“The hedge fund guys didn’t build this country,” Donald Trump told “Face the Nation” in August 2015. “These are guys that shift paper around and they get lucky.”
In fact, the paper-pushers got extremely lucky when Donald Trump was elected. Trump’s victory has facilitated one of the most audacious hedge fund plays in recent U.S. history — one poised to pay off in billions of dollars. Billionaire investors are buying worthless stocks in the hope of bullying the government into re-animating them. And now the government just might grant their wish.
The holdings in question are mortgage giants Fannie Mae and Freddie Mac, which the government put into federal conservatorship in 2008. The Treasury Department in 2012 changed the terms of the deal, sweeping all of Fannie’s and Freddie’s profits into the government.
After these maneuvers, shareholders were thought to have been wiped out. But hedge funds continued to buy stock in the companies. They wanted to force the government to recapitalize Fannie and Freddie and release them back into the private sector. In that event, the stock price would shoot up (before the financial crisis, each traded at $60 a share), giving investors an astronomical return on their investment. Hedge funds don’t have to disclose their stakes in individual stocks, but reports indicate that just one, Bill Ackman’s Pershing Square Capital, has $475 million invested in the companies.
The hedge funds mounted pressure on several fronts to ensure they’d win their bet. They lobbied Congress to privatize the mortgage companies. They built advocacy groups to argue for their position. They fought Treasury’s profit sweep in a series of lawsuits. And this year, they embarked upon buying themselves a president.
John Paulson, one of the largest investors in the Fannie and Freddie play, has a history of getting rich off the housing market. He famously worked with Goldman Sachs in 2007 to short subprime mortgage bonds, without informing investors on the other side of the bet about the poor quality of the underlying loans. That was worth $4 billion.
Since profiting off homeowner misery, Paulson has struggled with uneven returns. In the first quarter of this year, his main two funds each fell 15 percent, and his assets under management have dropped from $36 billion to $13 billion in just six years. But Paulson still had his Fannie and Freddie play, and he donated millions to the effort to influence the government on its behalf. Besides, Donald Trump, one of Paulson’s fund investors and business partners (Paulson was one of the owners of the Doral Golf Club when Trump purchased it), happened to be running for president.
Paulson cozied up to Trump. He hosted a $50,000-a-plate fundraiser in New York City. He served as an economic adviser to the Trump campaign. And he personally gave $330,000, the maximum donation, to the effort. Since the election, the market has recognized that this close relationship to Trump likely equals an end to the Fannie and Freddie profit sweep, a partial or total privatization of the mortgage giants, and a personal benefit for John Paulson.
On November 8, Fannie Mae was priced at $1.64 a share and Freddie Mac at $1.55. Since then, both have nearly doubled. Fannie has dropped slightly from its Monday peak at $3.15 but is still significantly higher ($3.07 by the close of Tuesday), while Freddie is at $3.03. The run pushed the stocks to their highest levels of the year.
Paulson, explicitly selected as Trump’s economic adviser for his expertise in housing, would presumably have significant sway over the resolution of Fannie and Freddie and the future of housing finance. His hedge fund told Bloomberg in a statement that Treasury’s profit sweep in 2012 “violated the rights of thousands of shareholders across America. … We look forward to an outcome that restores the rights of shareholders in these companies.”
Other Trump advisers share Paulson’s perspective. Former Ohio Secretary of State Ken Blackwell, overseeing domestic policy in the Trump transition, publicly accused the Treasury Department in 2014 of “a theft of private property” with the Fannie/Freddie profit sweep. Blackwell is a director of the Coalition for Mortgage Security, one of the many shadow groups advocating for privatization of the companies. Carl Icahn, a longtime Trump friend and business partner, has invested at least $50 million in Fannie and Freddie. Bruce Berkowitz, CEO of Fairholme Capital Management, the lead plaintiff in the lawsuit against the government over the 2012 profit sweep, donated $125,000 to Trump’s campaign.
Hedge fund managers may even get one of their own installed as treasury secretary. Steve Mnuchin, Trump’s national finance chair and the co-founder of the hedge fund Dune Capital, has been listed as a finalist for Treasury since the election. Mnuchin serves on the board of directors of Sears with Berkowitz, of Fairholme Capital. He also led an investment group to purchase failed lender IndyMac from the Federal Deposit Insurance Corporation in 2009, renaming it OneWest Bank and taking over as CEO. That investment group included John Paulson. In 2014 OneWest was sold to CIT Bank, making Paulson and his fellow investors over $3 billion.
The other main candidate for Treasury, House Financial Services Committee Chair Jeb Hensarling, introduced a bill in 2013 that would phase out Fannie and Freddie within five years, leaving the housing market to private interests. That would help traditional banks but not the hedge fund profit-seekers.
Paulson and his fellow influencers appear determined not to let that happen.