Congressional Inaction Could Lead to Additional Future Bailouts for Fannie Mae and Freddie Mac

To say the future for Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac's (NASDAQOTCBB: FMCC  ) shareholders is uncertain would be quite an understatement! The latest news about the possibility of Fannie and Freddie needing another huge bailout if another downturn happened is just another "what if" shareholders have to deal with. We already know the U.S. Treasury takes all profits earned by both companies, and shareholders are suing in order to change this arrangement. In addition, there are a bunch of Senators who aim to dismantle both agencies and give all proceeds to the government, wiping out shareholders in the process. After the dramatic rise in their stock prices over the past year, is now a good time to cash in?


Fannie and Freddie would need how much more?
The FHFA issued a report stating that a "stress test" had been performed on Fannie and Freddie, using the same assumptions the Federal Reserve uses to decide how well the nation's biggest bank would weather a recession.

Many investors were surprised to learn the banks would need up to $190 billion in additional bailouts by the end of 2015 in a severe downturn. This is more than the $187.5 billion in taxpayer-funded assistance they received in 2008.

While it sounds like a lot  -- and it is -- there is a pretty valid reason why the companies don't have much capital in reserve. Under their agreement with the Treasury, the companies have to hand over all of their quarterly profits. This prevents Fannie and Freddie from building up their capital levels to withstand a sudden financial emergency. It also sounds like less of a "bailout" when you consider the nearly $203 billion in payments the government has already collected.

While I don't think the need for another big bailout is very likely, it does help make the government's case for keeping Fannie and Freddie 100% government-controlled. Basically, I think the government will say something to the effect of "Why shouldn't we keep all of the profits? We'll be on the hook for billions if things go sour."

Other drama...will shareholders ever see some profit?
There are two other issues facing Fannie and Freddie which shareholders don't want to see happen. First, under the current arrangement, 100% of profits go to the Treasury. Well, with the companies profitable and making some serious money now, shareholders who stuck with Fannie and Freddie feel they should share in the rewards. Makes sense, right?

A group of shareholders have filed a lawsuit in an attempt to force the Treasury to more equitably distribute the profits. Who knows if they will prevail, but the new stress test results certainly don't help their case.

Nor does it help stop the Senate's efforts to dismantle both companies. There is a bill in the Senate Banking Committee which would wind down Fannie and Freddie, giving all proceeds from asset sales to the government. The bill is delayed temporarily right now, but the fight continues. If the bill did pass in its current form, shareholders would likely be totally wiped out.

There seem to be a collection of forces working together to ensure the government keeps reaping the profits of the two housing finance giant. Will shareholders ever see any profit? Only time will tell.

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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Related Tickers

9/1/2015 3:59 PM
FMCC $2.25 Down -0.01 +0.00%
Freddie Mac CAPS Rating: **
FNMA $2.35 Down -0.02 +0.00%
Fannie Mae CAPS Rating: **