Bill Ackman and his fund Pershing Square Capital Management have built quite a reputation in the past few decades. So much so that Ackman is now viewed as one of the greatest investors ever. Between 2003 and 2021, Ackman generated 17.1% annualized returns, easily beating the broader benchmark S&P 500.

These kinds of returns have led investors to follow Pershing's every move. Interestingly, Ackman's fund Pershing Square Holdings owns a 10% stake in two over-the-counter stocks. Although this move was made over a decade ago, Pershing has maintained its position in these two stocks. Let's take a look.

The case for Fannie Mae and Freddie Mac

In November 2013, SEC filings show that Pershing Square purchased a nearly 10% stake in the Federal National Mortgage Association (FNMA -3.25%), known as Fannie Mae, and the Federal Home Loan Mortgage Corporation (FMCC -1.64%), known as Freddie Mac.

Both Fannie and Freddie buy mortgages from banks and then hold them on their perspective balance sheets or package them into mortgage-backed securities, which they typically sell to investors. You'll see lots of banks buying mortgage-backed securities as alternatives to making loans. Fannie buys mortgages from larger banks and Freddie does the same for smaller banks. The two entities are a key part of the U.S. housing market because they allow banks to get mortgages off their balance sheets and therefore serve as a critical source of liquidity for lenders so they can make new loans.

Fannie and Freddie got into trouble during the Great Recession because they had been packaging too many subprime mortgages during the housing crisis of the Great Recession, which ultimately led to so much financial stress that the government had to bail out both companies and put them into conservatorship. The Treasury Department injected $187 billion of taxpayer money into the two companies in return for senior preferred stock.

In the 16 years since this has happened, there has been tremendous controversy over the fact that the two government-sponsored entities (GSEs) remain in conservatorship. In 2012, certain changes were made to the agreement between the GSEs and the Treasury Department that effectively required all of their profits to go to the Treasury after reaching a certain equity value. That ultimately led Fannie and Freddie to pass along more than $300 billion in profits to the Treasury, as of the end of 2019.

Shareholders, who have seen Fannie and Freddie's stock prices plummet and not recover, are not happy. They would like the government to release the GSEs from conservatorship and recapitalize them. In 2019, under the Trump administration, the agreement between the GSEs and the Treasury Department was amended, and the two GSEs were allowed to retain profits instead of giving them to the Treasury. The purpose of the amendment was to allow the GSEs to build capital and eventually exit conservatorship. The Federal Finance Housing Agency, the GSE's regulator, eventually established capital requirements for the GSEs, which are somewhere between $250 billion and $300 billion combined.

The GSEs have started to build capital quickly because they are big companies that can collectively generate between $15 billion and $20 billion of annual earnings. Total shareholder equity at Fannie Mae has risen from roughly $6.2 billion at the end of 2018 to nearly $86.5 billion in the second quarter of 2024. Freddie Mac recently surpassed $53 billion.

The issue is that Fannie and Freddie are still saddled with senior preferred stock from the Treasury of more than $193 billion combined, as well as tens of billions of preferred stock and common stock. The Treasury Department also owns warrants that expire in 2028 and give the agency the right (but not the obligation) to buy 79.9% of outstanding common stock in both GSEs. In a 2020 report from the Congressional Budget Office (CBO), the agency said that if Fannie and Freddie are to be capitalized, the two GSEs would likely need to redeem the senior preferred stock and address claims of existing shareholders.

A journey filled with variables

Fannie and Freddie had a combined $140 billion of equity at the end of the second quarter of 2024, meaning they are, in theory, halfway toward the capital required to exit conservatorship. However, they need to figure out what to do with the senior preferred stock, the Treasury's warrants, and potential claims held by other shareholders. A recapitalization feels like it would be pretty difficult if the GSEs redeem the senior preferred stock and the Treasury also cashes in its warrants, so something may need to change in these agreements if a recap is made a priority by the government. Either way, a recap would likely require an enormous initial public offering -- maybe the biggest one ever -- to get the GSEs out of conservatorship without waiting at least another decade or two.

This process is also highly political. Former President Donald Trump has been a big proponent of exiting the GSEs from conservatorship and began the process during his time in office, so if he wins the election his administration could speed up the process. But it's also quite possible that Kamala Harris' administration or another administration in the future won't prioritize exiting the GSEs from conservatorship, and the process is dragged out over many years.

Ackman hasn't sold his position in more than a decade. In Pershing Square Holdings' annual presentation in February, the company said it sees the reprivatization of the GSEs as an "eventuality" that could take some time. In a 2023 report, the company said it believes there is "political and economic rationale" for exiting the GSEs from conservatorship, and cited a Trump reelection as a potential catalyst.

Ultimately, the preferred and common shares will remain very risky, given the level of uncertainty and amount of capital needed. So if you are a risk-averse investor, I wouldn't bother with this investment. But if you are interested, I think the junior preferred shares could be worth a small investment for investors with time on their side. I own some of the preferred shares in my retirement portfolio, which are currently trading at just about 18% of par ($25). The commons have the most upside, but their path is the most uncertain and therefore comes with the most risk.