would operate as public companies regulated by FHFA (as a normal regulator, not conservator). Expect conditions: e.g., capital restoration plans must be maintained, and perhaps a consent order limiting certain risky activities until fully compliant with ERCF. The Treasury backstop might remain temporarily (for investor confidence), possibly in exchange for an ongoing fee. Eventually, the PSPA could be terminated, fully privatizing the entities.

Decision Tree & Timing: An optimistic timeline might be: 2025: Announce framework and initial PSPA amendment; 2026: execute capital raise and conversions, officially end conservatorship; 2027+: GSEs operate under heightened oversight but as private shareholders-owned entities. However, obstacles (market conditions, political pushback, court challenges by dissenting shareholders) could delay this. If the current administration fails to execute by the 2028 warrant expiry, there’s a risk the process stalls or a new administration reverses course.

Probability and Impact: We gave ~50% probability to this Recap & Release scenario in the Executive Summary as it stands in mid-2025. If achieved, common shareholders’ fate hinges on dilution vs. enterprise valuation. A successful recap could value the combined companies at levels comparable to large financial institutions (perhaps 1.0× tangible book if investors trust the franchise). With full capital, book value could be ~$300 B; if traded at that, Treasury’s portion (80%) would be ~$240 B, leaving ~$60 B for existing common and converted preferred. That outcome would imply multi-bagger returns from today’s market cap (FNMA ~$10 B at $9/share; FMCC ~$4.5 B at $7/share). However, the distribution of that $60 B between current common vs. juniors depends on conversion terms. Common shareholders are likely to see heavy dilution (their percentage cut potentially to single-digits if new money and warrant shares dominate). Still, the absolute value per share could rise if the pie grows enough. Preferred holders in this scenario likely get near-par, as political calculus may favor “making them whole” (since many are retirees, community banks, etc., as often pointed out in lobbying efforts).

2. Legislative Reform: The other pathway is if Congress enacts a comprehensive housing finance reform law. This could either complement the administrative approach or take a very different tack. Historically, legislative proposals have included:

• Utility Model Legislation: Convert Fannie and Freddie into regulated utilities with explicitly capped returns and explicit government guarantee on MBS. For example, one blueprint imagined turning them into utilities paying fee to a federal insurance fund, in exchange for an explicit backstop, with regulated pricing and fixed dividend to investors. This could potentially involve chartering them under a new statute, merging into a single entity or two specialized entities (one for single-family, one for multi-family).

• Multiple Guarantor System: Some bills suggested phasing out Fannie/Freddie in favor of allowing private companies to issue MBS with a federal guarantee on catastrophic losses (through a platform like Ginnie Mae). That implies winding down the GSEs or breaking them up into smaller guarantors.

• Recap with Conditions: Congress could authorize Treasury to sell its stakes and require certain affordable housing mandates or reinsurance mechanisms (e.g., a government reinsurance behind the GSEs’ own capital).

So far in 2025, there is no active bipartisan bill moving. Democrats generally prefer an explicit government guarantee and robust affordable housing support, while conservative Republicans prefer minimizing government credit exposure – a major philosophical divide. The administrative path is proceeding precisely because legislation is seen as unlikely.

If legislation were to arise (perhaps spurred by any market disruption or a compromise in a later Congress), what is the impact on current equity? It depends on how friendly the law is to existing shareholders:

• In some utility-style proposals, current common and preferred could be converted into equity of the new utility company, but with dilution or adjusted rights. If lawmakers view current shareholders as having been speculative opportunists, they might wipe out or severely dilute them as a political statement (similar to how Congress treated pre-conservatorship shareholders in rhetoric post-2008). On the other hand, if by then hedge funds and investors have normalized GSE shares, Congress might grandfather them in.

• A legislated solution might also address the warrants and senior pref explicitly – e.g., directing Treasury to exercise and sell the stock over time, using proceeds for affordable housing funds, etc.

• Legislative reform could take longer (2-3 years even if started) and likely would not happen unless a consensus emerges that administrative tinkering is insufficient or undesirable. Perhaps if a future administration is less keen, Congress might step in to formalize a utility model.

3. Alternative Administrative Scenarios: Beyond the two extremes (full release vs. status quo), there are intermediate administrative possibilities:

• Indefinite conservatorship with tweaks: If the current push falters (say markets won’t absorb a big equity issuance), the GSEs could remain in cons., but FHFA/Treasury might make incremental changes to improve investor sentiment – e.g., modestly reduce the senior pref liquidation growth (allow some earnings to count as build-up without increasing gov claim), or even start paying a token dividend to Treasury again (though that would slow capital build). Essentially a holding pattern where the GSEs keep retaining earnings for several more years until capital is naturally sufficient (estimated ~7+ years at current earnings). This delays upside for junior stakeholders and keeps commons highly speculative.

• Receivership/Restructuring (“Break the Glass”): In a crisis or if privatization efforts failed drastically, FHFA could theoretically place GSEs into receivership (a more drastic step than conservatorship), which would allow for restructuring debts and equity akin to a bank failure resolution. This is the nightmare scenario for legacy equity: in receivership, common and preferred shares could be canceled or paid pennies on the dollar in liquidation priority (the law (HERA) mandates FHFA as receiver to pay Treasury’s senior pref first, which would wipe out juniors in any insolvency scenario). Receivership was avoided in 2008 due to systemic risk and is very unlikely now absent a severe credit event. It’s a last resort “break glass” option if, say, the housing market crashed and GSEs needed new bailouts – not a base-case scenario.

• Merger of Fannie and Freddie: There have been occasional suggestions to merge the two into a single combined entity for efficiency (they already issue Uniform MBS interchangeably). Administratively, a merger during conservatorship could be attempted (with Treasury and FHFA approval). This would simplify eventual exit (one company instead of two) but would raise fairness issues (how to swap FMCC and FNMA shares). Current shareholders might get shares of the merged entity based on relative equity or market cap. This scenario isn’t actively pursued, but it’s out there as a thought. If it happened, likely it’d be neutral to slightly positive for equity (removing redundancy could boost value), but complicated to execute.

Decision Tree:

• Trump Admin (2025–2028) – If committed:

  • Path A: Successful recap & release by ~2026 → Common & preferred realize value (with dilution caveats as above).

  • Path B: Partial progress only → heading into 2028 election, warrants nearing expiry, either rush a solution or handoff.

  • If failure (political or market) → Could default to Status Quo or push radical options (e.g., receivership threat to force Congress’s hand, though unlikely).

• Post-2028 – If another shift in administration (e.g., Democrat wins 2028):

  • They may halt or reverse privatization (back to status quo or utility model via Congress). E.g., a Democratic admin might reinstate sweep dividends or heighten affordable housing requirements that conflict with private capital raising, effectively freezing out common equity value again. Preferred might continue legal fights or await a more favorable climate.

  • Or if Republicans continue beyond 2028, presumably they’d finish any incomplete privatization steps; by then the warrants would have to be exercised (2028 expiry), locking in government ownership share.

Capital Stack Impact by Scenario Recap:

• Recap & Release (Admin) – Treasury: likely converts to common and sells over time (taxpayers recoup large windfall). Common: heavily diluted but worth something tangible (a share in a fully private, profitable company). Preferred: converted or paid out near par (restoring their dividend rights in new form). Net effect: Gov stake shrinks over time, private shareholders gain real ownership of GSE earnings, stocks re-rate from speculative to fundamental value basis.

• No Reform (Status Quo) – Treasury: maintains senior pref (grows to perhaps ~$400B by decade’s end as earnings accumulate) and does not exercise warrants (maybe extends them). Common: remains effectively a call option on a future political change; intrinsic value stays near zero as all economic value accrues to senior pref (which is not being paid down). Preferred: continue as perpetual non-dividend instruments, trade on hope of future settlement. Capital keeps building but can’t be returned to these investors under PSPA.

• Legislative Utility Model – Treasury: might formalize its backstop for a fee or equity stake; could even convert its holdings into a public trust. Common: likely see conversion into utility equity; valuations might be lower (utility P/E ratios) but stable dividend yield possibly. Preferred: could be replaced with new regulated preferred with fixed coupons or cashed out; likely honored given politics, but upside capped.

In evaluating these, investors must consider timing and probability. Our base case leans toward an admin-led recap as the most imminent scenario (before political winds shift again). The decision tree essentially branches on 2024/2025 political outcomes, which we now know. With that branch resolved in favor of action, the next branch point is execution risk – can the plan actually clear the hurdles? We examine those hurdles in the next section (capital and valuation considerations).

In conclusion, the administrative pathway appears open now – it’s arguably the best chance in years to free Fannie and Freddie. But it’s a complex, multi-step process with interdependent pieces (Treasury, FHFA, investors, courts, Congress each playing a role). Scenario analysis suggests that if this path falters, the fallback is not immediately some other grand solution, but rather a prolonged conservatorship (which is bearish for current equity). Conversely, a legislative “big bang” is a lower-probability wildcard that, if it were to happen, could drastically redefine stakeholder outcomes (and likely not in favor of pre-reform equity, given political optics). Thus, monitor closely the execution of the admin recap plan – it is the linchpin of value for FNMA/FMCC at present.

Valuation Deep Dive

Valuing Fannie Mae and Freddie Mac is unusually complex, given their uncertain future state. We must consider two distinct valuation frameworks: one under the current conservatorship status quo, and one under a recapitalized, released scenario. We also need to account for the unique capital structure elements (Treasury’s senior preferred and warrants, and the junior preferred overhang). Below, we conduct a sum-of-the-parts and scenario-driven analysis.

Status Quo (Going Concern in Conservatorship): In the indefinite conservatorship scenario, common shareholders have no claim on earnings – all profits simply accumulate as retained equity that props up the enterprise (and increases Treasury’s pref claim). In theory, if this continued until capital requirements are met (~$328 B needed, with ~$147 B already available), by around 2030 the GSEs might be fully capitalized. At that point, absent reform, what happens? FHFA could begin allowing dividends or release them anyway. But if we assume pure status quo indefinitely, common equity never sees a dividend or buyback, and on any liquidation Treasury’s $340B+ senior pref takes all value first. Essentially, the intrinsic value of common in strict status quo is near $0 – it’s only worth the option that someday the rules change. Markets recognize this, which is why before recent reform hopes, FNMA/FMCC stock traded under $2, a tiny fraction of book value.

One could attempt a DCF of status quo: The GSEs would continue earning ~$20–25 B/year combined, growing book equity (which belongs to Treasury’s claim) until maybe 2030 when required capital is reached. After that, if nothing changes, they might start paying a 10% dividend to Treasury on the growing pref (or some revised deal). From the perspective of junior shareholders, the cash flow is zero in all those years. Only if at some distant point FHFA decides to end the sweep would cash flow start. The net present value of such a distant hypothetical is deeply discounted. This explains why, absent concrete reform prospects, the commons trade like perpetual call options. Preferred shares under status quo similarly accumulate unpaid dividends (in theory, though non-cumulative, they just sit in arrears conceptually) – they too get nothing until a catalyzing event. However, preferred have a stronger eventual claim (they’d rank ahead of common if the company were released or wound down). This is why preferreds have tended to trade at some portion of par (reflecting an expected recovery fraction). Without reform, they could remain unredeemed and non-income-generating indefinitely, but investors might eventually get liquidation preference if the GSEs ever exit or are liquidated. So status quo valuation for prefs might be the probability-weighted present value of a par recovery in some future scenario, plus maybe small chance of receivership scrap value.

In summary, status quo valuations are driven entirely by speculative probability of change, not fundamentals. By fundamentals alone, current common is essentially a claim behind a $340B government stake – essentially worthless. Preferreds at least have contractual par value that in any non-zero outcome must be dealt with, so they have a floor under positive scenarios. This asymmetry is why preferreds trade higher relative to potential payout than common (lower risk, though still high risk). If one believed conservatorship would never ever end, the rational value of both common and junior pref would asymptotically approach zero (since any residual value in 2080 or beyond is negligible today).

Recap/Release (Fundamental Value Analysis): In a scenario where GSEs are freed and recapitalized, we can value them more like normal financial institutions – based on earnings power, growth, and required capital structure. Key components:

• Earnings Power: Both GSEs have demonstrated stable earning capacity. For 2024, Fannie Mae earned $17.0 B, Freddie Mac around $9–10 B. Combined, that’s ~$26–27 B in annual net income. This reflects guaranty fee revenues on a ~$7.7 T book, credit losses near historic lows, and some interest income from portfolios. Going forward, growth in earnings will depend on the mortgage market (new guarantee volumes, fee rates) and credit conditions (loss provisioning). The GSEs’ earnings are partly like an insurance float business (g-fees) and partly spread business (investing their capital and some retained portfolios). Under a fully private model, they might target a return on equity (ROE) around 10–12% given their quasi-utility status. We should consider that if they hold a full 4% capital on $7.7 T assets, that’s ~$308 B capital; earning $25 B on that is only ~8% ROE. Indeed, analysts have noted the ERCF capital requirements seem excessive, producing pro forma ROEs in high single digits. This could pressure them to either raise guaranty fees (risking mortgage rates) or accept lower returns. A possible outcome is FHFA revises capital down somewhat or the market prices the stock at less than book if ROE is subpar.

• Valuation Multiples: Pre-2008, Fannie and Freddie traded around 10–12× earnings or about 1.5× book value, reflecting high ROEs (~20%+) then. Post-release, with more capital and less growth, they might trade closer to book value or even a discount if ROE is <10%. Comparable financials: large banks trade ~1.0× book for ~10% ROE; mortgage insurers trade at ~1× book for mid-teens ROE; mortgage REITs trade below book when ROEs are mid-single-digit. If GSEs are utilities with 8–10% ROE, 0.8–1.0× book might be reasonable. Conversely, if they can optimize and get ROE to >10%, maybe slightly above book.

• Sum-of-the-Parts: Fannie and Freddie’s businesses can be segmented into:

  • Guarantee Business: A stable fee income stream somewhat like an insurance company. This could be valued by a yield or multiple of earnings. The present g-fee revenues (~$7.1 B for Fannie in Q1 annualized, ~$5.9 B for Freddie) after credit costs translate into the net incomes above. If we believe $25 B/year sustainable combined, at a say 10× multiple, enterprise value ~ $250 B.

  • Retained Mortgage Portfolio: Each GSE still has a retained portfolio (capped by PSPA, but in a free scenario they might manage a modest portfolio for liquidity/investment). Currently, net interest income from portfolios and other investments is significant (e.g., Freddie had $5.1 B NII in Q1 2025). As rates rise and fall, this component can produce gains or losses. But it’s mostly a supporting role now; could be valued near book value of those assets or on NII yield.

  • Deferred Tax Assets (DTA): After huge losses in 2008-2011, GSEs have DTAs that they reinstated in 2013. Fannie’s DTA was ~$50 B then; much has been utilized, but a sizeable DTA remains (which is part of their $98 B net worth). In valuation, DTA is an asset that reduces future taxes – effectively increasing earnings over time. Any valuation should account for the fact that reported earnings benefit from using DTA (no cash taxes until it’s exhausted). A buyer might value the DTA at somewhat less than face (time value).

  • Credit Risk Transfer (CRT) impact: The GSEs offload some credit risk via CRT deals. This reduces potential losses (and reduces required capital marginally) but also costs them in interest/hedge expense (reflected in earnings). If fully private, they might expand CRT to optimize capital (since CRT can substitute for equity for risk coverage). That can enhance ROE if done efficiently. For valuation, heavy CRT use could allow a smaller required equity base for the same risk – effectively boosting ROE or freeing capital to return to shareholders, which would justify higher valuations. Current FHFA rule limits some CRT capital benefit, which could be loosened.

Modeling a Recap Scenario: Let’s illustrate a potential steady-state for Fannie Mae post-release:

• Suppose required Tier 1 capital is around 10% of risk-weighted assets (or ~3.5% of total assets). For Fannie, with ~$4.5 T assets (adjusted), that’s roughly $160 B needed (aligns with ERCF). If Fannie has ~$100 B today, it needs +$60 B. That could come from, say, converting $40 B of Treasury pref to common and issuing $20 B new shares.

• Post-recap, Fannie might have ~5.7 B shares (existing 1.16 B + 4.6 B from warrant + maybe ~0.5 B from new issue if priced around $40). If fully valued at book, market cap might be ~$160 B (if book = capital = $160 B). That’s ~$28/share. Existing common (20% of the company pre-new issue) ends up owning perhaps ~15% after new issue, so their portion would be ~$24 B, or effectively $20/share for current stock. That’s one optimistic scenario (assuming 1.0× book valuation).

• If valuation is only 0.8× book, that share might be more like $16. If required new issuance or conversion terms are worse for existing holders (e.g., issuing more shares at lower prices), their slice shrinks.

• Preferreds in such scenario: if converted at par, $33 B par would take maybe another chunk of shares (diluting common further). Likely they’d structure it so preferred get, say, $25 B in value (approx 75% of par) to balance interests, which still significantly dilutes. Each variable in this equation changes common’s outcome.

This exercise shows that under plausible assumptions, current common could be worth several times its trading price if recap occurs and the market values the new GSE equity reasonably. But it’s highly sensitive to dilution factors and valuation multiples.

Sensitivity Factors:

• Guaranty Fee Changes: Small changes in average charged g-fees can have big impacts. Currently ~50 bps on single-family. If post-release the GSEs raise g-fees (to earn higher ROE on higher capital), they could increase earnings – but this could also contract their volume if it pushes mortgage rates up. There’s a policy tug-of-war here between safety (higher fees, more capital) and affordability.

• Interest Rates: Rapid rate swings affect prepayments and the value of mortgage servicing rights, etc. Higher rates in 2022–2023 reduced refi volumes but widened net interest margins on portfolio holdings for a time. The GSEs’ earnings were actually resilient with 30-year mortgage ~6.5%. In a falling rate environment (if 2025–2026 see lower rates), new business might surge (boosting fee income) but they could face negative mark-to-market on their derivatives and credit risk transfers. Generally, moderate rate moves are fine; extreme moves can cause one-time hits (e.g., large hedge losses or credit reserve builds).

• Credit Losses / Home Prices: The biggest fundamental risk is a housing downturn. With average LTV ~50% on Fannie’s book and FICO ~753, credit quality is high. Stress tests show the GSEs could withstand a significant home price drop with current capital. However, if home prices fell 20% and defaults spiked, they might incur tens of billions in provisioning. This would dent their capital build and perhaps require raising even more capital in a recap scenario. Conversely, continued home price appreciation or low defaults (as currently) means they’ll enjoy low credit losses (Q1 2025 credit-related expense was actually a benefit for Fannie due to releases of reserves with improving forecasts). So macro conditions can swing annual earnings by several $B via credit costs.

• Capital Requirements Changes: A critical sensitivity: if FHFA/Pulte decide to lower the ERCF requirements (e.g., drop the capital buffers, or reduce risk weightings for low-LTV loans, etc.), the needed capital could be, say, $50 B less. That directly increases ROE and reduces dilution needed. There is speculation that current requirements (which some say are “far in excess of what is justified by actual losses”) might be moderated. Each 0.5% of assets less in required capital is ~$20–25 B less equity needed, which could boost valuation for existing shareholders.

• Treasury Warrant Treatment: By law/contract, these expire in 2028. If for some reason Treasury chose not to exercise fully (say it left some portion unexercised as a concession), the value remaining would accrue to common. This is unlikely – Reuters reported a market strategist’s view that the government could net >$250 B by listing the GSEs, which clearly assumes full warrant exercise – but it’s a sensitivity: if warrants were reduced or canceled, current common would skyrocket. However, such a giveaway to shareholders is politically radioactive (it would mean handing tens of billions to hedge funds), so we assume full dilution from warrants in any realistic scenario.

• Preferred Overhang Resolution: The cost of taking care of preferreds (paying par vs a discount) affects common value. If they insist on par ($33 B outflow or equivalent in shares), that’s more dilution to common. If they accept $20 B, that saves $13 B for common. This may come down to legal leverage and negotiation. The jury verdict discussed earlier gives preferred holders some leverage to ask for better terms (since they proved NWS was a breach, implying government might prefer to appease them). We suspect a middle-ground outcome (e.g., ~75% of par equivalent).

• Tax Rate & DTA: A final nuance – corporate tax changes could impact earnings (the GSEs pay the standard 21% federal rate now). Any increase in tax rate would reduce net income (and conversely, lower taxes would boost it). The DTA on books would adjust accordingly. Keep an eye on fiscal policy, though currently no major changes are expected in immediate term.

Market Valuation Snapshot: The market’s implied expectations can be gleaned by comparing trading prices to notional values. For instance, at ~$10/share, Fannie’s common market cap is ~$11.5 B vs a book value (ignoring Treasury pref) of ~$98 B. That’s ~0.12× book – extremely low, but rational given ~80% dilution ahead (after which that 0.12× could equate to ~0.6× on a pro forma basis). Preferreds around $10 are at 40% of par, suggesting maybe a ~40% chance of full par or 80% chance of ~50% recovery, etc. These prices have risen dramatically from a year ago (when common was ~$1–2, prefs ~$3–5), reflecting that investors assign a much higher probability to recapitalization now. In effect, the market might be saying there’s roughly a 50% chance of a favorable recap within a few years (hence common up ~5×). This aligns with our subjective probability assessment.

DCF/Intrinsic Approach Post-Release: We can do a simplified DCF for post-release equity. Assume by 2026 the GSEs have, say, $250 B combined tangible equity. Suppose they can pay out dividends at a 40% payout ratio and grow the book ~5% a year (via retained earnings and modest asset growth). If earnings on that capital are 10% ROE = $25 B, dividends ~ $10 B (to new shareholders, including Treasury while it holds stock). If cost of equity ~12%, the equity’s value as a perpetuity growing 5% would be: $25B – $10B reinvested = $15B free cash, growing 5%, so roughly $15B/(12%-5%) = $214 B equity value. That’s in the ballpark of the capital itself (so ~0.85× book). Different assumptions will change this (if ROE ends up 12%, value would be higher, etc.). But it shows that one can fundamentally justify valuations in the few-hundred-billion range, which makes current sub-$20B combined market cap look very low if one believes that fundamental state will be achieved. Of course, the timeframe and risk to get there justify a huge discount.

Bottom Line on Valuation: We effectively have a binary distribution of outcomes rather than a single intrinsic value. The upside case (recap/release) could see common stock settle at a fundamentally supported level many times the current price (even after dilution, possibly in the high teens or higher per share, vs $7–10 now, if all goes well). The downside case (no reform or adverse reform) could see common nearly worthless or heavily diluted in a way that current price is too high. This asymmetry is why the stocks are volatile and attract speculative interest.

From a common vs preferred perspective: Preferred shares have less upside (they cap at par $25 plus resumption of maybe a ~5-8% yield dividend if reinstated), but also perhaps less downside (in most scenarios short of catastrophic receivership, they should be paid something if the companies are re-privatized or wound down by law). They are akin to a high-yield distressed debt bet on eventual settlement. The common is more like an equity option on political outcomes – in a bull scenario it could exceed preferred percentage gains significantly (e.g., if common went from $10 to $30 that’s +200%, while preferred from $10 to $25 is +150%), but in a bear scenario, preferred might retain some minimal value while common could go to ~$0.

Resolution of Treasury Stake: For valuation, it is also critical to consider Treasury’s ongoing role. Will the government demand some ongoing economics even after release? Possibly:

• They could charge a quarterly commitment fee (a PSPA covenant that’s been waived each year, but could be activated upon release). This fee might skim some of the GSEs’ earnings to compensate for the implicit guarantee. In earlier talks, a fee of 10 bps on the guarantee book was floated. On $7.7 T, that’d be $7.7 B/yr paid to Treasury – which would materially reduce earnings available to shareholders. However, if fully private, the guarantee might no longer exist officially. But political reality might impose a fee for any continued backing.

• Treasury could also retain some senior preferred instead of converting it all, meaning it continues to have a preferred dividend that must be paid before common dividends. Ideally, the recap plan removes this overhang entirely, but if not, that piece would need valuation as a perpetual gov claim.

Given these uncertainties, any DCF or SOTP modeling must account for potential government charges, higher capital, and possibly lower growth (post-release GSEs might not grow their book rapidly, as they might be constrained by capital or charter limits – e.g., multifamily volume caps, which FHFA already sets).

In conclusion, our valuation analysis underscores two key points:

1. Enormous gap between status quo value and release value: This gap is essentially the “reform premium.” Right now, markets are pricing in a significant chance of reform, but not a certainty – hence prices are elevated from pure option-value levels but still far below fully privatized intrinsic values.

2. Dilution and capital are the swing factors: The ultimate share of that intrinsic value accruing to current stakeholders depends on how the recap is done. A shareholder-friendly plan might minimize new issuance and perhaps negotiate the government stake down slightly; a harsher plan could leave current common with only a sliver of the pie. This uncertainty is why even pro-reform investors often favor preferred (more straightforward claim on par) or maintain moderate position sizes in common due to binary risk.

For modeling detail-oriented investors, a sensible approach is to assign probabilities to scenarios, model each scenario’s per-share outcome, and take an expected value. By our analysis, that expected value appears to be somewhat higher than current trading (justifying some investment), but the distribution is extremely wide and sensitive to political events – meaning a classic high-risk/high-reward profile.

Market Comps & Sentiment

Market Comparables: Fannie Mae and Freddie Mac, in conservatorship, are sui generis – no other financial institutions have their exact profile. However, to gauge potential valuation and investor sentiment, we can compare them to a few groups:

• Large U.S. Banks: Mega-banks like JPMorgan or Bank of America operate with ~10–12% capital ratios and earn ~12–15% ROEs. They trade around 1.2× book value and ~10× earnings. If post-release GSEs were valued similarly, given (likely) slightly lower ROEs (due to higher required capital and a narrower business scope), one might expect ~0.8–1.0× book as noted. Pre-2008, the GSEs were highly leveraged but had an implicit guarantee, so they traded richer (Fannie’s P/B was >2× at times, P/E ~8–10× because of high leverage-driven EPS). Those days are gone; the new GSEs would look more like large, low-risk banks.

• Mortgage Insurers and REITs: Private mortgage insurers (PMIs) like MGIC or Radian take housing credit risk (though only on high-LTV portions). They trade around 6–8× earnings and often <1× book, partly due to cyclicality of housing and less government backing. The GSEs have more diversified portfolios and a quasi-government aura, so arguably they should trade at less of a discount than PMIs. Mortgage REITs (like Annaly, AGNC) invest in MBS and often trade at 0.8–0.9× book with double-digit dividend yields, reflecting the volatility of their leveraged portfolios. The GSEs’ guaranty business is more stable and utility-like, so one would think a higher multiple is warranted than MREITs. If turned loose with consistent earnings and possibly dividends, Fannie/Freddie might attract yield-oriented investors similarly to utility stocks (perhaps eventually paying modest dividends akin to a 3-4% yield).

• Insurance and Guarantee Businesses: One can analogize the GSE guarantee to an insurance model. Financial guaranty insurers (like pre-2008 MBIA, Ambac) insured MBS and traded on the assumption of low loss probability – before they collapsed in 2008. The GSEs differ in having much larger scale and federal oversight. Perhaps a better comp is the Federal Home Loan Banks (FHLBs) – cooperatively owned, thinly capitalized government-sponsored liquidity providers. They are not publicly traded, but they exemplify a utility model (paying just enough dividend to members to keep going). If Fannie/Freddie ended up as something akin to a member-owned utility, their equity might effectively be like a bond substitute (low return, low risk).

• International Parallels: There aren’t many. Some countries have national housing finance agencies (often government-owned). Ginnie Mae (in the U.S.) is a government corporation, not comparable for equity. The closest might be Canada Mortgage and Housing Corp (CMHC) – fully government – or China’s housing banks (state-run). These don’t offer market comps but underscore how unusual a partially privatized-but-backed model is.

Current Market Sentiment: Sentiment around FNMA/FMCC is highly speculative and headline-driven:

• Over the last six months (late 2024 to May 2025), common shares have risen several hundred percent (e.g., up ~325% over six months for FMCC as of early May). This rally was fueled by investor positioning ahead of the election and then actual policy signals. It suggests a mix of retail and hedge fund money speculating on policy outcomes. The stocks are prone to sudden spikes on news (e.g., Trump’s spin-off comment, or Ackman’s public statements) and equally sudden collapses on setbacks (e.g., the June 2021 SCOTUS decision saw shares plunge ~30% in a day).

• Short Interest: Data on short interest is limited on OTC stocks, but historically short interest has been relatively low as a percentage of float – partly because borrow is not always readily available, and also because these stocks already trade at low absolute prices (making shorting less attractive relative to upside risk on news). That said, some hedge funds have been known to short common as a hedge against long preferred positions (i.e., betting that if no reform occurs, common goes to zero while preferred might still have some value). If reform looked likely, those hedges could be unwound, contributing to rallies.

• Volume & Liquidity: FNMA and FMCC remain OTC/Pink Sheet listed, which limits institutional ownership (many funds can’t hold penny stocks or OTC). However, volume has been significant on news days – for example, tens of millions of shares might trade after a major announcement. Liquidity can evaporate during quiet periods, leading to price drift. If relisted on NYSE/Nasdaq post-release, one could see a broader investor base (index funds, etc.) which could support higher valuations more reflective of fundamentals.

• Technical Positioning: There is a contingent of retail investors very dedicated to these stocks (e.g., active on forums like Reddit’s r/FNMA_FMCC_Exit). They often treat the stocks with almost meme-like enthusiasm when news is favorable, talking about multi-bagger potential, referencing high target prices if warrants were canceled, etc.. This can create self-reinforcing spikes. On the flip side, if momentum shifts or if there’s disappointment (say, a reform delay), momentum traders could exit en masse, leading to sharp drops. In essence, volatility is high – 2025 year-to-date, FNMA’s 52-week trading range is roughly $0.50 to $10, illustrating that sentiment swings by an order of magnitude.

• Analyst Coverage: Due to their unusual status, Fannie and Freddie have minimal Wall Street equity analyst coverage. They are not included in major indices and not followed like normal companies. Most analysis comes from specialized research boutiques or investor letters (e.g., Pershing Square releases presentations on them). Thus, price discovery is more influenced by those prominent voices and legal/regulatory news than by quarterly earnings beats or misses. The Q1 2025 results, for instance, showed solid profits but that alone didn’t move the stock much; policy news did.

P/B and ROE Snapshot: If we artificially calculate current P/B based on tangible common equity excluding Treasury:

• Fannie’s common equity (if one subtracts the senior pref) is actually negative (because Treasury’s $120.8 B original pref counts in equity). But using “net worth” as a proxy (which is essentially total equity including Treasury), P/B is ~0.1× at current prices. That’s meaningless in normal contexts, but reflective of the government claim.

• ROE for 2024 was enormous if calculated on the sliver of nominal common equity (because common equity book was near zero). A more relevant metric: return on total capital (including Treasury’s stake) – roughly $26 B combined earnings on ~$300 B total capital (incl. pref) = ~8.7% return on that capital. This is basically the ROE a fully capitalized GSE might have, which again supports the notion that at full capital the valuation would be more middling (not high growth).

Mortgage Market Backdrop: A factor affecting sentiment is the broader housing finance environment. In 2022–2023, rising interest rates and Federal Reserve tightening reduced mortgage origination volumes drastically from the 2020 refi boom. Typically, lower volumes might hurt GSEs’ near-term revenue growth (less new loans to guarantee). However, both companies maintained earnings by increasing average guaranty fees and because their back book of business continues to generate income. Now, with the possibility of interest rates stabilizing or falling by 2025–2026 (as some forecasts suggest due to a potential economic slowdown), investors might anticipate a tailwind of higher originations (especially if rates drop, triggering a refinance wave). Fannie’s economists even forecast additional home sales and originations growth in 2025/26. That could boost earnings and perhaps make raising capital easier (a growth story is more attractive). This macro optimism can feed into sentiment – if investors think a recapitalized Fannie/Freddie will also benefit from a cyclical upswing, they may assign richer multiples.

Bottom Line Sentiment: As of now, the sentiment is speculative but optimistic. The stock prices imply considerable hope for a favorable outcome, but not certainty (they are not trading anywhere near full book value yet). It’s a trader’s market, largely event-driven. For long-term value investors, these waters are tricky to navigate; one has to have a view on politics as much as on P/E ratios. The technical dynamics (OTC listing, retail fanbase, hedge fund positioning) mean that volatility will remain extreme. For instance, if any signal emerges that the privatization might be delayed (say, an official comment pushing timeline to 2027), one could see a large pullback. Conversely, a concrete step (like an announced agreement in principle between Treasury and a group of investors) could send shares surging again.

In comparing to comps, the takeaway is that if/when Fannie and Freddie become “normal” financial stocks, they likely won’t command premium growth multiples given their quasi-utility role, but they could be valued similarly to solid, low-risk financials (around book value, mid-single-digit yields). The journey to that normalcy, however, is what current investors are trying to bridge – and that journey’s outcome remains uncertain, keeping sentiment in a state of flux.

Stakeholder and Ownership Map

Understanding who holds Fannie Mae and Freddie Mac securities – and their motivations – is key, as these stakeholders influence litigation, lobbying, and even the execution of a recapitalization.

Common Shareholders: The common equity is widely held among hedge funds, specialized investors, and retail traders, since traditional institutional ownership is low (due to OTC listing and speculative nature). Notable holders and figures include:

• Pershing Square (Bill Ackman): Ackman’s Pershing Square Capital is one of the largest holders of Fannie/Freddie common. Reuters reported Pershing holds about 10% of Fannie Mae’s common shares – roughly ~115 million shares – making Ackman a key stakeholder. He has been invested since 2013/2014 and has publicly advocated for recapitalization plans (Pershing released a “The Art of the Deal” presentation in Jan 2025 outlining a path to privatization). Ackman is viewed as an ally of the Trump admin on this issue (ironically, he wasn’t politically aligned with Trump historically, but here interests coincide). If recap happens, Pershing stands to gain massively. Ackman’s influence: he can mobilize media attention, and he has engaged with policymakers (he met with Trump officials in 2017, etc.). He also likely would participate in any new capital raise (Pershing could invest additional funds if needed).

• Retail Investors: There is a strong retail presence – as evidenced by active forums and the meme-stock-like moves. Many small investors hold FNMA/FMCC hoping for the “big score.” Some have held since pre-2008 (legacy holders who saw their value nearly wiped out), while others came in post-2012 as part of the “Fairholme/Ackman trade.” The Investors Unite group, established by shareholder activists, once represented many of these individuals in lobbying efforts.

• Other Hedge Funds: In the early 2010s, a number of hedge funds piled into GSE equity (both common and prefs): Bruce Berkowitz’s Fairholme Funds, Richard Perry (Perry Capital), John Paulson (Paulson & Co.), Carl Icahn, etc. Some have since exited or wound down. Fairholme (Berkowitz) was a leading preferred holder and litigant; as of a few years ago, Fairholme still held large positions in Fannie/Freddie prefs (Fannie’s ~$2B par held at one point). Berkowitz’s fund has shrunk significantly, but he appeared vindicated by the Lamberth legal victory (Boies Schiller, his lawyers, touted the win). It’s unclear how much Fairholme holds today, but likely still significant preferred stakes.

• John Paulson – His hedge fund was involved early (he made large purchases around 2013). He was rumored as a possible beneficiary in Trump’s plans (the Reddit comment even mentioned him as a potential Treasury Secretary pick with large pref holdings, though in reality Trump chose Bessent). Paulson’s current holdings aren’t public, but he’s probably still exposed via preferreds.

• Other Funds: Smaller value funds or family offices may hold positions. Notably, some community banks and insurance companies held Fannie/Freddie preferreds pre-2008 for income; many of those got stuck holding them after dividends stopped. Some may still hold and have lobbied for resolution (for example, railroad retirement fund or teacher pension funds that had small slices).

• Arbitrageurs: Given the multiple classes of preferred (each trading at slightly different prices), some investors trade the relative values expecting equal treatment at the end (a convergence trade). Also, some might be long preferred/short common or vice-versa depending on outlook (long pref as safer, short common as overpriced optionality, etc., or opposite if one expects common to get political favoritism).

The U.S. Government: The biggest stakeholder is of course the U.S. Treasury (and by extension the taxpayer). Treasury’s senior preferred stock (liquidation pref ~$348B) and warrants (79.9%) make it the economic owner of most GSE value under any scenario. However, Treasury’s goal is not to maximize profit at all costs; it has policy objectives. Over the years, Treasury’s position (under different Secretaries) has varied: some wanted to use GSE profits for affordable housing or deficit reduction, others (like Mnuchin in 2017–2020) wanted to release them responsibly. Currently, with a Trump-appointed Treasury Secretary (Scott Bessent), the government’s stake will likely be used in a way that aligns with privatization but also yields a politically sellable benefit to taxpayers – hence the talk of a >$250B “windfall” if IPO’d. Treasury will be a key negotiator with shareholders if any deals (like converting preferred or exercising warrants) happen.

FHFA and Management: FHFA as conservator technically holds all the decision-making power of the boards. Director Pulte is effectively a kingmaker for stakeholders: he can decide whether to settle with preferreds, whether to allow dilution, etc. Pulte’s own motivations include demonstrating a win for the administration, possibly personal ideology around smaller government, and maybe connections (critics point out that benefiting certain hedge funds could be seen as cronyism). If there’s any conflict of interest (no evidence Pulte holds any GSE securities, but hypothetically if any friends/allies do, that could color decisions), it will be closely watched. The new boards installed will presumably go along with FHFA’s plans.

Activist Influence & Lobbying: Over the conservatorship, shareholders funded extensive lobbying. Coalitions like Investors Unite and law firms on contingency (like Boies Schiller, which won the $612M case) have been pushing Congress and the courts. Notably:

• The hedge funds hired top lawyers (Ted Olson argued Collins for shareholders in SCOTUS, David Boies’s firm handled Lamberth case).

• Political donations were made: e.g., Ackman and others have been linked to contributions to sympathetic lawmakers. During the 2024 campaign, one can speculate some donors with GSE positions supported candidates who favored GSE reform.

• The result: The current administration is indeed stocked with some officials who are at least friendly to the investor perspective (though the primary motive is ideological, not purely doing hedge funds a favor). For instance, having Howard Lutnick (CEO of Cantor Fitzgerald) as Commerce Secretary suggests a tilt towards Wall Street viewpoints; Cantor has a big mortgage trading desk and would benefit from GSE float. The FHFA upheaval under Pulte was cheered by investors as removing “anti-shareholder” bureaucrats.

• On the other side, affordable housing advocates and some academics lobby against simply recapitalizing for shareholder benefit. They argue the GSEs’ windfall should go to public purposes or that Congress should redesign housing finance from scratch. Groups like the National Housing Conference, some think tanks (Brookings, Urban Institute), and community lenders express these views. However, with the current power alignment, those voices may not carry as much weight unless they convince some lawmakers to intervene.

Activist Investor Influence: Activists have shaped the narrative. Ackman’s public presentations provide intellectual framework (e.g., he’s argued that Treasury has already been repaid with a profit, so now it should convert its stake and let the companies go). Berkowitz was early to propose turning prefs into common and raising new capital (the 2013 Fairholme plan). In 2017-2018, a group of investors even hired Moelis & Co to craft a detailed recap plan (the “Moelis Plan”), which outlined raising ~$125 B over time and giving existing shareholders partial participation. That plan heavily influenced discussions at FHFA/Treasury during Mnuchin’s term. Many aspects of these plans are re-emerging now.

Given that multiple major hedge funds have skin in the game, one can expect the following going forward:

• They will likely participate in any equity offerings (they have an incentive to see it through).

• They may compromise on some terms (like accepting partial pref settlements) to get a deal done – better 70% of something than 100% of nothing.

• Conversely, if an admin tried to screw them (e.g., cancel warrants but also wipe out prefs with no comp), they would sue vigorously and could delay the process. The government knows this, so some accommodation is probable.

• Activists will keep lobbying Congress behind the scenes to not interfere negatively. If needed, they’ll testify in hearings or run PR campaigns about how recap will “lower mortgage costs in long run through efficient capital markets” etc. Meanwhile, opponents will argue the hedge funds stand to make billions (true) at expense of housing affordability.

Government vs. Shareholder Dynamics: For a long time, the relationship was adversarial (as evidenced by lawsuits). We are possibly pivoting to a more collaborative phase (government now wants to release, investors want to help). But a lingering trust deficit exists. The government will prioritize taxpayers and the housing market; investors will push for maximizing their stake. For example, on the warrants: Some shareholder advocates have suggested Treasury cancel or extinguish the warrants as a gesture (pointing out that Treasury’s 10% coupon plus NWS gave them enough return). However, politically and financially, Treasury is very unlikely to relinquish that value – doing so would open officials to criticism of gifting billions to Wall Street. So investors will likely drop that ask and focus on what they realistically can get (full par on prefs or minimal haircut).

Key Influencers to Watch:

• Steven Mnuchin and Craig Phillips: Former Trump Treasury officials deeply involved in GSE policy in 2017-2020. They may still have influence or be consulted by current team. Phillips in particular drafted a Treasury Housing Reform Plan in 2019 which advocated recap.

• Glen Bradford / Reddit community: Retail voices that sometimes float creative theories (like extremely high valuations if warrants voided). These don’t directly influence policy, but they keep a buzz alive, affecting sentiment.

• Courts & Lawyers: If any settlement is done, it might involve legal agreements with plaintiffs from suits (to prevent further litigation). Lawyers like Hamish Hume (Boies Schiller) who won the $612M case become stakeholders in that they might negotiate how that judgment is treated in a settlement (e.g., maybe government offers to pay it if preferred accept conversion, etc.).

In summary, the ownership map is concentrated but relatively small in absolute dollars (the entire market cap of common + pref right now is maybe ~$15–20B, which is a drop in global markets). We anticipate these stakeholders will continue to be extremely vocal and involved in every step of the recap/release process, serving as both catalysts and, potentially, sources of volatility if they express dissatisfaction (e.g., if Ackman were to dump shares or publicly object to a proposal, it could tank prices). So far, however, key holders seem aligned in welcoming the administration’s intent and likely ready to support a reasonable plan.

Macro/Housing Overlay

No analysis of Fannie and Freddie is complete without examining the broader housing market and macroeconomic backdrop, as it directly impacts their earnings, capital, and the urgency (or risk) of reform. Here we outline how various macro factors overlay on the GSE outlook:

Housing Market Conditions (Home Prices & Sales): After a meteoric rise in home prices through 2021 (up ~18% that year nationally), 2022–2023 saw a deceleration as mortgage rates jumped. Nationally, home prices were roughly flat in late 2022 and resumed modest growth by 2024. As of early 2025, home prices are up ~3% year-over-year on average – essentially a soft landing rather than a bust. Low housing inventory has propped up prices despite higher rates. For Fannie and Freddie, this environment has meant:

• Low Credit Losses: Rising or stable prices keep LTVs declining and allow troubled borrowers to sell or refi rather than default. Fannie’s average single-family mark-to-market LTV is just ~50%, meaning even a 20% price drop would only raise that to ~63%. Serious delinquency rates are extremely low (0.56% for Fannie SF, 0.96% for Freddie SF) – back to pre-2008 benign levels. The GSEs in Q1 2025 continued to release some loan loss reserves because credit performance outpaced forecasts.

• Mortgage Origination Volume: High rates (peaking around 7%) crushed refinance activity – 2022 had a ~60% decline in origination volume from 2021. Purchase originations also dipped but by less. For the GSEs, new business acquisitions in 2023–2024 were lower, and their outstanding guarantee book growth slowed (Fannie’s SF book actually shrank slightly YOY by Q1 2025 due to runoffs outpacing new acquisitions, while Freddie’s grew 2% YOY). However, volume seems to have stabilized and could pick up if rates ease. Fannie’s economists forecast a rebound in home sales and originations into 2025-26 with moderately lower mortgage rates and perhaps a mild recession easing rate pressure. Implication: If originations rebound, GSEs will add higher volumes of loans (albeit at lower coupons), sustaining or growing their guaranty fee income. More business also means more capital required, but also more earnings. In a recap scenario, strong volume would be a positive selling point.

• Affordability & GSE Initiatives: High rates and prices have worsened affordability, leading the GSEs (under FHFA direction) to implement programs for first-time buyers, lower-income borrowers (like down payment assistance, lower LLPA for certain groups). These don’t majorly affect the bottom line yet but are part of the mission tension. The new FHFA leadership’s pullback on some programs may slightly reduce credit exposure to riskier loans, but the overall credit profile is still prime-dominated.

Interest Rate Environment: The Fed’s tightening from 2022 raised short-term rates (SOFR ~4.3% by Q1 2025 from near zero in 2021) and long-term yields (30-yr mortgage ~6.65% at end Q1 2025). For GSEs:

• Net Interest Income: They benefit in one way – the GSEs invest cash and capital in short-term instruments, so higher short rates mean they earn more on float. Freddie noted higher net interest income in Q1 2025 due partly to lower funding costs relative to portfolio yield. However, they also hold some mortgage assets financed by debt, so a flattening yield curve can compress spread.

• Portfolio/Hedging: The retained portfolios have shrunk (<$150B now each, mostly legacy assets and some liquidity investments). Interest rate swings can cause mark-to-market gains/losses on derivatives used to hedge mortgage assets or on guarantee obligations (the GSEs mark-to-market some guarantee assets through “loss on derivatives” line). For instance, when rates fall sharply, they might take losses on their swaps as prepays accelerate. These accounting effects can create earnings volatility quarter to quarter.

• Prepayment and Duration: Higher rates have drastically reduced prepayments – loans in the book stay longer, which actually means the GSEs earn the higher vintage g-fees longer (good for revenue stability) but also means credit risk persists longer (though credit is good). If rates drop, a refi wave would replace older loans with new ones (the GSEs would likely refinance many into new MBS – maintaining market share). Prepay waves can cause transient losses on certain hedged assets but also generate new business volume and potentially allow raising fees on new loans.

Economic Growth and Unemployment: The baseline outlook as of 2025 is slower growth with a chance of mild recession. Unemployment might rise from 3.5% to, say, 5% in a mild recession scenario. Even if that occurs:

• Credit Stress: A mild recession could push GSE delinquency rates up somewhat, but given current borrower strength (high credit scores, significant home equity, and the benefit of COVID-era equity gains), a 2008-like default wave is unlikely unless home prices also plummet. The GSEs have significant credit enhancements now: e.g., 47% of Fannie’s book has some form of credit enhancement (MI, CRT, etc.), and Freddie’s even higher at 62%. That means even if borrowers default, a chunk of losses are absorbed by insurers or CRT investors. The presence of CRT (credit risk transfer bonds) effectively means private investors stand to lose first in some scenarios, shielding the GSEs (though they pay for this protection through interest).

• Refinance Relief: If a recession prompts the Fed to cut rates, the resulting lower mortgage rates could spur a refinance boom. While that would eliminate the above-market rates GSEs currently have on their books (coupon burnout), it could allow millions of borrowers to lower payments, likely reducing future default risk further. It’s a double-edged sword: less income from older higher-coupon loans, but more originations and better credit.

• Housing Demand: A deep recession could hurt housing demand and thus originations, but current housing undersupply suggests any downturn might mainly hit prices not new construction (which is already below needed levels). GSEs’ mission would shine in a downturn – they’d likely be asked to step up purchase of loans if banks pull back, as happened in 2020 COVID crisis when GSEs provided liquidity while others retreated. Paradoxically, crises reinforce their indispensability (the “public mission” aspect), but also risk them needing government support if losses spike.

Geopolitical/Inflation: Persistently high inflation could keep rates higher for longer, which continues the current status quo of moderate volumes and strong net interest margins on certain assets. A sharp disinflation could boost mortgage activity but also compress some margins. These macro swings generally cancel out over time for the GSEs, since they can reprice new guarantees fairly quickly (g-fees can be adjusted annually by FHFA – indeed, FHFA has periodically raised base guaranty fees, including after 2008 and slightly in recent years, partly to compensate for more capital).

Stress Test Results: FHFA conducts annual Dodd-Frank Act stress tests on the GSEs. The 2022 stress test (severely adverse scenario) showed that under a 9.5% unemployment, 30% house price crash scenario, the combined credit losses would be tens of billions but with retained capital plus Treasury commitment, they’d remain solvent. These results justify the high capital requirement but also show that at current ~$160B capital, they’d incur significant losses in a severe downturn (likely needing to draw some Treasury funds). For shareholders, another crisis before recapitalization could be extremely dilutive – Treasury would get more senior pref in exchange for covering losses, pushing any eventual common value further out of reach. Thus, macro stability in the next couple of years is critical for shareholders – they want no new bailouts before recap. The present macro outlook (mild slowdown, not a crash) is supportive.

Housing Policy Overlay: The GSEs also face mandates: affordable housing goals, multifamily lending caps (FHFA sets a limit each year, e.g., $73B each in 2025 for multifamily volume), support for underserved markets. Under prior leadership, these were a focus (e.g., equity plans to close racial homeownership gap). The new regime may dial back some initiatives that could have added marginal credit risk. For example, loans with lower credit/higher DTI – FHFA could institute stricter limits, which would marginally improve credit quality going forward, albeit at cost of mission. In a macro sense, this might slightly mitigate risk if the economy sours, but it’s not a big lever (the book is already high-quality).

Cross-Over with Reform: Macro conditions also influence the political timing of reform:

• If the economy and housing market are stable or improving, it’s a greener light to do an IPO or major capital raise (investors are confident, housing groups less worried about rocking the boat).

• If the economy were in deep recession or housing in freefall, regulators might hesitate to change anything major (fearing destabilizing fragile markets or that new private capital wouldn’t be available).

• As of May 2025, the environment is reasonably favorable (no crisis, moderate growth, high but potentially peaking rates). This likely emboldens the recap effort. Indeed, the first quarter results show the GSEs minting money even in a high-rate environment – a good selling point to investors: they are resilient across cycles.

Tail Risks: A few macro tail risks to note:

• Another Pandemic/Event: Something that causes widespread forbearance or intervention – in 2020, GSEs allowed mass forbearance with government support. They navigated it without draws thanks to Fed liquidity and eventually low defaults. A similar event could temporarily strain cash flows but lessons learned from COVID would help mitigate impacts.

• Global Financial Stress: GSEs rely on global investors for Agency MBS demand. If, say, global rates spike or there’s a credit crisis, Agency MBS spreads could widen, raising mortgage rates irrespective of GSE policy. That in turn could hit origination and possibly home prices. Also, if MBS spreads blow out, the value of GSE guarantees (to investors) is that much more important – might be positive for their franchise (more demand for guarantee), but negative if it leads to higher default risk.

• Inflation in Housing Costs vs Wages: If home price inflation resumes outpacing wage growth significantly, there could be political pushback on GSEs to do more for affordability (which could mean subsidized programs that might cost them, e.g., buying down rates for certain groups, which could pinch profitability). Right now, that’s not too severe, but always a dynamic to watch.

In summation, the macro/housing backdrop for Fannie and Freddie is cautiously favorable: credit quality is excellent, house prices are holding, and interest rates, while high, are expected to moderate, potentially boosting their business. This environment reduces the risk of a downside shock requiring new bailouts or undermining investor interest. It creates a window of opportunity to recapitalize while times are relatively good. However, investors in the equity should remain aware that their bet is heavily contingent on macro stability; a sudden housing downturn could quickly shift the narrative back to loss avoidance and Treasury support, which would be detrimental to shareholders. Conversely, a “Goldilocks” scenario of gently falling rates and steady or rising home prices over the next 2–3 years would greatly facilitate a smooth exit from conservatorship and likely enhance the value of the equity in any public offering.

Regulatory/Accounting Triggers

Fannie Mae and Freddie Mac’s operations are governed by a complex web of regulatory rules and accounting provisions that can trigger changes in capital and shareholder payouts. Key among these are the Enterprise Regulatory Capital Framework (ERCF) requirements, the Preferred Stock Purchase Agreements (PSPAs) covenants (which include dividend payout restrictions), and certain accounting treatments (like deferred tax assets). Let’s break down the crucial triggers and thresholds:

1. ERCF Capital Requirements: Implemented in 2020 (and amended slightly in 2021–22), the ERCF dictates how much capital (equity) the GSEs must hold relative to their risk-weighted assets and exposures. There are minimum ratios and buffers (much like bank Basel rules). A few critical points:

• Numerical Thresholds: As of Q1 2025, Fannie needed ~$187 B total capital (14% of RWA including buffers) and had an adjusted total capital of ~$154 B, a $33 B shortfall. Freddie needed ~$141 B and had ~$108 B, a ~$33 B shortfall similarly (these numbers align with the combined $328 B needed vs $147 B available as of Q3 2024). The buffer components (capital conservation buffer, stability buffer, countercyclical buffer if activated) mean the GSEs effectively need more than the minimum 8% risk-based ratio – up to ~14% of RWA and a 2.5% leverage ratio.

• Payout Restrictions: Under ERCF (similar to bank rules), if an Enterprise is below its buffer requirements, it faces restrictions on capital distributions (dividends, buybacks). Specifically, the “maximum payout ratio” for Fannie and Freddie is 0% currently because they are not above the buffers. That means they legally cannot pay any dividends to junior stakeholders and even the senior pref dividends are suspended by agreement until capital goals are met. They also can’t do equity buybacks (not that they would in cons.).

• Automatic Triggers: If the GSEs were released and fell below certain capital levels, ERCF has a ladder of consequences (like banks’ capital buffer frameworks). Falling into the buffer triggers restricted payouts, as noted. Falling below minimums might trigger a requirement to submit a capital restoration plan. In extreme shortfall, FHFA could re-enter conservatorship or other prompt corrective action.

• Countercyclical Buffer (CCyB): FHFA’s rule originally had a dynamic component where in times of high home price growth the required capital would increase (countercyclical capital buffer up to 2% of assets). In 2021, FHFA (Thompson) set CCyB at 0 and removed automatic linking to HPI. Pulte’s FHFA could revisit this – possibly keeping it at 0 (easier capital rules) unless a future housing boom warrants raising it. Lower buffers help shareholders by allowing more capital return.

• Advanced Approaches Delay: FHFA proposed delaying certain advanced risk modeling (Basel-like) to 2028. This is technical, but essentially it means they stick with the standardized approach for now, which they are meeting in part. It avoids an even stricter regime kicking in early. That’s favorable for giving time to recap.

2. PSPA Covenants & Triggers: The PSPA agreements (between Treasury and each GSE, managed by FHFA) have several important provisions:

• Dividend Stopper: The January 2021 Letter Agreement (and 2019 one) provides that the GSEs don’t have to pay dividends to Treasury’s senior pref until they hit the capital targets (adjusted for buffers). This allowed them to retain earnings. But it also effectively means Treasury is not receiving cash returns now – instead its pref grows by the retained earnings amount. Once capital targets are met, absent a new amendment, the prior rule would have them resume paying a dividend (which was 10% on outstanding pref or the entire net worth under NWS terms – however the NWS is technically still in place but the dividend is currently zero because of capital exception).

  • We might see an amendment before they reach full capital, because currently if they reached say $187B required, the sweep could technically restart for anything above that. FHFA would likely not allow that as it would siphon capital out immediately. So a trigger to watch is as capital gets closer to required (say 80-90% there), will they renegotiate to avoid a sudden dividend restart? Possibly the new plan would supersede that anyway.

• Capital Reserve Amount: There used to be a concept of a capital reserve in PSPA that gradually increased and then was eliminated by the 2017 amendment (replaced by NWS full sweep) and then reintroduced ($3B in 2017, then $20B in 2019 etc.). Now effectively the reserve is whatever ERCF allows (the entire build).

• Limits on Activities: PSPA has certain covenants limiting risk: caps on the size of retained mortgage portfolios (currently $250B each, which they are under by a lot), restrictions on purchasing higher-risk loans (e.g., % of low credit score or high DTI loans – some of which were temporarily relaxed due to COVID then reimposed), and no issuance of new capital stock without Treasury permission (thus they can’t raise equity now even if they wanted). Importantly, they cannot exit conservatorship without Treasury’s consent due to the need to terminate the PSPA. So PSPA effectively gives Treasury a veto.

  • For example, as of late 2020 the PSPA limited acquisitions of certain types of mortgages (single-family with multiple risk layers, etc.), which the GSEs had to manage to. Changes in these could affect market share slightly.

• Warrant Expiry: The PSPA warrant for 79.9% common expires 20 years from issuance (Sept 2028). That’s a hard deadline: if not exercised by then, Treasury loses that claim. This is a major time trigger because it means by late 2028 Treasury either monetizes or extends it. They could amend PSPA to extend, but again that might require compensation or raise legal questions. The current admin likely intends to exercise long before then (indeed, floating that the government could get $250B from an IPO suggests exercise soon). But if for some reason release hasn’t happened by mid-2028, Treasury would likely exercise while still in conservatorship and just hold the shares (making the government the outright 80% owner). That would be a significant event for commons (sudden dilution). So 2028 is a looming drop-dead date for some action. We include that on the timeline.

3. Accounting Considerations:

• Deferred Tax Asset (DTA): The GSEs have large DTAs from past losses. They’ve been recognizing them gradually. The DTAs are counted in regulatory capital (with some limitations; generally, DTAs arising from timing differences are allowed up to a % of CET1 if likely to be realized – they do expect full use given consistent profits). A quirk: if a GSE were to suddenly be private and highly capitalized, they might start paying normal taxes (they are paying taxes now actually, after the DTA was largely re-recognized by 2013, they resumed tax expense – e.g., Fannie had ~$0.92B tax in Q1 2025 on $4.58B pre-tax, ~20% rate). However, a lot of DTA still remains on the books (possibly tens of billions) which shelters some income. Any changes in corporate tax law or if they needed to revalue DTA (e.g., if tax rate cut, DTA value falls and hits earnings) is one factor. More importantly, in 2012 they wrote back the DTA to income (a one-time huge profit) which triggered big sweep payments. No similar accounting bomb is looming now, but if for any reason they determined some asset was overvalued (say, if interest rates permanently higher, the value of credit enhancements?), it could cause an equity hit. Not much indication of that though.

• Fair Value Sensitivity: The GSEs report comprehensive income including mark-to-market on certain available-for-sale securities. Rising rates in 2022 gave them unrealized losses in AOCI (which are excluded from regulatory capital under certain deferred regime or once advanced approach? Need detail: ERCF initially said AOCI counts in capital, but I think they changed that to allow AOCI filter for certain AFS securities – not sure if implemented). If AOCI were counted, rising rates hurt their “regulatory capital” by reducing AFS values. FHFA had a provision where AOCI is included in CET1, making capital more volatile. Bank regulators often exclude AOCI for bonds; FHFA initially included it, which Fannie argued is too harsh given rate swings. If Pulte’s FHFA revises that and allows an AOCI filter, it could instantly raise CET1 if there were unrealized losses. Conversely, if rates fall and those losses reverse, capital improves automatically. It’s somewhat technical but important in how conservative or volatile the capital measure is.

• CECL (Credit loss accounting): The GSEs use CECL (Current Expected Credit Loss) accounting for loan loss reserves. So in anticipation of a recession, they might build reserves (hit to earnings) even if actual losses haven’t happened. Conversely, in improving forecasts, they release reserves (boost earnings). This can cause earnings swings that aren’t actual cash losses. For instance, in Q1 2025, Fannie had a modest provision release vs big releases in prior year, affecting the YOY net income decline. If one models earnings forward, one must consider that in a benign scenario, reserve releases could continue adding to profits, but if macro outlook darkens, they’d increase provision (hitting profits). So earnings can be lumpy due to accounting, which in turn affects how quickly capital grows.

4. FHFA Rules and Potential Changes: There are some regulatory triggers we anticipate or recommend watching:

• GFE (Guarantee Fee) adjustments: FHFA could adjust base guarantee fees. In 2022, they imposed new fees on high-balance loans and second homes (to comply with PSPA limits under Treasury at the time, now maybe moot). If capital requirements stay high, FHFA might allow GSEs to charge more to earn sufficient ROE. Conversely, if capital is deemed too high, FHFA could lower fees to pass savings to borrowers. These policy choices directly affect earnings. Right now, guarantee fees are historically high (~50bp vs ~22bp pre-2008), partly to cover capital costs. We think any privatization plan likely maintains or even slightly raises G-fees to ensure profitability with big capital – meaning cross-cycle, mortgage rates may be a few basis points higher than they’d be with government support. If a future FHFA tried to cut G-fees for policy reasons, that’d reduce revenue. So watch FHFA annual g-fee reports and any announcements.

• Ending Conservatorship Triggers: FHFA could set out formal criteria for release. Former Director Calabria had indicated an exit would require certain capital level (perhaps meeting minimums, 3% leverage) plus development of a “living will” (resolution plan) and other risk management improvements. The Housing and Economic Recovery Act (HERA) doesn’t specify numeric triggers, it leaves it to FHFA’s discretion. Under Thompson, FHFA said they won’t release until capital met and perhaps until Congress weighs in. Under Pulte, likely they’ll say “we deem them ready once we have a plan in place.” So in reality, the trigger is political, not formulaic now. However, legally FHFA must declare the companies “sound and solvent” to exit. Achieving a certain threshold of capital could be cited as evidence of safety. If by late 2025 they have, say, $120B each required and they have $110B – they might fudge and say with a capital raise of the remainder, they can exit.

5. Dividends & Capital Distributions (Post-Release): Once out of conservatorship, normal rules would apply:

• They cannot pay dividends that breach capital requirements (like banks under Fed rules, must be above buffers).

• They might want to initiate preferred dividends again (if any preferred remain outstanding and not converted). Currently all junior prefs are non-cumulative, so missed dividends don’t have to be paid retroactively. But to restore normalcy, they’d likely start paying their stated quarterly dividend once released or nearing release to signal strength (e.g., one could imagine as part of settlement, resuming preferred dividends even before full release, once capital adequacy is in sight).

• Common dividends would likely come later – initially they’d retain earnings to grow capital or pay off government stakes. The ERCF buffer requirement might effectively stop common dividends for a long time unless earnings overshoot. Recall, even large banks, after stress tests, have to be above buffers to pay out. We expect no common dividend for years post-release; investors are more interested in capital appreciation.

6. Other Accounting Quirks:

• There was a provision where upon exiting cons., the GSEs might have to re-establish an allowance for the funding commitment fee (which was waived). Probably not material now.

• The senior preferred stock on balance sheet at only its initial stated value ($1,000 per share times ~120K shares = $120B for Fannie), not the full $216B liquidation pref. So book equity is not reflecting that extra $95B obligation because it’s off-balance sheet in a sense. If a deal is struck to extinguish that, accounting may record a big one-time gain or something if settled below carrying (but likely it’ll be at carrying or above).

• If warrants are exercised, it doesn’t affect P&L, but will dilute EPS massively going forward. They’d likely treat it as new equity issuance at par basically.

Regulatory Outlook: The Pulte FHFA likely intends to adjust regulations to facilitate recap. Some possible changes:

• Revise ERCF to be more in line with actual risk (which could lower required capital, thus reducing how much new equity needed or how long to build). For instance, credit risk transfer exposures might get bigger capital relief (currently limited to 10bps benefit IIRC), or remove the requirement for a stability capital buffer (0.5% of exposures) which Calabria had added. Fitch Ratings noted current combined required capital $250–300B is well above what private rating agencies think is needed. So expect potentially a proposal in 2025 to tweak capital rules (these would go through notice and comment).

• Commingled Securities Rule: FHFA proposed cutting the risk weight for commingled UMBS (one GSE holds some of other’s pools) from 20% to 5%, a minor change but reflective of trying not to overcount risk. That was done.

• New Products Approval: Post-release, GSEs will still have regulatory guardrails. HERA requires FHFA to approve new products. The GSEs might want to innovate (maybe credit risk transfer structures, fintech partnerships, etc.) to boost returns. FHFA’s approach could either be permissive (to help them compete and earn) or restrictive (to avoid mission drift). For example, if they wanted to restart certain higher-margin activities (like portfolio investments in non-agency MBS), FHFA might limit that for safety.

7. PACTA (Preferred Stock Agreements) Changes to Watch: The next amendment to PSPA is expected to outline new terms. Key triggers could be:

• Capital Ending Declaration: If Treasury declares the GSEs have reached a "safe harbor" capital, then certain PSPA provisions like the sweep might formally end.

• Fee Implementation: Possibly a trigger where once released, a periodic commitment fee to Treasury starts (which could be set to zero for first years then adjust, etc.).

• Affordability Investments: A potential requirement from the Biden-era Treasury was to have GSEs devote some earnings to affordable housing funds (the GSEs already pay allocations to Housing Trust and Capital Magnet Funds – ~$0.7B in 2022, mandated by HERA resumed in 2015). There was talk in 2021 of increasing those. The new admin might not emphasize that, but any future political compromise might.

In essence, the regulatory and accounting framework currently keeps Fannie and Freddie in a conservative posture – no capital distributions and building equity. Key triggers that would change investor fortunes are:

• Attaining required capital (or a regulatory decision to declare them adequately capitalized sooner): This is a precursor to any dividend or release.

• PSPA amendment execution: The day that happens and warrants are exercised will massively change the share count and ownership structure (dilution trigger).

• Warrant expiry in 2028 if nothing done: that’s a cliff where either shareholders get a windfall (if Treasury somehow doesn’t exercise, unlikely) or heavy dilution if exercised all at once.

Investors should monitor FHFA announcements (they issue capital disclosures quarterly which show progress, and any proposed rule changes in Federal Register) as well as Treasury-FHFA press releases for PSPA amendments. These technical signals will often precede or confirm the major strategic decisions regarding recapitalization.

To summarize, while much of the GSEs’ fate is political, it is bounded by these regulatory/accounting guardrails. The current rules virtually lock away any shareholder value until capital goals are met, which explains why ending the conservatorship requires either changing those rules or achieving the targets via infusion. The conservatorship can almost be seen as a regulatory state itself – one which the current administration is trying to exit by simultaneously modifying rules (to ease exit) and meeting thresholds (to justify exit). Successful navigation of these triggers – particularly hitting capital requirements (perhaps through a combination of earnings and new equity) – will be the tangible measure indicating that release is imminent.

Governance & Management

Fannie Mae and Freddie Mac’s governance structure today is a hybrid between a government conservatorship and a private corporation. Understanding who is actually in charge and how decisions are made is important for anticipating future moves and the dynamics post-conservatorship.

FHFA Control Dynamics: Since September 2008, FHFA as conservator has absolute authority over the GSEs. Legally, the FHFA Director “succeeds to all rights, titles, powers, and privileges” of the boards and shareholders. This means:

• The FHFA can override any board decision, replace board members, and direct business strategy. It has done so frequently (e.g., forcing the Net Worth Sweep, mandating the alignment of Fannie/Freddie programs, setting strategic plans).

• Shareholders cannot during conservatorship elect directors or enforce typical governance rights. For instance, annual shareholder meetings still occur but are perfunctory – FHFA effectively votes the majority of shares (including an enormous bloc from Treasury’s warrants, though not exercised, FHFA and Treasury agreements treat FHFA as controlling).

• FHFA has delegated day-to-day management to the companies’ executives, but those execs ultimately answer to FHFA. There is a Consent Order-like environment where many actions (issuing debt beyond a threshold, changing underwriting standards, etc.) require FHFA approval.

Boards of Directors: Both Fannie and Freddie do maintain boards, comprised of independent directors and a few designated by FHFA. Pre-conservatorship, boards were elected by common shareholders (with the Treasury warrants unexercised, common shareholders technically could still elect – but FHFA suspended shareholder voting rights). During conservatorship, FHFA has the power to appoint and remove directors. Historically, FHFA left a mix of legacy and new directors, often experienced financial services individuals, to provide oversight and advice. However, as noted in Recent Developments, Director Pulte has shaken up the boards in 2025:

• He removed certain members and appointed others aligned with his goals (including a controversial appointment of a Government Efficiency official to Fannie’s board, presumably to scrutinize operations).

• The boards still have committees (audit, risk, comp) and do normal oversight tasks, but any major strategic decisions (capital management, multi-year plans) are essentially directed by FHFA.

The current boards will likely persist through conservatorship but could be revamped again at release. Post-release, assuming conservatorship ends, shareholders (including Treasury and whoever buys new shares) will get to elect boards again. So we may see, say by 2026, a fully reconstituted board that includes representatives of new capital providers, etc. It’s possible some of the interim board members now might continue if they’re deemed good stewards.

Management (Executives): Both GSEs have CEOs, CFOs, etc. As of Q1 2025:

• Fannie Mae’s CEO: Priscilla Almodovar (appointed Oct 2022). She is a former banking executive with expertise in community development lending (from JPMorgan Chase). Her focus has been mission goals and improving technology. So far, there’s no public indication she’s been removed by Pulte – perhaps because Fannie had no immediate scandal or Pulte focused first on Freddie.

• Freddie Mac’s CEO: Until March 2025, Michael DeVito (appointed mid-2021, former Wells Fargo mortgage head). He was fired by FHFA/Pulte in March 2025 amid the conservatorship overhaul. No permanent replacement named yet; likely the President or CFO was made acting CEO.

• Other key execs: Both have newish CFOs (Fannie’s Chryssa Halley, Freddie’s Chris Lown) who present earnings; Chief Risk Officers; General Counsels.

• FHFA also placed “35 employees on leave” including possibly some at the Enterprises or just at FHFA itself. Among those were reportedly Freddie’s COO and the head of the FHFA examiners? It’s a bit unclear from news, but suggests FHFA suspects some entrenched personnel were not on board with reforms.

Management incentives and stance: GSE executives historically had caps on pay due to political scrutiny (the CEOs make around $600K base, plus potential deferred compensation up to $4 million with conditions – far below private financial CEO pay). This was to avoid public outrage that gov-backed entities pay fat cat salaries. In 2021, there was even debate about raising CEO pay to attract talent; ultimately caps remained. This pay structure means management might not be as personally invested (no stock options right now, no huge bonuses) in share price outcomes. They are more motivated by legacy, public service, and maybe eventual opportunities if they successfully navigate the company out of cons.

Currently, Pulte’s relationship with management seems tense. He clearly didn’t trust Freddie’s leadership (hence ouster). If Almodovar and her team align with the new agenda, they might stay. If not, Pulte may replace Fannie’s CEO too. In a recap scenario, it wouldn’t be surprising if new boards (with investor input) eventually bring in new CEOs perhaps from banking or finance with experience running public companies. Or possibly if the current execs prove capable, they’ll continue.

Corporate Governance: In conservatorship, normal governance practices (SEC reporting, audits, risk management frameworks) still operate. Both companies file 10-Ks, 10-Qs with extensive risk disclosures (with the caveat of their uncertain shareholder situation). They have to adhere to FHFA regulations and also certain NYSE standards voluntarily (even though delisted, they maintain some governance best practices). For example, they have independent audit committees, etc.

One unique aspect: because the U.S. government (via FHFA) effectively controls them, there’s a built-in conflict between FHFA’s goals and minority shareholders’ goals. Pre-2008, management occasionally lobbied vs. tighter regulation; now management is basically an arm of regulator. Post-release, this could flip again to a degree (management will owe fiduciary duty to shareholders again and might sometimes push back on FHFA mandates if they feel it harms shareholders beyond what’s required by law).

Talent and Staffing: A practical consideration – after 16 years, a lot of experienced staff have cycled out or become complacent under government direction. The companies have done innovative things (like building the Common Securitization Platform, introducing credit risk transfer, tech upgrades), but also some argue they’ve become bureaucratic (“obese” as Pulte said). Pulte’s overhaul aims to slim down overhead. For example, requiring FHFA staff to justify roles, or halting what he calls “non-essential” programs might reduce headcount. Both GSEs have thousands of employees (Fannie ~7,400, Freddie ~6,800 in 2022). Efficiency moves could improve earnings but might cause internal disruption. From an investor lens, a leaner cost structure (lower admin expenses) is positive for profitability – indeed, Pulte mentioned running them more efficiently to lower origination costs industry-wide. However, if too many key people leave, execution risk rises.

FHFA’s Future Role: Upon release, FHFA switches from conservator to regulator. The Director (Pulte, if still in term – FHFA Director has a 5-year term, but since SCOTUS says President can remove at will, it’s basically tied to administration now) will still wield a lot of influence: approving new activities, setting capital rules, possibly approving significant transactions. But it will be more like a bank regulator – they won’t have day-to-day veto on business decisions (like setting g-fees or hiring executives) unless an issue arises.

One governance item often discussed is whether, post-release, to treat Fannie and Freddie like Systemically Important Financial Institutions (SIFIs) with oversight by the Fed or FSOC (Financial Stability Oversight Council). FSOC could designate them as SIFIs, which would bring Fed regulation. That hasn’t happened in conservatorship because FHFA is primary. But if privatized, there’s a chance FSOC tags them (some argue it’s redundant with FHFA’s oversight; others say an extra layer is prudent). If they became SIFIs, the Fed might impose additional constraints (e.g., Fed stress tests, resolution planning akin to large banks). The 2018 law that eased some SIFI thresholds left a carve-out that FSOC can designate non-banks like GSEs. This is a medium-term governance consideration that could affect how they operate and how markets view them (SIFI designation would confirm their systemic importance but also likely mean stricter discipline akin to big banks).

Government Representation: Treasury and HUD do not directly sit on the boards (they did not nationalize the companies, they just have contractual rights). But with warrants exercised, Treasury could theoretically become the majority shareholder and might place officials on the board (like how the government did with GM or AIG boards during bailouts). It’s plausible that as part of release, Treasury will initially hold ~80% of voting shares – they may then appoint some directors representing taxpayer interests until they sell down. Possibly a condition of exit could be a golden share or special governance rights for government (for instance, requiring a certain capital level or veto on certain risky activities). Those details will matter for governance long-term and how much the market perceives them as truly independent companies versus quasi-public utilities.

Compensation and Talent Post-Release: If they do exit, expect that the companies will need to adopt competitive executive compensation to retain and attract leadership. The $600K CEO cap would likely be lifted (it’s a political hot potato, but necessary if they are normal companies). Shareholders might support that as long as management is driving returns. There could be stock-based compensation plans introduced (aligning management with stock performance, which currently is absent). So ironically, management teams might become more aligned with shareholders after release, whereas now they’re more aligned with regulator/politicians due to compensation structure.

Culture and Mission: Internally, GSEs have a culture of public mission, pride in supporting housing, etc. Under conservatorship they’ve been careful to adhere to FHFA’s housing goals. One risk post-release is a cultural shift if new private owners push for profit maximization at the expense of mission (like lowering standards for affordability initiatives, etc.). FHFA will likely bake in mission requirements to guard against that (e.g., continue affordable housing goals and duty-to-serve requirements even as private entities). But the tone from the top matters – the board and CEO will set it. The composition of owners (if, say, mostly hedge funds vs. a broader set of investors) might tilt priorities. This interplay of mission vs. shareholder returns will be a governance balancing act.

Key Takeaway: Right now, Bill Pulte and FHFA are effectively “the board” and “the controlling shareholder”. This autocratic but clear governance may actually expedite reforms (no need for multilateral consensus). Once out, governance normalizes but also gets more complicated (multiple shareholders, regulatory oversight rather than control, profit vs. mission trade-offs). Investors should be cognizant that while Pulte’s FHFA is steering the ship, the outcome will be driven by his team’s decisions. Should any conflicts arise – e.g., between FHFA and Treasury, or between FHFA and management – it could cause changes in personnel or direction.

So far, Pulte’s actions suggest a willingness to remove or sideline anyone not fully on board with the privatization mission. Therefore, one could say the current governance philosophy is “top-down, directive”. We expect that to continue until the moment of release, after which governance will shift towards a more typical corporate structure with new owners and board accountability to shareholders. The transitional period will be delicate: the existing management must keep operations smooth while essentially preparing to give up government protection and face market discipline. Those that navigate it successfully will likely continue in leadership; those who can’t may be replaced by more entrepreneurial or Wall Street-seasoned executives.

In closing, governance risk in GSEs is twofold: short-term (will Pulte’s shakeup disrupt operations? will new appointees perform?) and long-term (will governance post-release allow these entities to be run efficiently and safely?). At this moment, the short-term risk seems under control (the Q1 results show no disruption in performance). The long-term governance question will depend on the yet-to-be-determined new ownership and regulatory constraints. Investors should watch for signals like who gets appointed as permanent Freddie CEO, any further board changes, and how FHFA outlines its oversight role in an exit (e.g., requiring a majority of independent directors, etc.). These will shape how confidently the market views the companies once they stand on their own.

Policy/Execution Timeline

We now lay out a 24-month forward timeline (mid-2025 through mid-2027) of expected and potential events that could materially impact Fannie Mae and Freddie Mac, their path out of conservatorship, and their securities. This timeline includes regulatory milestones, legal case resolutions, and market-related events:

• Q3 2025: Administration GSE Plan Unveiled – We anticipate that by late summer or early fall 2025, the Treasury and FHFA will publish or leak a comprehensive recapitalization blueprint. This could be in the form of a Treasury Housing Finance Reform Plan (updated from 2019’s plan) or an outline given to Congressional committees. It likely details steps like PSPA modifications, capital raise targets, and safeguards for taxpayers. This will be a major catalyst: if the plan is viewed as shareholder-friendly (e.g., reasonable conversion rates for prefs, preserving some common stake), stocks could rally; if it’s harsh (e.g., heavy new issuance at low valuation), there could be selloff.

• Late 2025: PSPA Amendment Execution – Possibly in the fourth quarter of 2025, FHFA and Treasury may formally sign the amended PSPA agreements to implement reforms. This could coincide with an initial warrant exercise by Treasury (they might exercise a portion or all of the 79.9% at this point to take ownership on the balance sheet). At the same time, expect an announcement of intention to raise capital. Legally, this amendment might require only administrative approval, but politically, they may time it after some Congressional consultations to avoid backlash.

• Q1 2026: Equity Offering / IPO Phase 1 – If markets are conducive, the first large public equity offering could happen in early 2026. The GSEs (likely starting with Fannie Mae, the larger one) could issue new common stock either through a follow-on offering or a structured placement to institutional investors. The timing might align with full-year 2025 results (which should be strong, demonstrating earnings power). An IPO-style roadshow would precede it. It’s possible both GSEs do offerings around the same time to avoid one’s share pricing relative to the other being off-kilter. The size might be, say, $10–20 B each in this tranche. The success of this will be pivotal – a well-subscribed offering at decent valuation would accelerate plans; a weak reception would force rethinking.

• Mid-2026: Junior Preferred Share Exchange Offer – Around mid-2026, after initial capital raise, Treasury/FHFA will likely address the outstanding preferred stocks. Look for an announcement of an exchange offer where preferred holders are invited to swap their shares for common stock or cash. They may stagger by series or do all at once. The offer terms (e.g., 0.7 shares of common per $1 of pref par, or some fixed cash amount) will determine how prefs trade. The acceptance threshold will need to be high (perhaps requiring 2/3rds of each class to avoid holdouts). This period will be crucial for preferred investors: they will assess whether to accept or attempt to hold out for something better (though the government could then move to void prefs in receivership as a threat). Ideally, this resolves amicably by late 2026.

• Late 2026: End of Conservatorship – “Release Date” – Assuming capital raising and pref conversion goes well, by late 2026 the GSEs might have sufficient core capital (maybe 90–100% of ERCF requirements met). FHFA could then formally declare an end to the conservatorships. This could coincide with Treasury receiving consideration for its senior pref (e.g., conversion into common – effectively finalizing that stake as common equity). The “release” might be a specific date where each GSE files papers to terminate conservatorship and the boards/management regain full control under regulatory oversight. The optics may be managed such that it happens at the start of a quarter or fiscal year (maybe Jan 1, 2027 or something). On this day (if it comes), FNMA and FMCC would be just like other publicly traded companies and likely re-listed on a major exchange (NYSE) for greater liquidity. The Treasury would still likely own a big chunk of common stock, but as a shareholder, not through a PSPA.

• Early 2027: Treasury Sell-down & Warrants Completion – Post-release, the government may outline a plan to sell its common shares (from warrant exercise and converted pref) over time. Perhaps via secondary offerings or gradual ATOM (at-the-market) sales. They might target reducing from ~80% ownership to a minority stake by, say, 2028. The timeline could involve quarterly offerings if market can absorb, or one-time large placements to institutional investors. The execution of these sales will impact share price (a large supply of stock to be sold tends to cap upside until it’s done, but also the removal of government ownership overhang is bullish long-run). They’ll try to balance maximizing taxpayer return with not flooding the market.

• Mid-2027: Regulatory Milestones – By mid-2027, a few regulatory things likely due:

  • The GSEs may need to submit living wills/resolution plans (FHFA was working on a rule requiring them akin to banks’ plans for rapid resolution in a crisis).

  • They might also have to meet certain liquidity and risk management criteria FHFA set as conditions for release (for instance, maintaining a certain amount of available cash).

  • FHFA could finalize any capital rule tweaks (if they put an interim final rule in 2025 to reduce capital, they’d finalize after comment by 2026).

  • Possibly a recalibration of affordable housing goals now that they are private again (ensuring they keep lending to low-income segments to a specified %).

  • Also by this time, FSOC might decide whether to label them as SIFIs. If yes, they’d start working with the Fed on additional oversight.

• Legal Resolutions: On the legal front, within this timeframe:

  • The appeal of the Lamberth $612M verdict should be decided likely by late 2025 or 2026 in the D.C. Circuit. If the government wins the appeal (verdict overturned), preferred shareholders lose that leverage (could cause a dip in pref prices, though by then hopefully negotiation is in process). If shareholders win (verdict upheld), the government might pay out the judgment or settle as part of the exchange. It could also go to Supreme Court in 2026 if appealed further.

  • Any other remaining lawsuits (some takings cases may still technically be on remand for smaller claims, etc.) might wrap up. Possibly a global legal settlement could be rolled into the exchange offer (e.g., shareholders drop all claims in exchange for certain terms).

• 2026 Election Watch: November 2026 midterms (congressional elections) – If there’s extreme controversy around the GSE moves, it could become a political talking point, but midterms mainly affect Congress composition. If Democrats took one or both chambers, they could hold hearings or attempt legislation to tweak whatever the admin is doing (for example, impose conditions like affordability requirements). But likely, by mid-2026 the process may be advanced enough that legislative intervention is moot. Still, investors will watch rhetoric – if opposition in Congress is strong, it could slow things (via threats to cut FHFA funding or lawsuits).

• Nov 2028 Presidential Election Timeline: While outside our 24-month window, the looming fact is that by mid-2027, everyone will be looking to the 2028 presidential cycle. If by 2027 the GSEs are not yet out, then the timeline compresses because the admin would want it done before that election heats up (to claim victory and avoid uncertainty of a different party’s approach). Thus, mid-2027 is kind of the latest to comfortably release them with time to spare. If it’s dragging into 2028, the market will start handicapping what a new administration might do (which could complicate final capital raise efforts).

• Periodic Earnings & Disclosures: Throughout, each quarter’s 10-Q/10-K will provide clues: growing capital, any changes in footnotes about PSPA discussions, etc. They might also start disclosing pro forma post-conservatorship info as it nears (like a capital plan section in filings).

• Market Events: The MBS market might see technical adjustments – for instance, if it’s announced the PSPA backing will end by a certain date, MBS investors might demand clarity on the explicit/implicit guarantee going forward by that time. So, we might see by late 2026 a formal policy on government guarantee (will there be legislation for an explicit guarantee fee or just leave it implicit?). That could coincide with release, or if not done, the uncertainty could impact MBS spreads (thus likely they’ll address it).

Illustrative Timeline (mid-2025 to mid-2027):

• Jul–Sep 2025: Treasury/FHFA release recap plan details; possibly initial PSPA amendments (e.g., raising cap on capital retention, minor tweaks).

• Oct–Dec 2025: Formal PSPA amendment signing; Treasury starts exercising some warrants. Potential announcement of equity offering in Q1.

• Q1 2026: First new equity issuance to investors. Possibly uplist FNMA/FMCC to major exchange around this time to broaden investor base before offering.

• Q2 2026: Follow-up offerings if needed. Offer made to preferred shareholders for conversion.

• Q3 2026: Preferred shareholders vote/accept exchange. Litigation settled concurrently. GSEs by now have bulk of required capital.

• Q4 2026: FHFA declares conservatorships to end effective year-end. New boards seated (with members representing new shareholders/Treasury).

• Q1 2027: Conservatorship officially ends. GSEs operate under their own governance. Treasury still holds large common stake.

• Mid 2027: Additional secondary offerings by Treasury to reduce its stake (could be 2027–2028 gradually). GSEs possibly reinstate modest preferred dividends if any prefs remain unexchanged. Common dividends likely still retained to build capital until buffers met (maybe beyond 2027).

This is a best-case execution timeline. There are risks that could slow it:

• If equity markets slump in 2025/26 (due to recession or global issues), the offerings might be delayed.

• If political opposition mounts (e.g., a court injunction or Congress passing something to pause it – though that seems unlikely given current alignment).

• If technical issues (e.g., inability to get enough pref holders to agree) occur, they might need plan B (like using more cash or even legislative help).

On the other hand, it could potentially accelerate if things go extremely well – though given the need to build investor confidence, a phased approach is more probable than an overnight exit.

For investors and analysts, key dates to monitor on this timeline will be:

• Official announcements (they might not pre-announce dates, so one has to keep ears open for speeches by FHFA Director or Treasury Sec indicating timeline).

• SEC filing of any registration statement for new stock (that would tip off an offering coming).

• FHFA’s annual Scorecard and Conservatorship Scorecard – each year FHFA sets objectives for GSEs, if in the 2025 Scorecard (usually released end of previous year or early year) it includes “prepare for exit” tasks, that’s a signal.

• Court deadlines for appeals – the D.C. Circuit appeal in the Lamberth case likely had oral arguments possibly early 2024, so a decision could come mid-late 2024; by 2025 it might be at SCOTUS petition stage or resolved.

All these milestones ultimately serve one goal: by mid-2027, to have Fannie Mae and Freddie Mac fully re-integrated into the private market with appropriate capital and regulatory oversight, and with the government largely stepping back to a more limited role (e.g., perhaps just as an guarantor of last resort or collecting a fee). Achieving that within roughly two years is ambitious but, given the momentum and imperative, not impossible. It’s effectively a race against political and economic clocks.

Cross-Asset Impacts

Any major change to Fannie and Freddie’s status will reverberate beyond their stocks and bonds, affecting the broader mortgage and fixed-income markets – including Agency MBS, the “To-Be-Announced” (TBA) market, interest rate swaps, and potentially U.S. Treasury markets. Here we examine these cross-asset impacts, especially in a recap/release scenario:

Agency MBS Market: Fannie and Freddie guarantee over $7.7 trillion in MBS, forming the backbone of U.S. housing finance. Currently, these MBS carry an implicit guarantee due to the PSPA – investors assume the U.S. government will not let them default. The conservatorship itself bolsters confidence that Uncle Sam stands behind the Enterprises (indeed, the PSPA funding commitment of $256 B remaining is effectively a taxpayer backstop). If the GSEs exit conservatorship:

• Backstop/Guarantee Clarity: One big question: Will the government’s guarantee remain explicit, become completely implicit, or be replaced by something like a bank-like status? In absence of new legislation, the formal PSPA backing might be wound down. Scenario: If the PSPA is terminated upon release, then technically MBS investors only have the GSEs’ capital standing between them and losses, not an unlimited Treasury guarantee. However, markets may still assume an implicit government support due to GSEs’ systemic importance (“too big to fail” logic).

• MBS Spreads: If investors perceive even a slight increase in credit risk or liquidity risk in Agency MBS post-release, they will demand higher yields (lower prices). This means wider MBS spreads over Treasuries. How much? Likely modest if capital is strong. But for example, if GSEs are holding ~3.5% capital, that implies a very remote chance of insolvency (but not zero). J.P. Morgan’s analysis suggests if creditworthiness is seen as weaker without full government wrap, spreads could widen, primary mortgage rates could rise. Perhaps on the order of several basis points – some observers estimated a purely privatized GSE guarantee might add 10–20 bps to mortgage rates long term.

• Shift to Ginnie Mae: If GSE-backed MBS lose any luster, lenders might favor FHA/Ginnie Mae execution (which has the full faith and credit guarantee) for certain loans because investors might pay more for Ginnie MBS (which are 0% risk weight and fully government-backed). Already Ginnie (FHA/VA loans) has about 20% of the market. A shift of a few percentage points could occur if the pricing difference widens (e.g., banks might choose FHA for borderline loans instead of GSE). J.P. Morgan noted decisions on guarantee could impact Ginnie Mae’s market share. However, Ginnie loans are different segment (often lower credit).

• TBA Market Liquidity: The TBA market (forward trading of agency MBS) relies on fungibility of Fannie and Freddie MBS (hence the creation of Uniform MBS). As long as the market believes F&F MBS are essentially government-sponsored, TBAs will remain extremely liquid. If privatization introduced doubts, there could be slightly more differentiation (like perhaps pricing differences between Fannie, Freddie if one is perceived stronger, or lower liquidity if some investors (like banks or countries) are restricted without a gov guarantee). But likely, FHFA/Treasury will aim to preserve TBA liquidity – possibly by arranging an explicit line of credit at Treasury that continues for a transition period or by ensuring robust capital to soothe concerns.

• Credit Risk Transfer (CRT) Market: A release might accelerate CRT issuance as GSEs use it to manage capital. CRT bonds (like Fannie’s CAS, Freddie’s STACR deals) might see spreads tighten if GSE credit risk is seen as more pure corporate risk rather than government proxy (investors would analyze them more like MBS mezzanine tranches). On the other hand, if GSEs hold lots more capital, they might not need to offload as much risk via CRT, potentially shrinking that market. But given CRT has been embraced, likely they’ll continue it for efficiency. It’s somewhat niche in cross-asset, but relevant to certain credit investors.

• Mortgage Rates & Housing: Ultimately, if MBS yields rise even modestly due to these changes, it directly translates to higher mortgage rates for consumers, unless offset by other factors. A 10-20 bp rise in MBS yields in a $12T mortgage market is significant in aggregate interest cost. Policymakers are aware of this. This is why some push for an explicit federal guarantee paid for by a fee, to keep MBS yields low and stable. If the administration cannot get a law for explicit guarantee, they may quietly maintain some implicit support (like Treasury line stays for a while or re-establish PSPA in smaller form) to reassure markets.

Agency Debt & Funding Markets: Fannie and Freddie (pre-2008) were huge issuers of agency debt (short-term discount notes, medium-term notes, etc.) to fund their portfolios. Now, with smaller portfolios, their debt outstanding is much lower (~$100B range each). Post-release, if they decide to hold more assets or just for contingency, they might issue more debt. The pricing of that debt will be a tell: currently their debt trades very close to Treasuries because of implied guarantee. Freed GSE debt could trade at somewhat higher spreads, closer to high-quality corporate or supranational spreads. Not a huge market mover nowadays, but relevant to money market funds and bond indices.

Swap Spreads: Agency MBS are often hedged by interest rate swaps and Treasuries. If Agency MBS spreads widen, swap spreads might move as well (as mortgage hedgers receive fixed in swaps, etc.). There is a complex interplay: significant widening of MBS spreads could tighten swap spreads as hedgers pay Treasury and receive swap, etc. Also, if less implicit government backing, some large foreign investors might marginally reduce Agency MBS holdings in favor of Treasuries or swaps, affecting demand. But likely any moves would be incremental.

Bank Balance Sheets and Capital: Banks hold a lot of Agency MBS (risk-weighted at 20% under Basel). If GSEs are privatized without explicit government support, regulators might consider whether Agency MBS should carry a higher risk weight (since not full faith credit). It’s possible they’d keep it at 20% given the low risk, but if it moved to, say, 50%, banks might reduce holdings or need more capital. Similarly, for large institutions, a change in status could influence how MBS are treated in liquidity buffers (HQLA status). Right now, Agency MBS are Level 1 or 2A HQLA (high-quality liquid assets) depending on criteria, largely because of government ties. If considered slightly less liquid or safe, that might shift demand. However, since F&F would still be huge and likely systemically important, I suspect regulators keep MBS treatment unchanged to avoid rocking banks.

U.S. Treasury Market: If mortgage rates rise due to GSE changes, that could ironically reduce prepayments on existing MBS (investors hold MBS longer, less negative convexity), affecting demand for hedges (less need to pay swaps or sell Treasuries when rates fall if fewer refis). Additionally, if more mortgage financing cost is borne by private capital (via higher g-fees to meet ROE), mortgage rates might decouple a bit more from Treasuries (some risk premium). But overall link remains strong.

One more cross-asset angle: Housing credit availability. If a misstep in privatization led to significantly higher mortgage costs or reduced GSE footprint, it could push more borrowing either to FHA (Ginnie) or to private market (non-agency jumbo, etc.). We might see some shift in who finances marginal borrowers. Private-label MBS could try to fill any gap if GSE pull back certain segments (like investor properties or cash-out refis, which PSPA had caps on). So securitization markets outside GSE might see changes (some growth if GSE guarantee is perceived weaker for some loans).

Federal Home Loan Banks (FHLB): Indirectly, changes to GSEs could impact FHLBs (12 regional banks that provide liquidity to mortgage lenders). If GSEs become more constrained or raise fees, banks might rely more on FHLB advances to fund mortgages rather than sell loans to GSEs. Or conversely, if GSEs get strong, they might take more market. FHLBs had a huge advance surge in 2022 with rising rates (banks borrowed more). Congress and FHFA have been reviewing FHLB’s role (there’s a separate discussion about FHLB reform). This is adjacent but could interplay: if GSEs are privatized, maybe FHLBs remain the government’s main housing arm? Unlikely, but cross-asset within housing finance ecosystem, there’s interplay.

Derivatives referencing GSEs: There aren’t many direct derivatives except CRT (which we mentioned) and the credit default swaps on Fannie/Freddie corporate credit. Those CDS have long been kind of odd (post-conservatorship, the default risk was low due to government backing). Post-release, the GSEs would again have meaningful credit spreads and CDS might trade like other large financials. That’s of interest to fixed income investors and could become a traded way to hedge or speculate on GSE credit.

“Break-the-glass” scenario effect: If, contrarily, something extreme happened like receivership or merging them, it would absolutely roil markets. Merging would raise questions about the TBA market (different securities, any pooling issues). Receivership would cause technical default on their debt (triggering CDS, freezing MBS liquidity until sorted out). Because those scenarios are disruptive, they’re considered emergency options only. The baseline is to avoid such market turmoil, which is partly why the admin is taking pains to engineer a smooth path. The housing finance system is so large that any miscalculation could have spillovers – policymakers are very aware that a stable TBA market is crucial to 30-year mortgage availability. So we expect them to ensure any new framework keeps MBS investors essentially just as confident as before. If needed, they might even arrange an explicit standing repo facility for Agency MBS (the Fed already in 2019 set up one for Treasuries and Agencies to support liquidity) – something like that could reassure markets.

In conclusion, while GSE equity investors focus on their shares, they should monitor the MBS market response to reform steps. A notable widening of Agency MBS spreads in anticipation or following announcements could signal trouble – either requiring a policy fix (like providing explicit guarantee) or implying higher mortgage rates that could politically backfire. On the other hand, if MBS spreads remain tame through the transition, it indicates the market is comfortable – a sign of success. Thus far, even with Trump’s announcements, the MBS market has taken it in stride because it expects government will ensure continuity (and capital builds make the system safer).

For cross-asset traders, key signals will be:

• Indications of an explicit guarantee coming (if Congress or admin moves on it, MBS spreads would likely tighten, as that’s best case).

• Clues of Treasury support retention (like extended PSPA) versus complete removal.

• The GSEs’ credit ratings post-release: Currently they carry ratings one notch off AAA because of government support. After release, rating agencies will evaluate standalone credit. If they end up rated, say, AA- or A+, many institutions will still treat them almost government-like, but a downgrade could widen spreads a bit.

• Swaption volatility: If mortgage convexity dynamics change, implied volatility in swaptions (options on swaps) might adjust. During conservatorship, Fed holdings of MBS (QE) and stable GSE behavior have kept vol relatively lower. With more private capital at risk, some think the GSEs might not be allowed to hedge as freely if not government-backed (though they still would). Minor point, but interesting academically.

To sum up, the goal is to minimize cross-asset disruption. The timeline likely includes transitional measures to ensure MBS investors remain whole and mortgage rates don’t spike. If done well, the cross-asset impacts will be minimal and short-lived (a few basis points wiggle). If done poorly, there’s risk of a ripple that could tighten credit conditions broadly – something no administration wants on their watch, hence our expectation of caution and possible backstops to maintain confidence.

Break-the-Glass Scenarios

While the base case scenarios revolve around recapitalization or status quo, it’s important to consider “break-the-glass” contingencies – drastic measures that could be taken if conventional solutions fail or if there’s an urgent need to address the GSEs outside the normal framework. These include the “utility model” concept, forced merger, indefinite conservatorship, or even nationalization. We explore each:

1. Utility Model Conversion: The utility model would formally turn Fannie and Freddie into regulated public utilities for housing finance – akin to an electric utility company. This idea gained traction in policy circles as a middle ground:

• Under this model, the GSEs would have a regulated rate of return (say 9-10% ROE) set by a regulator (FHFA or a new regulator), and in exchange, the government would explicitly guarantee their MBS (or at least provide a catastrophic backstop) to keep costs low. They’d essentially operate as infrastructure providers, with less competition risk and a mandate to serve all markets reliably.

• This could be implemented via legislation or conceivably via charter changes if Treasury/FHFA negotiated it, but likely needs a law for an explicit guarantee.

• For shareholders, a utility model might cap upside (no breakout profits in boom times; excess must be returned to consumers or to capital reserves) but also reduce risk (almost government-guaranteed stability). Preferred shares could be treated akin to preferred in a utility – pay regular dividends, relatively safe. Common could trade at moderate multiples of book like a stable utility stock with steady dividend yield.

• Some reform advocates (including some investor groups) supported this as it would cement GSEs’ role and potentially allow a predictable path to release (investors might accept lower returns in exchange for clarity and guarantee). Critics argue it perpetuates government involvement and might deter innovation.

• When to break this glass? If pure privatization looks unachievable (e.g., insufficient capital can be raised, or political consensus emerges that an explicit guarantee is needed), a utility compromise might be forged. Possibly by a future Congress if current plan stalls.

• Impact on equity: If done initially via legislation, it could forcibly restructure equity (like convert all existing shares into shares of the new utility under some formula). Ideally, they’d honor par for preferred and give common some stake, but Congress could also wipe out current equity claiming it was needed for stability (though after the 2023 verdict showing government overreach, outright wipeout without compensation would be legally risky).

• The utility model basically is lower risk, lower reward. If implemented post-release, it might mean stable dividends but no growth.

2. Forced Merger (“Single Utility”): Some have proposed merging Fannie Mae and Freddie Mac into one entity. The rationale: eliminate duplicate costs, simplify the system (one set of securities, one guarantor). In conservatorship, FHFA could likely merge them by charter change or using receivership to consolidate (since they are separate companies by law, might need legislative help unless they do some creative reorganization).

• A merger could be forced as part of an exit plan: e.g., create a new company (“Unified Federal Mortgage Corp.”) and transfer both GSEs’ assets and liabilities into it, then extinguish the old charters. Or let one acquire the other.

• Pros: Operational efficiency, easier oversight, avoids competition lowering standards. Cons: Would create an even bigger single point of systemic risk, and reduces lender choice.

• For equity, merging means figuring out exchange ratio of FNMA to FMCC shares. Historically, Fannie was ~2x the size of Freddie by assets and revenue. If based on relative value or capital, FNMA shareholders might get, say, 2 shares of new company for each share, Freddie maybe 1 for 1 (just conceptual). Preferred series likewise would merge or be equated.

• It hasn’t been a front-line proposal recently because most prefer two entities to spur some innovation and for political reasons (two HQs, two sets of influence). But in a pinch, merging could simplify raising capital (only need one entity to capitalize) and might allow easier implementation of utility model.

• Break glass scenario: If one of them was in much worse shape than the other (not the case now; both are healthy), or if funding for two separate was hard but for one combined could achieve scale, they’d consider it.

3. Indefinite Conservatorship (Permanent status quo): This is essentially not breaking the glass but just never ending the “temporary” conservatorship. Yet, it is a scenario to acknowledge – perhaps the glass remains unbroken. There was a genuine possibility under previous administrations that they might just keep Fannie/Freddie in conservatorship indefinitely as quasi-nationalized entities providing public utility-like service but without addressing the equity. Indeed, since 2012 some in Congress were content with the arrangement (Treasury gets profits, housing gets support, shareholders are sidelined).

• If current efforts fail (e.g., due to a new admin in 2025 reversing course or inability to raise capital), we could slide back into that limbo. They’d continue retaining earnings until maybe 2030s to meet capital (as mentioned, ~7 years to organically get required capital). Eventually they would have enough capital that perhaps then a future admin or Congress might act (or they start paying Treasury again at 10%).

• The risk here is political: leaving them in cons. forever is de facto nationalization without clear authority, plus it keeps capital locked at companies that can’t return it to investors or fully deploy it.

• Effect on equity: Likely prolonged depression of prices, though if they fully capitalize and still not released, at some point pressure would mount to do something (maybe start paying a small dividend to junior pref to avoid lawsuits about enrichment of Treasury beyond agreement? Perhaps not, since NWS still legally stands).

• This scenario is basically the “kick the can” that we had for 14 years – possible if political will evaporates.

4. Receivership/Nationalization: The most extreme break-glass is to place the GSEs into receivership under HERA. In receivership, FHFA would liquidate or restructure the companies, and by statute it must wipe out common equity (and likely preferred) if assets < liabilities (which under fair value might be argued if Treasury’s senior pref is treated as liability). Receivership could be used to create successor entities shorn of old equity claims. For example, in 2008 some advocated going to receivership to void shareholder interests and relaunch GSE functions in a new vehicle or fold into a government agency.

• This would be highly disruptive now that the GSEs are financially strong (hard to justify “failed” institution). It would provoke lawsuits for takings (shareholders saying we weren’t insolvent, you expropriated us).

• But one could conceive a scenario: If the Supreme Court or Congress somehow said the current conservatorship is illegal or must end, and no capital solution ready, the administration could opt for receivership as a quick fix, effectively nationalizing them (and then maybe reprivatize later).

• Under Biden’s admin, there was concern that if forced to consider release, they might instead opt for receivership to force Congress’s hand. But SCOTUS did not force such a timeline. Under Trump admin, receivership is off the table because they want to unlock value (receivership would destroy current investor value).

• Nationalization outright: Short of receivership, Congress could pass a law nationalizing them (buying out shareholders at some low price and folding into HUD or a new agency). This is very unlikely given ideological opposition and the need to pay just compensation (which could be tens of billions). So it’s more a theoretical specter than a practical route.

5. Hybrid or New Structure “Break Glass”: Other imaginative scenarios:

• Mutualization: Convert GSEs into lender-owned mutual cooperatives (like FHLBs). Some proposals would have current shareholders bought out or massively diluted as ownership transfers to banks. This could require banks injecting capital (not likely appetite).

• Split up by business line: E.g., spin off multifamily units as separate companies (some advocated as those have distinct risks). That could be done in a receivership or via sale. Unlikely in near-term but possible long-run if deemed better to have specialized firms.

• Merger with FHA/Ginnie: Another far-fetched idea: combine GSEs with FHA or GNMA to create one big housing entity. This would essentially nationalize them because FHA/Ginnie are government. Not seriously considered due to complexity and differing missions.

• Perpetual Conservatorship with Modifications: Not ending cons., but making it more livable – e.g., allow junior pref dividends again even while in cons (would require Treasury okay), or allow partial private capital raises but still under cons. (some suggested raising third-party capital that sits junior to Treasury to test markets). This would be like half measures. Possibly considered if full release is delayed – like maybe they try to do a partial capital raise under cons. and leave Treasury in control until more is raised. It blurs lines but could happen if needed.

When Would These Break-Glass Options Trigger? Think of them as fallback if:

• The current recap plan fails (due to market or political block).

• A financial crisis hits before they’re released, forcing emergency action (like if house prices crashed 30% and GSEs needed new Treasury draws, maybe Congress would then step in with a permanent solution which could involve utility model or nationalization).

• Or if a new administration in 2029+ has a completely different philosophy (e.g., a progressive Democratic admin that doesn’t want hedge funds profiting, they might say “we’re ending this charade, let’s nationalize with compensation equal to recent market price and fold into a public utility”).

From an investor perspective, most of these break-glass scenarios (except perhaps utility with compensation) are quite negative for current equity:

• Utility model via legislation might give something but limit upside.

• Merger doesn’t change aggregate value much but could cause uncertainty in conversion.

• Indefinite status quo means dead money.

• Receivership/nationalization basically wipes out or severely haircut shares.

Thus, one invests in FNMA/FMCC believing those worst-case options will be avoided. The government similarly sees them as last resort because they either create market chaos or require political heavy lifting.

Interestingly, some elements of these scenarios can be used as leverage: For example, the government can threaten receivership to push shareholders to accept a deal (we saw hints of this in legal arguments – FHFA always maintained they could put GSEs in receivership if courts invalidated NWS, which would moot shareholder wins). Likewise, shareholders can push for utility model if they see admin faltering because it at least codifies an outcome with some value.

Conclusion on Break-Glass: The current trajectory (recap/release) is intended to avoid these extreme measures. But investors should keep them in mind as tail risks. They essentially set the boundary conditions: e.g., common shareholders’ floor value might be zero (if receivership) and upper bound limited by utility-like returns even if released (since the government likely won’t allow them to become high-flying unregulated entities).

One might consider the probability of break-glass scenarios low in the next 2 years with the current administration, but if timelines slip, those probabilities could rise. For instance, if by mid-2027 it’s not done and politics shift, then maybe “Plan B” utility via Congress becomes real.

For now, we treat these as contingency discussions. The presence of these options does, however, implicitly pressure all parties to reach a consensual recap solution – because each break-glass has downsides for someone: utility or nationalization would cheat shareholders (hedge funds won’t like), receivership could disrupt markets (Treasury won’t like), indefinite conservatorship leaves GSEs unable to support housing fully in downturns due to lack of capital (nobody likes in long run). So ironically, the specter of these bad outcomes helps motivate a good outcome.

Actionable Takeaways

Finally, we distill the analysis into actionable insights for an investor or investment committee:

Base Case Outlook: As of May 2025, our base case is that the “recap and release” scenario will proceed over the next ~2 years, resulting in Fannie Mae and Freddie Mac exiting conservatorship. This scenario presents a potentially lucrative opportunity for current equity, but execution will determine the exact payoffs:

• We project common shareholders could see multi-bagger gains from current levels if the recap is done at even moderate valuations. For example, FNMA stock (recently ~$10) could plausibly trade in the $15–$30 range post-dilution by 2026, given our valuation analysis and peer comparisons (roughly 0.8–1.0× pro forma book) – though that is contingent on significant dilution and successful capital raises. The upside comes from the market finally valuing the GSEs on earnings (which are substantial) rather than policy speculation. However, if dilution is worse than expected or the market assigns a low multiple (say due to lingering uncertainty or high capital costs), the common’s upside might be more modest (e.g. settles closer to $10–$15 post-release). At current prices, the risk/reward for common appears skewed to the upside, but with binary risk – one must be prepared for potential near-total loss if reform derails.

• Preferred shareholders likely have a more defined outcome: in a successful recap, we expect a recovery of 75–100% of par value for junior prefs via conversion or settlement. Owning a Fannie or Freddie preferred at $10 today (par $25) offers a potential +150% to +>200% return to par. We find it probable that any solution will treat preferreds relatively generously (politically easier to justify paying par to mom-and-pop holders of income securities, and legally prudent given the contract rights). Thus, preferred shares have a high probability of at least doubling if recap occurs. Their downside in a failure scenario is also significant (they could languish or be wiped in extremis), but they might retain some trading value even in status quo (as they have). Risk/reward on preferreds is somewhat more conservative than common – less upside but still very attractive if you assume a >50% chance of release. As a bonus, if recap succeeds, eventually those preferred could resume dividends (~5–8% yields), or their conversion to common could itself provide additional upside if common appreciates thereafter.

• Treasury warrants and government stake: The 79.9% warrants mean that current common shareholders will only ever own at most ~20% of the companies post-release (before any new capital dilution). It’s key to factor this in any valuation. Practically, the government’s exercise of warrants is not something investors can buy directly (except by buying common now, which already bakes in some expectation). The presence of the warrants implies massive dilution, but also is the reason why the government will want a high stock price (to maximize its gain). This alignment means the administration actually benefits from higher share prices once warrants are exercised, so they won’t want to overly punish common holders – a subtle positive for investors.

Catalysts and Monitoring: This investment thesis will play out via policy catalysts, not just earnings. Key events to watch and prepare for:

• FHFA/Treasury Announcements: Any official release of a capital restoration plan or PSPA amendment. Could come with little notice. That will likely cause immediate repricing of securities (e.g., if terms of conversion are revealed). Being positioned ahead of this is ideal; one must gauge likelihood via political intel.

• Court Decisions: Particularly the D.C. Circuit appeal on the $612M verdict (expected possibly 2025). A win for shareholders (upholding verdict) would be a morale boost and could bump preferred prices (strengthening their negotiating hand). A reversal could momentarily hurt prefs, but by that point, things might be resolved anyway. Collins remand isn’t a catalyst anymore since it yielded little.

• Election Rhetoric: Although the next presidential election is 2028, the lead-up (2027 primaries) might start to reflect on GSE progress. If by mid-2026 it’s clear progress will happen, the issue might fade from campaign. But if it’s unresolved, prepare for political statements impacting stocks (like we saw with Trump’s Truth Social post sending shares +30%).

• Credit/Macro Events: Keep an eye on housing indicators – significant deterioration (e.g., sudden home price decline or credit uptick) could slow or derail recap plans. Conversely, a strong housing market or falling rates can create a favorable environment for equity raises (investor optimism, lower credit risk).

• Investor Sentiment and Technicals: Right now, retail and event-driven funds are driving trading. If initial concrete steps are taken (like a capital raise), we could see more mainstream institutional investors get involved, adding buying support and perhaps stabilizing volatility. The stocks might uplist to NYSE/Nasdaq around the time of an offering, attracting index funds or momentum funds. This could improve liquidity and narrow bid-ask spreads.

Risk Factors and Mitigants:

• Political Risk: A sudden change in political leadership or priorities is the biggest risk (for instance, if something caused Pulte to be ousted or the administration to divert attention). However, given the public commitment, that risk seems lower near-term. Mitigant: broad bipartisan fatigue with conservatorship (even many Democrats quietly agree it should be resolved) means outright opposition may be muted as long as affordability measures are not harmed.

• Execution Risk (Capital Raise): The ability to raise tens of billions of private capital is no small feat. If market conditions in 2026 are poor (e.g., recession, bear market), the offering could struggle or be done at a very low price (diluting current holders more). To mitigate, Treasury might line up anchor investors in advance (there were rumors of sovereign wealth funds interested, etc.). Also, the GSEs could possibly issue subordinated debt or other instruments to partially fill capital – though equity is needed primarily. We will gauge demand by any signals from banks, insurers, asset managers – if they start publicly saying GSE equity is interesting, that’s a good sign.

• Valuation Uncertainty: It’s possible that once free, markets might assign a lower multiple to GSEs than we anticipate (maybe due to fear of future regulation or limited growth). If the stocks trade, say, at 0.5× book, then current common could be overvalued even with release. One way to protect against that is focusing on preferreds (since their payoff doesn’t require a high multiple, just par recovery).

• Lawsuits and Settlements: We think most legal issues will be settled alongside recap. There is a tail risk of some holdout litigation that complicates the process (like if some shareholders reject the exchange and sue, causing delay). But FHFA can likely steamroll holdouts by using receivership threat or just moving ahead (if majority have converted, the old shares might be thin).

• Housing Downturn: As mentioned, a severe downturn would not only reduce GSE earnings and capital but could force Treasury to inject more funds, which could subordinate or dilute current shares further (in effect, a partial re-nationalization). That scenario (though not base case now) is something to hedge perhaps via macro instruments (e.g., short homebuilder stocks, or buy options that pay off in a credit stress). It’s low probability near-term given robust credit quality, but one can never rule out an exogenous shock.

Given current pricing, the market is already pricing in maybe a ~50% chance of favorable outcome. In our view, the probability is higher (perhaps ~70% that some form of recap/release happens under this administration). This positive expected value, combined with the magnitude of upside, makes the risk-reward compelling. However, size positions prudently: these are not “widows and orphans” stocks; they are more akin to event-driven distressed equity. There may be gut-wrenching volatility along the way – for instance, any hiccup (a delay, a court negative, etc.) can send shares down 30-50% short-term. One must be able to hold through that or add if conviction remains.

We conclude that Fannie Mae and Freddie Mac present a unique asymmetric opportunity rooted in policy change. Our stance is bullish on both common and preferred in anticipation of recapitalization, with preferred as the safer bet and common as the high-octane kicker. The next 24 months are likely to be decisive – either unlocking substantial value or, if things go awry, leaving us with suboptimal, stagnant holdings. Given our analysis of stakeholders, incentives, and the administration’s commitment, we lean towards a positive resolution. Thus, we recommend positioning accordingly, while remaining vigilant to adjust should the winds shift.