The GSEs have checkered pasts and deep flaws. But they’re making money again — and housing is coming back, which makes betting on their demise risky.

If legislative proposals to reform them are any measure, Fannie Mae and Freddie Mac are living on borrowed time. A clutch of proposals seek to privatize or liquidate the government-sponsored enterprises. This isnt just because the two mortgage companies share a scandalous past: accounting misstatements, fraud charges and questionable executive payouts, not to mention getting blamed, fairly or not, for the subprime crisis and then nearly collapsing before a U.S. Treasury bailout.

Its also because these huge enterprises continue to suffer from dual identities: public and private. Founded as public agencies, Fannie and Freddie increasingly assumed private aspects. In fact, the very essence of the GSEs was the ambiguity of corporations that were private in their operations and public in their mission of affordable home ownership. Part of being federally sponsored was an implicit guarantee that the government would bail out Fannie and Freddie if they got into trouble; this allowed them to operate with tiny capital bases and grow large, profitable and politically powerful. And bailouts did occur at the height of the financial crisis. Then­Treasury secretary Henry (Hank) Paulson Jr. argued that the GSEs structural ambiguities were untenable and urged lawmakers to come up with a more viable long-term structure. Out of office, he advocated for GSE privatization in his memoir of the crisis, On the Brink.

Six years later Fannie and Freddie are thriving again, and the debate over what to do with them continues.

Today, the two GSEs attract a lot of attention: from the administration, Congress, the mortgage industry and a group of high-profile investment firms that hold large equity stakes in them. Leading this pack of corporate activists is William Ackman, founder of Pershing Square Capital Management; his newly reconciled colleague Carl Icahn; Bruce Berkowitz, founder of Fairholme Capital Management; and Richard Perry of Perry Capital. This so-called gang of four has adopted a take-no-prisoners approach in legal and lobbying efforts to rescue Fannie and Freddie  and their own investments  from a possible legislative phaseout. The activists have loudly protested the government takeover of the profits they insist should come to them; so far, the government is winning that showdown.

At stake are Fannie and Freddie preferred shares with an estimated face value of $33 billion and an equally large windfall of common shares held by private investors. The potential upside for the common stock is pegged as high as 10 times face value.

Fannie and Freddies misfortunes in 2008 might have been cataclysmic, but they produced fertile ground for speculators. Investors bet big on a turnaround of beaten-down GSE shares that lost more than 95 percent of their value during the crisis, plunging from the mid-$20s in May 2008 to less than 50 cents a share within days of the bailout. However, as real estate recovered, the GSEs began raking in profits again: $84 billion for Fannie and $49 billion for Freddie in 2013.

Ackman and Berkowitz made their GSE bets public in mid-2013.

Berkowitz tops the list, with 15 percent of his fund invested in Fannie and Freddie preferred, worth an estimated face value of $3.5 billion. Ackman recently increased his stakes to 11.2 percent of Fannie Mae and 11.1 percent of Freddie Mac through a recent total return swap between Pershing and UBS. Icahn tossed in a $50 million bet in June on Fannie and Freddie common shares, purchased from Fairholme. Perrys position, which remains undisclosed, reportedly totals about $500 million in preferred shares and a smaller stake in common stock.

As part of the 2008 bailout process, the Federal Housing Finance Agency became conservator of Fannie and Freddie and entered into an agreement with Treasury to receive as much as $200 billion of bailout money. In exchange, Treasury received preferred stock valued at an equivalent amount, warrants to purchase as much as 79.9 percent of the common stock and a 10 percent dividend. Over the next four years, the GSEs received $187.5 billion in capital infusions from Treasury. The companies, however, found themselves continually cash-short, owing in part to the mandatory 10 percent dividend, and Treasury had to advance cash to them. To end that vicious cycle, FHFA and Treasury entered into an agreement on August 15, 2012, referred to as the third amendment or the net-worth sweep. In lieu of dividend payments, Treasury would sweep all the net income of the GSEs on a quarterly basis.

The sweep effectively capsized investor plans. The investors responded by filing a barrage of lawsuits, arguing that the sweep constituted a violation of the U.S. Constitutions Fifth Amendment, specifically the takings clause, which protects against seizure of private property for public use without just compensation.

Perry and Fairholme filed lawsuits in the summer of 2013 in U.S. District Court for the District of Columbia, with Fairholme also filing a suit in the U.S. Court of Federal Claims. Ackman sued a year later in U.S. District Court and federal claims court. His suits accused the federal government and the two GSE regulators, FHFA and Treasury, of violating the takings clause.

In September, however, that legal strategy hit a wall. Judge Royce Lamberth of the U.S. District Court tossed out the Fairholme and Perry lawsuits. He declared that the language in Fannie and Freddie stock certificates supports the profit clawback by Treasury. The judge summed up: The plaintiffs true gripe is with the language of a statute that allowed FHFA, and, consequently, Treasury, to take unprecedented steps to salvage the largest players in the mortgage industry . . . the plaintiffs grievance is really with Congress itself.

The government essentially took control of the whole shooting match, says Daniel Crowley, a public policy partner at law firm K&L Gates in Washington. The GSE takeover was a first for the government. On a macro level the conservatorship was a takeover of the entire residential housing market. The issue in the district court is that Fannie and Freddie are not in liquidation but under conservatorship and the third amendment had no impact on shareholders dividends or liquidation preference rights. If this is the case, the investors are taking a long shot.

The activists, in fact, are playing a complex game that involves far more than just some dividends. They have inserted themselves into the larger political debate, which involves a raft of congressional proposals on Fannie and Freddie. In one scenario the government would eventually sell the GSEs to investors  privatizing them, as opposed to liquidating them, which might leave scant rewards for shareholders. Berkowitz and John Paulson, founder of hedge fund firm Paulson & Co., have both pushed for privatization. Berkowitzs proposal essentially advocates for the sale of the GSEs mortgage insurance business to Fairholme and several private investors. Paulson has met with members of the Senate Banking Committee and urged it to privatize rather than liquidate the GSEs.

The fate of Fannie and Freddie is caught up in a tangle of politics and special interests. Still, despite Republican gains in the midterm elections, pundits expect housing reform legislation to move slowly. As for the White House, in 2013 the administration released a policy paper titled A Better Bargain for the Middle Class: Housing, which outlined its goal of supporting homeownership and affordable rental housing. The paper described the GSEs as a broken business model but continued to support housing affordability through the Federal Housing Administration (FHA).

That stance captures the tension between the GSEs two missions of producing private profits and serving the public good. As long as both goals are viewed as legitimate, the attempt to map out a path for Fannie and Freddie will prove torturous.

Fannie and Freddie both began life as reform institutions. The oldest of the mortgage GSEs, Fannie Mae, or the Federal National Mortgage Association, was launched during the New Deal, in 1938, to address the housing crisis. Fannies mandate was to act as a secondary mortgage market facility that would purchase, hold and sell FHA-insured loans. The agency subsequently underwent several transformations, becoming a public-private entity in 1954. A second reorganization occurred with the passage of the Housing and Urban Development Act of 1968, which shifted the agency from mixed public-private ownership to a for-profit shareholder-owned company. No longer a part of the federal budget, Fannie funded itself in the markets.

By 1970 an expansion in the secondary mortgage market drove the establishment of the Federal Home Loan Mortgage Corp., or Freddie Mac, to assist thrifts in managing interest rate risk. Largely funded by another New Deal creation, the Federal Home Loan Banks, Freddie Mac began to purchase longer-term mortgages. At about this time, both GSEs began to buy and sell mortgages not guaranteed by the government.

The expansion of U.S. housing and secondary mortgage markets over a 30-year period allowed the GSEs to become formidable economic and political forces. In the 1980s, Fannie began to issue mortgage-backed securities and build its mortgage portfolio, while Freddie primarily focused on MBS issuance. The GSEs capitalized on their special government privileges and market dominance to actively lobby and shape GSE-related legislation.

Most citizens had no idea what the GSEs did, but affordable homeownership was popular. Homeownership has been at the center of government policy because it provides the foundation for the American middle class, says Henry Cisneros, who served as secretary of Housing and Urban Development under President Bill Clinton and is now executive chairman of urban real estate investor CityView. The middle class is important, as they propel and bring stability to the economy. The moral issue is around making homeownership available to all without artificial barriers based on race or prejudice.

Many critics of the GSEs argue that the seeds of the subprime crisis were planted during the Clinton era under the banner of affordable homeownership. Cisneros offers his own explanation of what went wrong: The focus of the policies at the time was to share the benefits of homeownership with those who were marginalized. It was after the Clinton years that the initiative was hijacked with people selling predatory products. The economic exuberance created the bubble and introduced bad actors with the wrong motives.

Cracks surfaced well before the subprime crisis. Many critics point to the tenure of James Johnson, who ran Fannie Mae from 1990 to 1998, as the time when the GSEs began to exert enormous political power to drive their private profit-making activities. Johnson had been former vice president Walter Mondales campaign manager and chief of staff, and he spent five years at Lehman Brothers Holdings. Under Johnson, Fannie exerted great sway over Congress, basing its demands for autonomy on the social good of expanding affordable homeownership.

At the peak of their power, Fannie and Freddie silenced any critics, says Armando Falcon Jr., who from 1999 to 2005 was director of the Office of Federal Housing Enterprise Oversight (OFHEO), which at the time served as the chief GSE regulator. So many people were on their payroll, no one could question their actions or be negative. Falcon flagged serious accounting and internal control problems as early as 2003 and came under considerable attack by the two mortgage giants and their defenders throughout his tenure.

Still, the exposure of alleged accounting fraud used to inflate senior management bonuses ultimately led to the firings in 2004 of Fannie Mae CEO Franklin Raines and CFO J. Timothy Howard. In 2003, Freddie Mac admitted to using improper accounting after OFHEO exposed earnings misstatements of $5 billion from 2000 to 2003. Freddie settled with a $127 million penalty in 2003 and a $50 million fine by the Securities and Exchange Commission in 2007.

Falcon initiated a new investigation of Fannie in 2004, discovering accounting misstatements of $6.3 billion more from 2000 to 2003. Two years later the SEC slapped Fannie with a $400 million fine, one of the largest penalties in a case of alleged accounting fraud. Falcon left office in 2005 and was briefly replaced by James Lockhart III.

What nearly destroyed the GSE mortgage machinery was its exposure to subprime loans, Alt-A loans and private label MBSs. Alt-A mortgages typically carry a rating between prime and subprime. These types of home loans carry a higher loan-to-value ratio, less documentation, lower credit ratings and higher debt-to-income ratios for borrowers. Private label MBSs are not backed by Fannie or Freddie and are considered to be riskier. To accommodate the growing demand for these mortgages, the GSEs expanded their use of automated underwriting systems. The rise in AUS usage, beginning in 2000, effectively reduced cost and turnaround time for loan approvals. The GSEs are widely regarded as pioneers of the AUS, which combined underwriting criteria with statistical algorithms to predict the default probability of loan applications.

According to a 2009 HUD policy brief, Fannie Mae and Freddie Mac: Past, Present, and Future, 200006 marked an explosion in Alt-A and subprime lending. In 2003 dollar originations for these loans stood at $215 billion; three years later they hit $1 trillion, some 50 percent of the conventional market. A ramp-up in purchases of private label MBSs also took place, peaking in 2006 at $80.3 billion for Fannie and $157.5 billion for Freddie. At the end of 2008, totals stood at $52.4 billion and $99.9 billion, respectively.

HUD reported that an almost 90 percent reduction in the value of private label securities accounted for the GSEs major losses in 2008. Citing a U.S. Government Accountability Office study, HUD concluded that exposure to subprime and Alt-A loans pushed the GSEs into conservatorship.

But the real estate collapse wasnt the GSEs only problem in 2008. Fannie and Freddie had insufficient capital underlying their outsize portfolios  one consequence of the markets belief that the government would bail them out  and had overleveraged to meet growth targets tied to compensation incentives. In September 2008, just days before Lehman collapsed, Hank Paulson placed both GSEs under conservatorship with FHFA, which had been formed in the Housing and Economic Recovery Act of 2008 (HERA), which merged OFHEO with the Federal Housing Finance Board. FHFA stepped in to guarantee as much as $300 billion of subprime 30-year mortgages held by the two GSEs; the guarantee kicked in when appraised values fell by 90 percent.

HERA granted FHFA, as conservator, broad powers to immediately take over all rights, powers, titles and privileges of the GSEs and over any stockholder, officer and director with respect to the GSEs assets. A critical provision, a no-injunction clause, prevents any court action to be taken against FHFA in its execution of its duties as conservator. The FHFA conservatorship sustained Fannie and Freddie after the crisis. While capital infusions solved immediate liquidity issues, FHFA embarked on a strategic overhaul to address management and operational failures. An equally important goal was the recovery of taxpayer losses in the bailouts. Although the GSEs boards and management remained responsible for daily operations, they were now on a much shorter leash. Fannie and Freddie had to operate within set guidelines, initially focused on recovering the cost of the bailouts and abiding by SEC rules. These initiatives placed a priority on reworking the GSEs balance sheets and unloading legacy assets with poor underwriting standards.

In early 2012, FHFA acting director Edward DeMarco unveiled the Strategic Plan for Enterprise Conservatorships. A core priority was mitigating taxpayer exposures. The plan also sought to uphold public policy goals for affordable homeownership and assisting compromised homeowners in refinancings and foreclosures. In August 2012, FHFA and Treasury jointly released the net-worth sweep. The announcement was accompanied by the first clear signals from the Obama administration of its intent to eventually phase out the GSEs. One policy move accelerated the wind-down of Fannie and Freddies retained mortgage portfolio four years ahead of schedule.

Last year a new FHFA director, Melvin Watt, a former Democratic congressman from North Carolina, introduced a reformulated strategic plan. Watt is channeling his agencys energies toward ensuring liquidity for single and multifamily markets while monitoring credit risks and shifting them to the private sector. Between the two GSEs, a total of $352 billion in credit risks from unpaid principal balances on single-family mortgages has been taken off the books. FHFAs newest initiative is the development of a common securitization platform to improve liquidity and transparency among a wider group of market participants.

Both Fannie and Freddie have been generating record earnings, making a phaseout more difficult. At the end of 2013, Fannie posted $83.9 billion in net income and Freddie reported $48.7 billion. Strong fiscal performance continued well into the second quarter of 2014. The two GSEs have repaid $192.4 billion to Treasury  more than their draws. That doesnt include the dividends, which cant be applied to the bailout balance under the terms of the net-worth sweep.

The GSEs return to profitability rekindled debate over whether to end their public existence and the consequences of replacing them with untested alternatives.

The political situation in which this debate is unfolding is a quagmire. Gridlock has prevailed in Congress, but although Republicans picked up seats in the midterms, including control of the Senate, neither party has the 60 votes necessary to pass legislation there, and the White House retains the veto. Fannie and Freddie now pump billions into the federal government, and this certainly helps with the deficit. And affordable housing, though traditionally a Democratic issue, still has broad appeal. Meanwhile, the 2016 presidential election is looming. Both parties will be cautious about doing anything that will threaten the economy or still-fragile housing markets.

Conflicting visions are rife not only between Republicans and Democrats but within the GOP caucuses. The House GOP has been clear that its mission is to extricate the government from the housing market and engineer an orderly wind-down of Fannie and Freddie. Senate Republicans lean toward a less drastic reengineering of the GSEs. In January, Alabama Republican Richard Shelby assumed chairmanship of the Senate Banking Committee, which has oversight over the GSEs. Shelby is considered an advocate of reforming the conservatorship model and a supporter of privatization. Though the bipartisan Johnson-­Crapo GSE reform bill  technically, the Housing Finance Reform and Taxpayer Protection Act  managed to pass Senate Banking last May by a 13-9 vote, the legislation failed to gain a floor vote because of a lack of Democratic support.

If the GSEs are liquidated or privatized, the biggest uncertainties involve the impact on housing. A likely increase in mortgage costs is being debated industrywide. Current forecasts for new mortgage rates are in the range of 40 to 100 basis points higher. The proposed common securitization platform remains untested. FHFAs Watt recently noted that the platform would be tested by Fannie and Freddie before a wider rollout would be considered.

For many voters, affordable homeownership has become a right, with Fannie and Freddie serving as de facto backstops. A March 2014 Moodys Analytics study estimated that the government still guaranteed nine out of ten mortgage loans, to the tune of $1 trillion. The study also noted that taxpayers are exposed to credit risk on two thirds of the $10 trillion mortgage debt outstanding.

Several congressional housing proposals are in play. There are currently two leading GSE reform measures: the Johnson-Crapo bill in the Senate and the PATH Act, a House proposal. The PATH Act primarily calls for a GSE phaseout within five years and for FHFA to oversee mandatory risk-sharing programs. FHFA would establish a National Mortgage Market Utility and act as a regulator for the Federal Housing Authority and the Rural Housing Service. The National Mortgage Market Utility would replace GSE securitization platforms and facilitate access to the secondary market for loan originators.

In the Senate, Johnson-Crapo will likely be revisited by the 114th Congress. Sponsored by recently retired South Dakota Democrat Tim Johnson and Idaho Republican Mark Crapo, the bill calls for increased capital requirements for mortgage guarantors and a shift of risk-taking to the private sector. The bill supports a phaseout of the GSEs that would leave little for shareholders. In their place, Johnson-Crapo would install a new agency, the Federal Mortgage Insurance Corp. (FMIC), which would resemble the Federal Deposit Insurance Corp.(created in 1933 to end bank runs) and would act as a regulator while providing MBS insurance via a special fund. The FMIC would take over the insurance function previously provided by the GSEs, covering 90 percent of losses on MBSs. The bills proponents contend that this provides a joint public-private risk-sharing mechanism.

There are flaws with the proposal. The government still maintains a significant exposure to mortgage risk, although the FMIC can waive the risk-sharing provision in a financial crisis as often as three times in any three-year period.

Senate conservatives remain skeptical about creation of a new federal agency and question its effectiveness. Congressman Jeb Hensarling, a Texas Republican and chairman of the House Financial Services Committee, asserts its a wealth redistribution scheme. Hensarling is the leading sponsor of the PATH Act.

Meanwhile, liberals dont think Johnson-Crapo does enough for affordable housing. The strongest opposition has come from Senator Elizabeth Warren. The Massachusetts Democrat continues to be concerned by what she views as the bills negative impact on homeownership eligibility.

California Democratic Representative Maxine Waters recently introduced yet another proposal, the Housing Opportunities Move the Economy Forward Act, containing elements from various Senate proposals. One key feature: the preservation of the 30-year fixed-rate mortgage.

Thats politically prudent. The 30-year mortgage has been the cornerstone of the U.S. housing market for nearly 70 years and is both a central achievement of Fannie and Freddie and a unique feature of the American market. Before the Depression, most mortgage holders negotiated rates annually. After World War II, the 30-year mortgage provided stability for middle-class homeowners, protecting them from interest rate volatility. With payments spread over a longer time frame, the 30-year mortgage made homes affordable to many first-time buyers.

Fannie and Freddie play a key role in providing a stable source of funding for residential mortgages, especially for low- and middle-income families, through their role in the secondary market. The GSEs support banks, thrifts and mortgage companies by purchasing their loans, which they repackage into pools of securities and sell to investors. The implicit government guarantee allowed the GSEs to attract investors despite lower yields on agency securities  in effect, subsidizing 30-year mortgages. Moreover, loans with long-term fixed rates that qualify under GSE rules enjoy a no-cost prepayment option that allows borrowers to refinance or pay them off without a penalty. Many GSE defenders believe that without Fannie and Freddie there is no viable securitization market unless the private sector steps in. Many predict that without securitization 30-year mortgages will disappear.

Ackman recognizes the importance of the 30-year mortgage. The 30-year mortgage is a critical pillar of housing finance, he says. Without its existence there exists a negative impact on the markets and will result in repricing of the entire housing stock.

Those realities inform the way Ackman reads the political situation. The chance of GSE reform passing has zero prospects because the proposal is not economically feasible, he says. To preserve the 30-year mortgage, the government needs to build up Fannie Mae and Freddie Macs capital base to the point that they have a fortress balance sheet. The GSEs can then sell their assets to private investors and become fully privatized, with the government not needing to backstop any future activities.

Dismantling mortgage GSEs and creating a viable alternative is challenging, says Leo Tilman, executive chairman of Capitol Peak Asset Management, an adjunct faculty member at Columbia University and an authority on financial markets. These organizations were meant to play three major roles: fostering homeownership, enhancing liquidity of the mortgage market and stabilizing the mortgage market in times of crisis. All three will need to be addressed by an alternative solution.

The securitization market, which has been slow to recover from the financial crisis, is a key piece of the puzzle. By all accounts, progress continues to be made toward transition to a common securitization platform. A new CEO and two board members for Common Securitization Solutions, the entity set up by Fannie and Freddie to manage the securitization infrastructure, were announced in November. One of CSSs goals is maintaining liquidity for 30-year fixed-rate mortgages.

New infrastructure for public securitizations is moving forward, but private label securitizations are another story. Securities within the private securitization pool do not meet GSE criteria. The PLS business and the GSEs are two separate markets, says Mike McMahon, head of investor relations at Mill Valley, Californiabased Redwood Trust, one of the largest private securitization players in the U.S., with a 40 percent market share. PLS has not come back because large banks have no incentive to securitize, and with the dearth of securitization activity, large players like BlackRock and PIMCO have no economic incentive to hire teams to invest in PLS. Structural issues affecting PLS have never been addressed postcrisis. GSE reform will not affect the PLS market unless the government shrinks or reduces the types of loans that can obtain a GSE guarantee.

If there is one group that maintains a vested interest in a resolution to the GSE conundrum, its the corporate activists. Ackman, Berkowitz and the others acquired their stakes at deeply discounted levels relative to their par value. As of the end of the March 31, 2013, quarter, Fannies and Freddies common stock was still trading at 70 cents. Berkowitz, in a 2013 Fairholme news bulletin, declared his stake to be one fifth of its liquidation value.

The activists are vigorously challenging the legality of the net-worth sweep. Statements released by Fairholme to Institutional Investor in October 2014 called the sweep lawless. Fairholme declared that a small cabal of federal employees had concocted this unlawful scheme and is hiding behind a you cant sue us defense.

The activists argument is that the government committed theft in the net-worth sweep. Other institutions, like the big banks and insurer American International Group, were bailed out and rehabilitated, not seized.

The activists may be able to count on some support in Congress. Pat Toomey, the Republican senator from Pennsylvania and a former investment banker, sits on the Banking Committee. He publicly denounced codifying the sweep within Johnson-Crapo and has been outspoken in support of what he considers fair treatment of investors.

The activists have diverse supporters. Longtime consumer advocate Ralph Nader is backing a group called Restore Fannie Mae to end what he calls the unconstitutional conservatorship of Fannie and Freddie, writing op-eds in the Wall Street Journal and organizing roundtables to drum up support. Restore Fannie Mae is a housing lobbying group backed by some prominent GSE shareholders, including Berkowitz. Timothy Pagliara, CEO of Franklin, Tennessee, wealth management firm CapWealth Advisors and his Investors Unite Group are trying to mobilize GSE shareholders to assert their rights against the net-worth sweep.

Berkowitz, John Paulson and private equity and alternative-investment giant Carlyle Group have all argued that privatization will end the government backstop of housing and return it to the private sector. Detractors of privatization, however, assert that putting the GSEs in the hands of private investors will give them control over the secondary mortgage market. Private investors rely on free-market mechanisms, allowing them to potentially command higher rates of return at the expense of, say, mortgage holders. The other concern is that big players will crowd out smaller market participants like community banks, credit unions and mortgage banking companies.

In fact, the investors have taken different approaches to the GSEs. Berkowitzs and Perrys principal stakes are in the preferred shares, and Ackman has a large stake in the common. Preferred shares sit higher in the capital structure; in a liquidation scenario the common stock will be last to be made whole. Still, in a presentation delivered at the Sohn Investment Conference in May 2014, Ackman maintained a bullish view on the GSEs long-term earning power, estimating it at a combined $16 billion annually, taking into account current fee levels and a 35 percent tax rate.

Berkowitzs investment thesis for his preferred holdings hinges on two possible outcomes. In one, a court judgment ending the net-worth sweep would allow Treasury to buy back the senior preferred stock held by Berkowitz. The other features either a sale of the GSEs legacy assets with common shareholders getting paid or a rights offering effectively recapitalizing the GSEs with preferred shares at full value. To date, Berkowitz has been stymied on both counts.

Ackmans lawsuit in the U.S. Court of Federal Claims continues. Judge Margaret Sweeney is presiding over Pershings case and ten other GSE-related investor lawsuits. This venue may prove more favorable for Ackman. The court was established to allow redress for claims against the federal government. The courts own website describes it as the Peoples Court and the keeper of the nations conscience.

Even before Sweeney makes a decision, legal gambits are ongoing. After watching his fellow activists lose in U.S. District Court, Ackman on October 31 filed for a voluntary dismissal of his lawsuit there. If Ackman can win his lawsuit in federal claims court, he may be able to return to the district court with more ammunition. However, on December 4, Treasury filed a motion to strike the voluntary dismissal notice, seeking to have Ackman face the same decision handed down in Perrys case, preventing him from using any favorable ruling at the claims court level before the district court. The investors are probably beating a dead horse, says K&L Gatess Crowley. Forum shopping is unlikely to result in a favorable outcome. The court has decided that FHFA and Treasury both acted within the law. The best recourse for these investors is to take their claims to the policy arena and engage the administration, the Hill, FHFA and Treasury. Should the judicial process prove unsuccessful, the battle seems destined to shift to political Washington, much as Judge Lamberth suggested.

Ackman remains unbowed  hes a veteran of long campaigns. He says he hopes it wont have to be done, but hed be willing to take his case to the Supreme Court. Tactically, Ackman has delayed his case so the discovery process in Berkowitzs similar suit can go forward.

What will happen to Fannie and Freddie if reform legislation does not pass? One scenario would be that the GSEs continue under FHFA conservatorship. But given the White Houses mandate to reduce retained mortgage portfolios, the void left would need to be filled. This would probably require private participation. Institutional investors would, in turn, demand higher rates of return, boosting the cost of capital, and more guarantees. In the end, mortgage markets might contract and grow more expensive.

Meanwhile, the showdown may just be starting. There is no indication that any of the current proposals have enough bipartisan support for passage. The White House appears committed to backing only proposals that address affordable housing. When asked whether GSE legislation will remain in limbo, Cisneros says: Theres every incentive to get the housing sector on track. This is a big and important imperative for the overall economy. The economy has been impacted as housing has not been unleashed. Which means Fannie Mae and Freddie Mac may once again be getting a reprieve.  

Amy Poster (aposter@BERDONLLP.com) is a director in the financial services advisory group at New Yorkbased Berdon LLP. She served as senior policy adviser at the U.S. Department of Treasury Office of the Special Inspector GeneralTARP during the financial crisis.

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