Warren Buffett Makes a Lesson of Fannie Mae and Freddie Mac

Warren Buffett had some choice words for Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  )  shareholders at Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) latest annual meeting.

It wasn't his typical style. Buffett usually refrains from naming names, but on the topic of preferred stock, he had no such filter: "Noncumulative has certain defects, and preferred holders of Freddie Mac and Fannie Mae are finding that out. They are a terribly weak form of security."

The terrible weakness
Preferred shareholders ordinarily receive preferential treatment; hence, the name. Preferred shareholders are supposed to receive their dividends first, before common shareholders can stake their claim.

Cumulative preferred shares should have an even greater advantage over noncumulative preferred shares. If dividends are skipped in any given year, they're to be repaid later when a company can pay a dividend. Fannie and Freddie preferred shares are noncumulative, however, and thus, all the dividends that should have been paid since September 7, 2008 are simply lost.

Dividends soared starting in 2009, when all preferred dividends were redirected to the U.S. Treasury.

If Fannie Mae and Freddie Mac are ultimately returned to the hands of public owners, then preferred shareholders may, once again, collect a dividend. They won't, however, collect all the dividends previously skipped.

Why it matters
As a war builds over who should legally own Fannie and Freddie, normal preferred dividend distribution days are passing by. The amounts are growing significant by the day. In just a few months, preferred shareholders will have waited six years for any dividend at all.

And while Fannie Mae or Freddie Mac shareholders would ultimately stand to make massive returns if the government releases them to private hands, and shares trade back to par, there's no disputing the fact that the icing on the cake -- dividends in arrears -- will never come.

If there's something to be learned from Fannie Mae and Freddie Mac, it's that noncumulative preferred and cumulative preferred shares have their commonalities; but when it really matters, it's the differences that truly count. 

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  • Report this Comment On May 22, 2014, at 10:51 AM, bigjohn327 wrote:

    warren should stick to his sweetheart deals and government manipulation instead of law. since his opinion means nothing and the legal system can go back and claw back all monies illegally taken by the government self dealing

  • Report this Comment On May 22, 2014, at 11:07 AM, VKistheone wrote:

    This is a different circumstance, FNF are both paying dividends and its going to treasury. And previous to 2012 the company was operating at a loss so no dividends cold be paid!! I think the Great Buffet might be losing his edge at his age!!! Great investor in his time, someone I look up to and red all his books, but he is 100% wrong in this deal. The treasury will have to pay back company for dividends taken is the lawsuits prevail.

  • Report this Comment On May 24, 2014, at 2:07 AM, maestrolindo wrote:

    Face it. There are no viable options for housing reform. And since congress is so concerned about the well being of tax payers, I am sure they are aware of the tremendous windfalls which lay ahead for tax payers in the wake of recapitalizing and releasing the GSE's from conservatorship.

    The government is the largest shareholder of Fannie and Freddie, owning 79% of their common stock. Tax payers will make 600 billion from the government selling the GSE's equities and collecting taxes on the their future profits.

    The senate banking committee's plan to turn the housing market into a giant federally backed insurance company increases systemic risk for tax payers to 90% in the event of another crisis.

    Economies of scale allow Fannie and Freddie to guarantee low cost mortgages and the house's plan to fully privatize the industry will increase the cost of home ownership significantly.

    Congress doesn't know what they are doing.

    I am surprised that Warren Buffett isn't accumulating shares of Fannie and Freddie. Maybe he is listening to Bob Corker.

  • Report this Comment On May 24, 2014, at 2:57 PM, smauney wrote:

    real estate economic development and the GSE's: Growth, Stability, Decline and Renewal. No manipulation by political, government or social forces can alter this real estate cycle. Overall, we're in the renewal stage. However, doing away with Fannie Mae and Freddie Mac could possibly do irreparable harm in an omni-fashion starting out as a ripple and turning in to an economic tsunami that does harm well beyond the world of real estate. That's why even those who wish to destroy the GSE's keep saying "we have to get this right". If they don't, it will be the fall of another empire in a long list of empires who thought they were invincible.

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