Bill Ackman Offers a Solution to the Fannie/Freddie Mess

This is the problem with our system - the truly greatest minds are going to areas where they can of course derive the greatest wealth. And the best glad handlers go to Washington D.C. and are way over their head with situations such as this - now today (once again, America the reactive) we are hearing about solutions from D.C.. Thankfully Mr Ackman was kind enough to share his plan for a grand fix of Fannie/Freddie (without sacrificing all our paychecks) with people in leadership - as this level of creativity is beyond their pay grade. Ironically, Ackman went short these 2 names (teaching us it is never too late to short dogs) last Thursday so he still made his coin. Which he needs to considering this roster of long positions (ouch). But he is more of a long term value guy, so maybe in the end he'll be proven correctly.

As for FNM/FRE - as we said earlier these 2 companies are levered 60:1+, worse than Bear Stearns or most hedge funds which have been blowing up. For those interested in the subject, it's worth a listen. There are some truly brilliant minds working in the hedge fund industry - unfortunately just like in any field there is a bell curve with some not so great minds working there as well, as we've documented ;)

• Hedge fund manager William Ackman said Tuesday mortgage companies Fannie Mae and Freddie Mac are not as well capitalized as their executives say they are.

• "It doesn't matter what the rating agencies say about their capitalization," Ackman said, in an interview on CNBC. "Implicit guarantees don't work in the market that we're in now. What matters is capital. These institutions need to have a fortress balance sheet. (JPMorgan CEO) Jamie Dimon talks about a fortress balance sheet. We need a Fannie and Freddie with a fortress balance sheet."

• A government plan, announced Sunday, has done little to alleviate these concerns.

• Ackman, who runs the New York-based Pershing Square Capital Management, has a short position in both the junior debt and the equity of both Fannie Mae and Freddie Mac, and is critical of the federal plans to backstop the two companies if needed.

• In the CNBC interview, Ackman laid out a plan he claims will reduce leverage at the two government sponsored enterprises. "I think the whole 'government-sponsored' nature of the entities is going to start to fade," Ackman said. "The only reason you need government sponsorship is you were levered 140 to 1. 'Heads I win, tails the taxpayer loses' is not a good structure."

• Ackman is purposing a restructuring of Fannie and Freddie in which the common and preferred equity would be extinguished and the subordinated debt exchanged for equity warrants. Ackman purposes that for every $1.00 of senior unsecured debt held, a holder would receive $0.90 in new senior unsecured debt and $0.10 in value of new common equity. "That raises equity by $75 billion," he said. "By eliminating subordinated debt of $11 billion, you're creating another $11 billion worth of equity."

• In addition, the government would make a stand-by purchase commitment for new Fannie Mae common equity at initial value for three years, and would issue subordinated debt or preferred stock if capital is needed in the future.