Does This Milestone Mean You Should Buy Fannie Mae and Freddie Mac?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks rose today, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 1.3% and 1.1%.

Which large-capitalization stock has risen more than 700% this year, all the while remanding the near totality of its (considerable) profits to the federal government? Mortgage agency Fannie Mae (NASDAQOTCBB: FNMA  ) , which has experienced a remarkable revival after having been at the brink of collapse at the height of the credit crisis in 2008.

The government was ultimately forced to step in to prop up Fannie Mae and its "fraternal" agency Freddie Mac (NASDAQOTCBB: FMCC  ) with an aggregate $187.5 billion in taxpayer funds (incidentally, shares of Freddie Mac have produced a similar year-to-date return of roughly 700%). Under the terms of the conservatorship, the government began appropriating all of the agencies' quarterly profits last year beyond a $3 billion net worth cap.

A staggering $185 billion in dividend payments
However, Fannie and Freddie announced separately today that they will make a combined $39 billion in payments to the government before the end of year, which would put total remissions at $185.2 billion -- within $2 billion of the amount taxpayers fronted them (note, however, that these payments, which are technically dividend payments on the government's senior preferred shares, do not qualify as repayments of the taxpayer aid per se).

So do Fannie Mae and Freddie Mac's enormous profits indicate that they are good common stock investments? Clearly, returns this year have been stratospheric -- albeit with huge volatility, Fannie Mae's stock has suffered a peak-to-trough loss of roughly three-quarters along the way. However, both organizations present some highly unusual risks: Their common equity may be in private hands, but, for now, the government calls the shots and takes all the profits.

Current profitability is unsustainable
Second, even Freddie Mac's CEO, Donald Layton, warned against using the past couple of years' bumper earnings as a benchmark of future profitability, telling reporters that the level of these earnings "is not sustainable in the long run." He added, "It's a reflection of the housing cycle coming back. I would not ever characterize the next few years as ones in which there would be steady earnings necessarily, or in any way promise steady earnings."

Finally, it's not even clear that the mortgage agencies are going concerns! Lawmakers in both houses of Congress are working on legislation to wind them down. In truth, though, I don't expect anything concrete on this front for a number of years -- I don't see anyone stepping in to fill the enormous void Fannie Mae and Freddie Mac would leave in the mortgage market in the immediate future.

Fannie Mae and Freddie Mac are no blue chips
Bottom line: Fannie and Freddie may look like blue-chip stocks, but they are, in fact, special situations that require much knowledge, experience, and intensive monitoring to invest in. At the 2001 Berkshire Hathaway annual meeting, when Warren Buffett was asked why he had sold nearly all of Berkshire's shares of Fannie Mae and Freddie Mac, he replied: "We felt the risk profile had changed." While the agencies are now safer than they were five years ago, common equity holders' position remains fraught with uncertainty. Fannie and Freddie's profits may have some luster, but these are shares that could quickly tarnish a portfolio's performance.

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  • Report this Comment On November 09, 2013, at 11:10 AM, hikingviking wrote:

    Only a few short years after the death of the Glass-Steagall Act of 1934; signed away by Bill Clinton in 1999, Buffet understood and realized how devastating the loss of the law would be to Fannie and Freddie. He foresaw banks reaching back into their 1920's bag of tricks for profits based on hedging and highly risky investing schemes. Well, between 2000 and 2007, that is exactly what the banks did in the mortgage market. However, at the end of 2008, the government (Frank-Dodd among others) decided to solve the mortgage crisis by stuffing Fannie and Freddie with billions of dollars in bad loans from....wait for it......yes, you are right.....the banks. Buffet knew the government would force Fannie and Freddie to abandon all reason and accept unwillingly these bogus loans which would cause them great financial instability. That is how smart Warren Buffet is. Fannie and Freddie, like them or not, create an even playing field for home purchases for the rich and the poor. Eliminating them will leave us with..............the banks. Fannie and Freddie will ebb and flow with the market and when released from the government's grip they will fly just like they did during their first 50 years. They are helpful tools without government manipulation. IMHO

  • Report this Comment On November 09, 2013, at 6:55 PM, Caludio wrote:

    I will not be surprised to learn that Mr Buffett is buying Fannie and Freddie now at $2.30... and probably he will sell them again in 2017 but at

    $50. He knows when to buy and when to sell

  • Report this Comment On November 10, 2013, at 11:13 AM, infinitemf wrote:

    Lots of people write about FnF without knowing facts and laws. Some do it to confuse the issue and benefit from it, others do it without knowing what they are doing. So It is difficult for many to see the real truth in the haystack of misinformation.

    FnF Net bailout loan was 137 billion and not 187 billion. So far USG/taxpayers have profited to the extent of 48 billion on investment of 137 billion by charging 10% usary interest.

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