Since the dark days of the post-Lehman collapse lows of the 2011 of under $0.20 per share, Fannie Mae (FNMA) has returned a 20-bagger, reaching above the $4 per share level for much of 2014, despite calls from some in Congress for its dissolution.

Well, investors reluctant to take a stake in Fannie because of the threat to its very existence just received another scary disincentive from Washington.

The White House nominee to head up the Department of Housing and Urban Development, Julian Castro, has told the Senate Banking Committee this week that if confirmed he would push to close down Fannie (and Freddie), stating the  popular government-sponsored enterprise (GSE) no longer serves the American people the way it once did when it was created in 1939, during the depths of the Great Depression.

“I absolutely believe that there are better alternatives [for financing homes] than what we have” with Fannie, Castro told the committee.

With a comment like that from the probable next HUD chief, it’s not a surprise that FNMA had decoupled from a rising S&P leading up to Castro’s appearance in Senate chambers.  As scripted many times, the big money already had a heads-up to Castro’s sentiments regarding Fannie.  And again on script, FNMA rose $0.10, or 2.44%, during Castro’s testimony; it was another day at the office, buying FNMA at much better prices on the ‘news’ of Castro’s prepared testimony.

But here’s what investors and traders of Fannie really need to know.  And knowing the skinny about Fannie can mean the difference between making no return on your idle cash or making a big score on a gamble we see worth taking.

Firstly, support for the dissolution of FNMA has little support from Democrats, handicapping Castro’s wish for a shut-down of Fannie at a long shot.  Last month’s Senate committee bill to end Fannie (and Freddie) appears to have garnered no real support.

On the political front, we see no threat to Fannie’s role of guaranteeing home mortgages.  So, we suggest blocking out the noise coming from Congress.  Higher interest rates on home mortgages would decimate the already-fragile U.S. housing market.  That’s enough of a risk to stifle any serious vote from Washington to end Fannie.

As Fannie stands now, it has paid back all of the bailout money it received during the financial crisis, and has subsequently been providing Treasury with income from profits made during the rebound in the housing market.  So, everything seems fine so far.  Taxpayer money given to Fannie is paid back.  That mission is accomplished.

However, Fannie still remains under conservatorship with the Federal Housing Finance Agency (FHFA); and the agency doesn’t appear to want to let go of its power over investors.

Under FHFA’s controversial and unilateral “Third Amendment to the Preferred Stock Purchase Agreement (PSPA) of August 2012,” 100% of Fannie’s profits have been transferred to Treasury’s coffers.  The sudden announcement of this “Third Amendment” came just in time for Fannie’s surge into the black.  As a result, large investors have sued FHFA, citing the arbitrary decision by FHFA to unilaterally amend agreements has no legal statute to support the action.

It is our opinion, FHFA has been overtly looting Fannie on behalf of Treasury.

Without going into the details of Fannie’s book, we instead refer the reader to a well-written article on the subject of Fannie’s book of loans, reserves, and capital structure.  We agree with the author’s assessment that Fannie’s reserves are now adequate, and should also satisfy the FHFA to release it from conservatorship.  At the very least, the FHFA should allow Fannie to retain its earnings for the benefit of shareholders.  A court will decide that matter, which we believe will be among one of the major catalysts for a big move in FNMA in the coming months.

Conclusion

If Fannie’s big investors win their lawsuit to reverse FHFA’s “Third Amendment,” and allow Fannie to retain its earnings, we believe the rally in FNMA could be quite strong from fresh investment and some short covering (9% of outstanding shares).  Though the big investors in question are holders of Fannie’s preferred shares, Fannie’s common shares should rise quite rapidly in sympathy with the added value to Fannie’s preferred shareholders.

The obvious question the court will have to answer is: if the FHFA can dictate to whom Fannie’s profits will go now that the taxpayer has been paid back in full, then why would FHFA allow Fannie’s common stock trade if it benefits only Treasury?  Why would a stockholder of FNMA buy a single share if the whole set-up is rigged in favor of Treasury and against common shareholders?  Why would anyone become a common shareholder of Fannie?  What is the benefit, then, of taking a risk in FNMA?

We suggest that the court will be hard pressed to ignore the rights of the common shareholder in the class action lawsuit.   And that’s where the potential big move higher could stem from: a court decision favorable to common shareholders.