I bought U.S. mortgage lender Fannie Mae (NYSE: FNM ) more than two years ago. It had a good turnaround story: Battered and bruised because of accounting improprieties like those at its brother Freddie Mac (NYSE: FRE ) , it was simply too big too fail, had new management in place, and possessed cleaner books. Best of all, it was cheap.
Trading at less than 7 times earnings, it was at a level it had not seen in decades. Some wits had coined the word "Fanron" to describe the shenanigans uncovered there, but it seemed my thesis for investing was borne out because within a year my shares were trading about 40% higher.
Yet I also wondered what would happen when Fannie Mae was no longer able to sell its mortgage-backed securities into the market? It didn't take long to find out how easy it was to knock down the whole house of cards: The 85-year-old institution Bear Stearns (NYSE: BSC ) became a penny stock overnight. My 40% gain in Fannie's shares also became a 50% loss.
Mobilizing air force
However, with Fed Chairman "Helicopter Ben" Bernanke commandeering a jumbo jet to implement his dollar drop onto the capital markets, Fannie Mae enjoyed a wild week, with its stock up 70%. The market approves not only the intervention but also the broad powers it has been given. Perhaps I ought to feel better, but I don't. Simply put, Fannie Mae is no longer the company I originally bought, and despite a newly resurgent stock, I foresee worse times ahead.
A foundation of what?
Fannie and Freddie have been given the authority to lower their capital to just 3% of the mortgages they hold, down from 3.25%, allowing them to support about $200 billion more in mortgage commitments. Regulators agreed to cut Fannie and Freddie's capital requirements by a combined $5.9 billion, while allowing them to borrow up to $33 for every dollar they have on hand. Bear Stearns, by comparison, was leveraged $34 for every dollar in capital at the end of 2007.
Mortgage lenders now own or guarantee about 45% of all U.S. mortgages in existence, but they are expected to buy or guarantee about 80% of all the mortgages made this year. The additional capital they'll be raising as part of the agreement (The Wall Street Journal reports that it could be $10 billion each) will allow them to buy even more loans above the $200 billion level just set.
Fannie will use part of its additional capital to help distressed borrowers that have resetting ARMs while also funding bigger loans in high-cost areas. Both Fannie and Freddie got temporary Congressional authority to purchase loans of up to $730,000 in regions with the most expensive homes.
This is not the Fannie Mae I originally bought. It has become overextended, too exposed to subprime mortgages, and too subject to the twin vagaries of rising defaults and falling home prices. When the break comes it will fall harder, faster, and further than it did before.
There's a singular moment when a wrecking ball swings, when it sits poised above its return arc, seemingly able to sustain that position forever. Then gravity resumes and the ball hurtles down again to slam into a building facade, shattering brick and splintering timber.
That singular moment is where Fannie Mae is now. It is suspended above a wrecked housing market that is waiting for the ball to fall forward again and smash into the brick-and-mortar of reality. It's something I'm not sure I want to be part of any longer.
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