More Reason for Fannie Mae and Freddie Mac Shareholders to Be Afraid

Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) have seen their stock prices rise by almost 950% over the last year -- but recent congressional action reveals the future may not be so bright.

More potential overhaul
Press wires have been abuzz lately about the possible action from the Senate Banking Committee to introduce a bill in the coming weeks that would bring overhaul to the mortgage financing industry and overhaul the current system entirely.

Source: Future Atlas on Flickr.

The chairman and ranking members of the committee, Tim Johnson (D-SD) and Mike Crapo (R-ID), respectively, issued a rare joint statement last week that noted; "With the hearing and information-gathering stage behind us, our hard work continues as we dive deep into the drafting and negotiating phase of Housing Finance Reform. Our goal from the start has been to produce the strongest bipartisan bill possible -- a bill that will strengthen the housing finance system while ensuring a level playing field for all lenders and access to credit for all creditworthy homebuyers, no matter where they live."

There was no guidance on what the bill will entail, but many have speculated it will draw on the Corker-Warner bill, which has called for the winding down of Fannie Mae and Freddie Mac within the next five years and would ultimately provide the common shareholders of the two government sponsored entities with little to nothing in return.

Source: 401(K) 2013 on Flickr.

The statement from Johnson and Crapo noted this was the "top priority," for the committee and affirmed it was also a priority for President Obama, who called for "legislation that protects taxpayers from footing the bill for a housing crisis ever again, and keeps the dream of homeownership alive for future generations," in his State of the Union address.

Why it matters
Fannie and Freddie shareholders need to be concerned because this would be the second major bill from the Senate proposing significant change to the underlying structure of the housing market, with the role of the two GSEs being a central focus.

Already, Fannie Mae and Freddie Mac operate with a total disregard for common shareholders by returning all profits to the U.S. Treasury, the two paid back dividends totaling $39 billion in December alone. Fannie Mae also said simply in its annual report, "we are no longer managed with a strategy to maximize shareholder returns," and "every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms."

With two Congressional bills that cross party lines, the support of the United States president, the director of the body that controls Fannie and Freddie, and even the companies themselves all aligned to ensure the companies don't operate in the interest of shareholders, but instead of U.S. taxpayers, with total overhaul as the ultimate aim, common shareholders of Fannie and Freddie have every reason to be concerned the days of wild speculation and surging stock prices are over.

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Read/Post Comments (6) | Recommend This Article (4)

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 February 15, 2014, at 8:14 AM, smauney wrote:

    You forgot - It won't pass both houses this year.

  • Report this Comment On February 15, 2014, at 12:25 PM, maestrolindo wrote:

    They are desperate. Congress is impotent and our President is a liar. They will blabber about a new bill, likely the same day Q4 earnings are reported to prevent a run on the price per share, but they are just dragging their feet. Feel free to read the New York Times article written today which paints an accurate picture of what's happening. What you're described above could happen in Venezuela or Argentina but not the United States.

  • Report this Comment On February 15, 2014, at 1:39 PM, maestrolindo wrote:
  • Report this Comment On February 16, 2014, at 1:49 AM, gagdump wrote:

    MF is strangely obsessed with bashing Fannie. This was news in May. Why keep dredging it up again when there is no new news about any bill? No news value was added in this article. Again, what is their obsession?

    Here is what will really happen: Wind down = the federal reserve buys MBSs from FNMA

    That's all. Just like H and R Block did in 2007. Is HRB still around? Yes. In this case, FNMA makes even more money by selling securitized mortgage bonds to the fed. This "gets the government out of the mortgage business" just like HRB "got out of the mortgage business". It's that simple. Obama said privatize and wind down, then sperling says no to one certain kind of "privatization". Guess what kind of privatization they have in mind and guess who the only entity is who is able to and does buy MBSs? It's the fed. Soon, the fed will own the whole indebted country. But they can't say this because to do so would be to admit to dumb Americans that the fed is not the government. While it's being wound down, here is your chance to make some money. FNMA can only go up wildly from here, with added profits from the "winding down" ie, the sale of their debt. Look at HRB and see how they did it.

    What do I think the media is doing? They are MANAGING FNMA. In a political campaign, you don't want to peak too early. The media, govt and even Obongo went to obvious extremes to manage FNMA. It was not to peak too early. Now, it is the right time to let it peak - the midterm elections are everything to the democrats. They know they have the next presidency in the bag; the elimination of all adult supervision in the House is their aim and they will do this by a strong Fannie. "See how we have brought back the economy, even the last of the 2008 crashers - behold our Fannie." They will then argue, I'm afraid convincingly, that the repubs have no economic plan. FNMA will be the poster child of the democrats' midterm race. Here is your last chance to make money in our former Republic. Make socialism work for you for once. Get into FNMA now; it will be restored to 60 by June.

  • Report this Comment On February 16, 2014, at 12:00 PM, hikingviking wrote:

    Can anyone really look at how the government mislead FNMA and FMCC shareholders and conclude anything but manipulation? The closed door closet sessions on FNMA and FMCC would be fantastic to listen to. Moving forward does anyone really trust the government to re-wire the housing finance system following the Obamacare tragedy that is still in a state of moving collapse. The only purpose to modify the twins would be to re-distribute wealth. Bad loans forced upon the mortgage giants were why (if ever) they needed money from the Treasury. Come on Fools. Give it up. You guys must have at least a 1000 shares a piece of FNMA and FMCC. Speculative play or not these puppies should not be messed with or the housing finance system will collapse and potential PPS is wealth making. No appetite from big banks to keep the housing machine moving forward on 30 year fixed without huge interest rate spikes. I assume you know what that will do to housing starts. Ask yourselves why the housing system worked so well for so many years and then after Clinton signed away the Glass Stegal Act it didn't. You guys are beginning to sound like re-distribution pumpers. Seriously, FNMA and FMCC last earnings have been as much or more than Google. One more thing, ask Corker why he didn't get his 30% out of AIG, GM, Solyndra, etc. when he expects it out of the twins. Sumpin' ain't right in DC.

  • Report this Comment On February 17, 2014, at 11:41 AM, Caludio wrote:

    Somebody that goes by the user name of "Metalhead" posted a link to an article of Dean Baker. I liked it so much that I copied it here below to make it easier for our forum to reach it. I also emailed a copy of the article to the office of my Congressman. Every decision making person in DC should be aware of what this article says.

    Privatizing Fannie and Freddie and the Return of Subprime By Dean Baker

    February 10, 2014

    In his State of the Union Address President Obama made a quick reference to his hopes for reforming Fannie Mae and Freddie Mac. Unfortunately, reform in this context doesn’t mean “better.” Reform is likely to mean privatization. In fact the most likely form of privatization at this point would feature the sort mix of private incentives and government guarantees that makes another financial disaster virtually certain.

    The smart money in Washington is betting on the Housing Finance Reform and Taxpayer Protection Act (S. 1217), better known as the Corker-Warner bill after its two lead sponsors. This bill, which was put together by two of the more centrist senators in both parties, does not just get the government out of the mortgage guarantee business. There actually would be a plausible argument for that position.

    But the Corker-Warner bill does much more than just eliminate Fannie and Freddie. In their place, it would establish a system whereby private financial institutions could issue mortgage-backed securities (MBS) that carry a government guarantee. In the event that a large number of mortgages in the MBS went bad, the investors would be on the hook for losses up to 10 percent of its value, after that point the government gets the tab.

    If you think that sounds like a reasonable system, then you must not have been around during the housing crash and ensuing financial crisis. At the peak of the crisis in 2008-2009 the worst subprime MBS were selling at 30-40 cents on the dollar. This means the government would have been picking up a large tab under the Corker-Warner system, even if investors had been forced to eat a loss equal to 10 percent of the MBS price.

    The pre-crisis financial structure gave banks an enormous incentive to package low quality and even fraudulent mortgages into MBS. The system laid out in the Corker-Warner bill would make these incentives even larger. The biggest difference is that now the banks can tell investors that their MBS come with a government guarantee, so that they most they stand to lose is 10 percent of the purchase price. This doesn’t bode well for a Corker-Warner future, since banks obviously had little difficulty selling junk filled MBS that carried no government guarantee at all.

    Certainly the Justice Department’s treatment of the bankers who packaged fraudulent mortgages and misrepresented their quality to buyers will not discourage the same behavior in the future. None of these people went to jail and in most cases they are much richer today than they would have been if they had pursued an honest career.

    The changes in financial regulation are also unlikely to provide much protection. In the immediate wake of the crisis there were demands securitizers keep a substantial stake in the mortgages they put into their pools, to ensure that they had an incentive to only securitize good mortgages. Some reformers were demanding as much as a 20 percent stake in every mortgage.

    Over the course of the debate on the Dodd-Frank bill and subsequent rules writing this stake got ever smaller. Instead of being 20 percent, it was decided that securitizers only had to keep a 5 percent stake. And for mortgages meeting certain standards they wouldn’t have to keep any stake at all.

    Originally only mortgages in which the homeowner had a down payment of 20 percent or more passed this good mortgage standard. That cutoff got lowered to 10 percent and then was lowered further to 5 percent. Even though mortgages with just 5 percent down are four times as likely to default as mortgages with 20 percent or more down, securitizers will not be required to keep any stake in them when they put them into a MBS.

    Anyone banking on the bond-rating agencies to protect against the proliferation of junk MBS wasn’t paying attention to what happened to the Franken Amendment in the rules writing process. This amendment, which passed the Senate with a huge bi-partisan majority, would have eliminated the conflict of interest that results from having the bank issuing a MBS paying the rating agency that assigns the rating.

    This conflict of interest would have been eliminated by having the Securities and Exchange Commission (SEC) pick the rating agency. This simple step would take away the incentive to rate every piece of junk as investment grade, as was the case during the bubble years.

    This change would have taken effect, except the SEC, after being inundated with industry comments, deciding that picking rating agencies was too complicated. As a result we have the exact same system in place as we did during the bubble.

    In short, the Corker-Warner plan to privatize Fannie and Freddie is essentially a proposal to reinstitute the structure of incentives that gave us the housing bubble and the financial crisis, but this time with the added fuel of an explicit government guarantee on the subprime MBS. If that doesn’t sound like a great idea to you then you haven’t spent enough time around powerful people in Washington.

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    Dean Baker is co-director of the Center for Economic and Policy Research and author, most recently, of The End of Loser Liberalism: Making Markets Progressive

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