Don't Touch Fannie Mae and Freddie Mac

The Department of Commerce released its final figure for first-quarter GDP growth this morning, revising it downward from 2.4% to 1.8%. In a Reuters poll, economists' estimates called for the figure to remain unchanged. Nearly all components of GDP growth were revised downward, with the notable exceptions of housing and government. Consumer spending -- the largest component of GDP -- came in at 2.6% growth, down from 3.4%.

Despite this news, investors in the U.S. stock market continue to shake off their macro jitters this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.81% and 0.79%, respectively, at 10:05 a.m. EDT.

Fannie and Freddie: future uncertain
At the beginning of the month, I highlighted government mortgage agencies Federal National Mortgage Association (NASDAQOTCBB: FNMA  ) and Federal Home Loan Mortgage Corp. (NASDAQOTCBB: FMCC  ) , commonly known as Fannie Mae and Freddie Mac. As the result of an extraordinary run this year, the stocks now have, to my knowledge, the highest market capitalization of any penny stocks in the U.S. market.

FNMA Chart

FNMA data by YCharts.

Unfortunately, a bipartisan group of senators is now presenting a bill to wind down both entities over a five-year period, which raises the possibility that equity owners could be wiped out. The bill would replace them with a Federal Mortgage Insurance Corporation, modeled on the Federal Deposit Insurance Corporation.

In aggregate, the two firms have received nearly $190 billion in taxpayer-funded injections in the wake of the credit crisis; the U.S. Treasury now owns roughly 80% of both companies. Fannie and Freddie are scheduled to repay $132 billion to the government at the end of the month.

At the beginning of June, fund manager Fairholme Capital Management, run by famed value investor Bruce Berkowitz, announced that it had acquired a $2.4 billion stake in the preferred shares of Fannie and Freddie (the preferred shares have also enjoyed a huge run-up in price, increasing more than 10 times in value from their 2012 low.) Fairholme has argued that the pair ought to be restructured, but not wound down, saying, "There are no substitutes."

As enticing as eye-popping returns can be, I would advise individual investors to refrain from betting on the outcome of this saga. There may yet be value in the federal mortgage agencies, but understanding their balance sheets and handicapping the political process requires time and expertise that ought to make this idea an automatic nonstarter for most investors.


Read/Post Comments (9) | Recommend This Article (16)

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 June 26, 2013, at 10:28 AM, msimons4 wrote:

    Shareholders take all the risk while the government takes all the money.

  • Report this Comment On June 26, 2013, at 11:02 AM, Baringo999 wrote:

    Fannie and Freddie are not going to be wound down.

  • Report this Comment On June 26, 2013, at 11:47 AM, consAREidiots wrote:

    no news.

  • Report this Comment On June 26, 2013, at 12:18 PM, MadStabber wrote:

    So they had the best quarter ever, delinquency is down to a comfortable level and congress can't pass wind, what me worry?

  • Report this Comment On June 26, 2013, at 2:57 PM, jbtorrez wrote:

    The real question here is why aren't we hearing about Fannie fighting back? Where are the advocates for keeping a stable and profitable company operating? Although Obama has many plusses, this is staggering that the government would do this in a CAPITALIST country.

    I see this as part of a larger problem with what is happening to the American spirit. When Bernake announced that stimulus would TAPER off (not be cut off tomorrow, people) we see a 400 point crash in the market.

    What is wrong with this country that we don't welcome getting out of a fiscally unsustainable plan? It was a helping hand, a crutch-- not meant to keep the country on permanent bed rest.

    Stand up America and start WORKING, start THINKING, stop demanding the easy wrong and take the hard road that will lead us back to some sense of right, some independence, some moral decency.

    With that kind of attitude we ought to scrap capitalism and just sign up for communism because we are becoming a nation of lazy, ignorant, greedy fools-- a very bad combination.

    The government only does what we allow them to, and with no one speaking up in opposition government is running rampant.

  • Report this Comment On June 26, 2013, at 5:24 PM, standup123 wrote:

    we should gather and protest to prevent FnF wind down, who with me?

  • Report this Comment On June 26, 2013, at 5:33 PM, Dangremaus wrote:

    I agree here! Where are the counter arguments and when will they be presented to Congress? How do we stand up to two Congressmen who obviously just want to make names for themselves. This is frustrating at the least.

  • Report this Comment On June 26, 2013, at 8:31 PM, notafool2013 wrote:

    I agree with you all here. The problem is the bad blood. Fannie Mae should not pay a specific congressman as a consultant. Right now, both sides want this company out. They even list phasing out Fannie Mae as an objective to achieve in that bipartisan report. In addition, the previous senior management was gullible, and incompetent. Suing these banks afterward can only prove that it is not the company's fault, but it does not prove the company is competent. The Senate does not want this thing happen again. Obviously, they want to change. The problem is that if the change is making it worse or better.

    The current management works very hard to show profit results on every quarter. However, if the same thing happens again, can Fannie Mae definitely do not need the government support? They do not have a solid system to show to the public yet.

    I have proposed a tracking system to Fannie Mae as well as my two Senators and my Congressman. There are a lot of people got hurt here too. I hope that I can get my voice heard by these representatives with the weight from these shareholders .

    They want a change and we give them a change. The new system should be stable, accountable, and profitable. The lender should have some reserve accounts as collateral reserve with Fannie Mae. These balance amounts are based on the historical default rate and current loan amount. The new loan fee will be based on the historical default performance. In other words, there is a credit history profile on each lender. The lender needs to be accountable. The government assistance will the third line of defense in addition to the Fannie's reserve and the lender's reserve.

    The ultimate result is that this system can take a hit without much assistance from the government if the same situation happens again. The number will not lie and there is a scientific base on the solution.I believe my system is better than what the government has right now. Basically, they just give up. How can we trust these elected representatives to fix the country if they can not even fix a company?

    I have done what I can now. I think the Fannie Mae survival rate is roughly 3 - 5% for the two Senators and one Congressman. I am assuming that they can listen to my appeal. If the Fannie Mae implements an equal or better system, then the survival rate may go up to 15% if the company let everyone know about it. The rest will rely on every shareholder to send any petition to all elected representatives.

    A crucial element is the Fannie Mae itself. This company needs to come out a simulation result or real system implementation to convince everyone that the profitable result is not just a pure luck relying on the economy situation. This company can handle good or bad situations and prove itself worthy.

    All shareholders can only help to provide ideas. The rest is up to this company. We sincerely hope that the old tricks (hiring someone as a consultant) will not happen on this new dog (or a phoenix) in the future.

    So far, I am long for this company because I believe the Warren Buffet's philosophy - just look at the management. You can start writing letters to your district Senator and Congressman. Don't forget to bring your sisters, brothers, sons, and daughters. The more, the merrier. We have to use the political means to solve the political obstacle. Just tell them how bad the idea is to use the bipartisan solution.

    If you do not have a good idea, you can use mine (the tracking system with three-tier reserves) If these people fight for you, they will need weapons (ideas) to convince their colleagues. They are just lawyers. We have to help them to help us.

  • Report this Comment On June 26, 2013, at 10:11 PM, PaulApp wrote:

    Unfortunately, this country has became the United Socialists of America! They always invent new wheel so the elite groups of corrupted government and companies will benefit!

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