World's Scariest Stocks: Fannie Mae and Freddie Mac

What else is stewing in our cauldron of evil? Prepare yourself before proceeding to the rest of our world's scariest stocks.

Rubber masks don't frighten me. Your witch costume doesn't make me flinch. The mechanical ghoul in my neighbor's yard impresses nobody. I nodded off during Paranormal Activity.

But you know what makes me scream like a schoolgirl? The fact that Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) still give off the impression of being capitalistic, shareholder-owned companies.

Let's be frank: They're not. Fan and Fred aren't really companies anymore. They're arms of the federal government, scarcely more capitalistic than the DMV. They're owned by taxpayers. They don't even seek profits. The shares that still trade and the value they reflect are purely a function of speculation and confusion. These shares are worth nothing. Nothing. Nothing.

I'll get into that in a sec. But first, consider these quotes from various SEC filings:

Fannie Mae: "Directors do not have any duties to any person or entity except to the conservator." (That means management has no fiduciary duty to shareholders).

Freddie Mac: "[B]ecause we are in conservatorship, we will no longer be managed with a strategy to maximize common stockholder returns."

Freddie Mac: "[T]here is significant uncertainty as to our future capital structure and long-term financial sustainability, and there are likely to be significant changes to our capital structure and business model beyond the near-term that we expect to be decided by Congress and the Executive Branch."

Fannie Mae: "The credit losses we experience in future periods as a result of the housing and economic crisis are likely to be larger, perhaps substantially larger, than our current combined loss reserves."

Freddie Mac: "We expect our pursuit of public policy objectives at the direction of the Conservator will, in many cases, have a negative impact on the financial results of our segments."

Freddie Mac: "[O]ur dividend obligation to Treasury will continue indefinitely, and there is no assurance that we will be able to pay that obligation in any future period."

You get the idea. These aren't shareholder-owned companies anymore.

To put this in quantitative perspective, the U.S. Treasury, to date, has pumped in about $98 billion to keep to two agencies afloat. That money has to be paid back, plus at least 10% interest, before current common shareholders lay claim to one honest dime. When you consider the above comments hinting at perpetual unprofitability, ask yourself: How, for the love of Pete, will these companies repay taxpayers? They can't. And won't.

And consider this: Earlier this year, the Treasury's allocation to cover Fannie and Freddie losses was upped from $200 billion to $400 billion. Point being, the money pumped in so far is likely just the beginning.

Just recently, KBW, a financial-services investment bank, slapped $0 price targets on both these companies. "In order for the government-sponsored entities to survive," KBW wrote, "they need to be recapitalized through investments from the banks that benefit from their role in the secondary market." In other words, they need a massive slug of capital from the likes of Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) .

Yet under that scenario, KBW noted, "both the common and preferred equity of [Fannie and Freddie] should be worthless."

Worthless, folks. Not worth less. Worthless.

All of this raises the question: Why do Fan and Fred shares still trade? And why does the market still think they're worth anything? When the companies imploded last year, the Treasury likely didn't automatically ax common shareholders solely to give the impression that it was simply assisting, not taking over. Same goes for AIG (NYSE AIG). And today, some may hold the belief that because Uncle Sam backs their operations, Fan and Fred are therefore ultra-safe investments. Not so. The government won't let Fan and Fred fail. But that doesn't mean common shareholders can't be totally wiped out. In fact, the more backing these two receive, the more certain it is that shareholders will be axed.

There are bargain stocks in today's market. Fannie and Freddie aren't them. But we'd still like your opinion. What do you think? Are Fannie and Freddie the world's scariest stocks? You tell me in the Fool poll below.

Warning: We've rounded up more scary stocks. Click if you dare.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool's disclosure policy wonders what that odd thumping sound in the basement could be.


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