What happened
Shares of government-sponsored mortgage giants Fannie Mae (FNMA 6.64%) and Freddie Mac (FMCC 5.60%) were rocketing higher on an overall down day for the markets, appreciating 11.4% and 10.9%, respectively, as of 2:50 p.m. ET.
Given both companies' exposure to volumes of mortgages made in the United States, it's perhaps no surprise that both companies have seen their share prices plummet over the past year, as the Federal Reserve has rapidly raised interest rates and the housing market has ground to a halt. Fannie Mae is down 42% over the past year, and Freddie Mac is down 44%.
However, a major homebuilder sentiment report today offered a ray of hope that the housing market may be bottoming out. With a beaten-down share price, both stocks shot up on the incrementally positive news.
So what
While there are some differences between these two giants, such as the types of mortgages they will guarantee and which institutions they typically buy mortgages from, their business models are pretty much the same: They buy mortgages from banks and other mortgage lenders, package them into securitizations, and resell the packages as mortgage-backed securities to other investors, while offering a guarantee of principal and interest payments. In exchange for the packaging and the guarantee, each entity takes a fee.
Today, the January National Association of Home Builders/Wells Fargo Housing Market Index was released, showing a four-point uptick in sentiment to a reading of 35. That was far better than the slight decline economists predicted.
The overall index is made up of several components, including current sales conditions, expected sales conditions, and buyer traffic, and all three subindexes rose slightly in January. For context, the index is still nearly 60% below the January 2022 reading of 83.
As inflation has shown a welcome moderation in the fourth quarter, long-term interest rates have declined. Since mortgage rates are generally priced off of long-term risk-free rates, average 30-year mortgage rates have fallen from 7.37% at the end of October to just 6.17% as of yesterday. That has likely spurred the improvement in sentiment.
Now what
Investors should be aware that Fannie Mae and Freddie Mac are still under government conservatorship, even 14-plus years after they entered into majority government control during the Great Recession of 2008.
In 2012, after both entities became profitable again, the government made a deal allowing it to collect all profits after a certain capital base had been reached. In 2019, officials in the Trump administration enacted reforms that would let the two mortgage giants begin to build capital again.
However, the Trump Administration also set the capital requirements for an eventual exit from conservatorship very high, which may not be reached for years. Now, two years into the Biden Administration, there remains a lot of uncertainty if these entities will ever exit the conservatorship, and if so, when.
Given that the government is now making a handsome profit on its rescue investment from 2008, it may be politically difficult for the government to allow these two entities to privatize again and really return a lot of profits to private shareholders. The battle is now being played out in the courts between private shareholders and the government, or the issue could be settled through future legislation.
Either way, these two entities are very abnormal investments, with a lot of interference from the government and long-term uncertainty hanging over them.
