Warren Buffett Makes a Lesson of Fannie Mae and Freddie Mac

Preferred shareholders in Fannie Mae and Freddie Mac have little claim to a growing pile of dividends in arrears.

May 22, 2014 at 9:26AM

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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.

Preferred Dividends

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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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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