Freddie Shareholders: There's Nothing Left

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Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) fell 22.2% and 24.4% yesterday, respectively, unveiling some of the lowest share prices seen since the late '80s, when the average home cost around $90,000. In perhaps the saddest indication of just how pitiful these stocks are, Annaly Capital (NYSE: NLY  ) -- a small, scarcely followed REIT that purchases Fannie and Freddie securities -- now eclipses the market cap of both Freddie and Fannie. The customer, as they say, is always right.

Fueling the decline was a Barrons article highlighting the truth: There's literally nothing left for common shareholders, particularly for Freddie.

I'm not kidding
At last count, Freddie's shareholders lay claim to negative $5.6 billion in assets, based on mark-to-market accounting. If you missed it, that's negative. Now, as many financial firms have learned lately, mark-to-market accounting may be leaps and bounds from reality. Regardless, investors, regulators, and more importantly, the U.S. Treasury Department could give a flying Freddie about what management "thinks" assets are worth. Negative $5.6 billion. That's the investing equivalent of your doctor entering the room with his head down, clearing his throat, and asking you to have a seat.

Raise $5.5 billion of these and call me in the morning
Consequently, Freddie needs to raise capital. Few disagree on this, including CEO Richard Syron, who announced plans to raise $5.5 billion in capital in May. Unfortunately, waiting has its price: The capital has yet to be raised, and Freddie's stock sits more than 80% below where it was in May. Raising $5.5 billion at these prices will accomplish two things: Bring shareholders' equity to, well, zero, and dilute the pants off any hopes of a rebound.

That said, you would think the stock would now trade closer to zero -- pennies at best. For most companies, it would, but Fannie and Freddie have an implicit government guarantee floating around. That guarantee does wonders to keep these companies alive, but let's distinguish between two very different concepts: Guaranteeing the assets Fannie and Freddie own and insure, and guaranteeing the livelihood of common shareholders.

That's where the Barrons article comes back into play. What scared the dickens out of shareholders yesterday was the reminder that, in the case of government intervention, common shareholders will likely be decimated. As Barrons put it, "It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime ... Such a move almost certainly would wipe out existing holders of the agencies' common stock."

This makes a lot of sense. Freddie and Fannie are too big to fail, no doubt about it, but keeping them alive by no means has to include common shareholders. Barrons suggests that any recapitalization would come from preferred shares that would effectively wipe out anything common shareholders held onto.

This should sound sort of familiar. In Bear Stearns' fiercely debated bailout, the $29 billion chipped in by the government went to finance select assets, not into the pockets of shareholders. JPMorgan Chase (NYSE: JPM  ) took care of that part. In fact, it's possible all public money will be recovered, and the "bailout" won't cost tax payers a penny. That's how it should be.

By the way, we can't afford any of this to begin with
At a time when economic pain hovers around monstrous deficits, everyone knows these bailout programs have limitations. After all, the money to fund them comes from issuing debt ... the same reason companies are in such a pickle to begin with. As George Washington once said, "To contract new debts is not the way to pay old ones."

Besides, If Freddie and Fannie shareholders get bailed out, who's next? General Motors (NYSE: GM  ) ? United Airlines (NYSE: UAUA  ) ? Sallie Mae (NYSE: SLM  ) ? The list could go on. When we're this close to an election, taxpayers are certain to stomp their feet at any attempt to prop up common shares. Privatize profits, nationalize losses? It just won't fly.

Put it all together, and Freddie shareholders seem destined for doom. Barring an astonishing real estate turnaround, there are two outcomes: Either the company remains on its current path, with negative equity and real estate in the throes of disaster, or (more likely) it gets intervention from Uncle Sam, in which case common shareholders get reminded of Aryabhata's greatest discovery: the concept of zero.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Annaly Capital and JPMorgan Chase are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 19, 2008, at 10:24 PM, TMFAleph1 wrote:


    Instead of unfounded accusations, why not explain what you think are the limitations or errors in the article?

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On August 20, 2008, at 1:07 AM, vegas0825 wrote:

    Absolutely, but first lets ask why the article mentions panic from share holders but yet the article is titled "Freddie share holders there is nothing left". Then we go to the fact that Morgan uses Barrons as a back stop three times as i count. His words but yet not. As for the mark to market accounting,we all know that what is a loss today can be a profit tomorrow, so to say that they have negative equity is not factually true. I used to enjoy some of his articles until the 7/30/08 ABK article where he flat out accused the monoline of being insolvent. Now lets talk about scare tactics and media panic! The fool is read by alot of basic investors who at first glance probably logged on and unloaded at huge losses not the job of an unbiased journalist. There are alot of really good companies that are caught up in the environment at not much fault of their own. ABK,MBI,FNM,FRE to name four that maybe took a little too much risk but they were mislead as to what they were servicing,underwriting,insuring and in some cases had no choice because that is what they do. Others that should be paying a price in this country but he does not mention these facts anywhere. No need to promote the fear that could bring down the economy to a point that even Morgan has to worry about where his next check comes from. If you are claiming in headlines that all is lost for the common share holders bring the proof to the table in plain numbers so that the average guy can make an educated decicion. Either that or put a disclaimer that the opinions are meant for people that have no regard for the future of this country. I have lots to say and i left you with severalsublines to comment on. If i am wrong point it out and let others who read this rag pick who has valid points. Cant always tell me the man with the pen and the ability to delete my last two comments on this article are always gonna have the last word. If so i am done with the Fool and will spread the word.

  • Report this Comment On August 20, 2008, at 3:05 PM, jeffsmathers wrote:

    An analogy....

    Yes, the 'bathtub' is almost empty he says ..... but it can be filled back up !

    BTW, The bathtub is in forclosure, and China holds the title .... oh! and the 'water' isn't real water, but we are going to print "WATER" on paper notes and fill the bathtub with those instead.

    ...and there is the little problem with the interest on the paper...... sorry.

    I'll just take a dirt shower, thanks.

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