William Ackman Bets on Our Addiction
William Ackman, the CEO of Pershing Square Capital, seems to be in the financial news just about every day. If he’s not defending his effort to take over Botox manufacturer Allergan via his agreement with Valleant Pharmaceuticals, he’s bashing the business practices of Herbalife. Last week he made a presentation at the Ira Sohn conference on the investment prospects of Fannie Mae and Freddie Mac. Pershing Square has built a 10% position in the common stock of both mortgage lenders.
On the surface, Mr. Ackman’s bet seems to make little sense. The common stock faces competing claims of various preferred shareholders, and most importantly, the Federal Government. Moreover, the US Treasury has been sweeping all of the profits out of the two mortgage giants since 2012 in what is called a “profit sweep.” As you can imagine, there’s all sorts of litigation around the Federal government’s actions. And, Congress is debating bills to eliminate Fannie Mae and Freddie Mac altogether, and replace them with private mortgage issuers backed by federal insurance. Nick Timiraos of The Wall Street Journal provides an excellent summary of these issues at: http://blogs.wsj.com/moneybeat/2014/05/05/why-bill-ackman-is-bullish-on-fannie-freddie/.
At the Ira Sohn conference, Mr. Ackman went through a deck of 110 slides that make the case that Fannie Mae and Freddie Mac are worth about ten times their current stock prices. In order to get to his estimated valuations, Mr. Ackman argues both mortgage giants should be preserved, the profit-sweep should be terminated, and Fannie and Freddie should be reformed. There’s already evidence that Congressional efforts to abolish Fannie and Freddie are faltering. The bipartisan Crapo-Johnson bill looks like it may languish in committee as liberal democrats get cold feet and Wall Street lobbies against the bill.
While Mr. Ackman’s slides ably lay out the financial and policy case for preserving Fannie and Freddie, he deftly avoids explaining the real reason why his bet may pay off. It’s the same reason that brings liberals and Wall Street into alliance to fight the Crapo-Johnson bill. America’s residential housing policy is built on massive federal subsidies. We’re addicted to home ownership, even though we really can’t afford it. In 2011, American’s deducted $365 billion in mortgage interest on top of $173 billion in residential real estate taxes. How many of you could afford home ownership without these deductions?
The tax code is only beginning of the subsidy. Imagine for a moment if the 30-year fixed rate, no-prepayment penalty mortgage ceased to exist. Today a $200,000 30-year mortgage will cost about $1,000 per month (not including the tax deductions for interest). If the best banks had to offer was a 15-year mortgage, the monthly payment would be about $1,450 per month. Without Fannie and Freddie, our housing market would not only face shorter-term mortgages but also higher down payments and higher fees. In other words, the housing market would suffer from serious withdrawal symptoms.
At some point in the future, we will have to address our housing addiction. Since we haven’t even admitted that we have an addiction problem, Mr. Ackman is probably making a pretty good bet.