I’ve got a simple rule for overly complex investing situations: If you come across a minefield, walk around it, not through it. Fannie Mae (NYSE:FNM) and her little brother, Freddie Mac (NYSE:FRE), are minefields right now -- you’d be better off avoiding the stocks altogether. Sure, Fannie might look cheap at its lowest price in more than 15 years, but there is no law that says it can’t go lower (after all, General Motors (NYSE:GM) hit a 53-year low in June).
The company’s second-quarter results were hardly reassuring. On Friday, Fannie announced a quarterly loss of $2.3 billion -- its fourth consecutive quarterly loss. Going forward, management now expects the decline in housing prices to reach the top of its range of estimates of 15% to 19% peak-to-trough (that decline is currently 8%).
The deepest cut
The company had the sense to cut its quarterly dividend from $0.35 to $0.05, which will preserve $1.9 billion in much-needed capital through 2009. No company likes to cut its dividend -- it unnerves investors and may chase off those who focus on a regular cash dividend. However, when a company is capital-constrained in a poor capital-raising environment, it’s a shareholder-friendly initiative.
In truth, Fannie Mae management waited too long to take action on that front, which suggests that (a) management badly underestimated the severity of the housing crisis and the company’s economic requirement for capital (instead of focusing on regulatory capital requirements); or (b) the “too big to fail” mindset had already corrupted the corporate decision-making process.
It’s not a pretty story, but unfortunately, it’s par for the course in this crisis, from Citigroup (NYSE:C) to Lehman Brothers (NYSE:LEH) and Merrill Lynch (NYSE:MER). The latter two have yet to cut their dividends; last Wednesday, respected banking analyst Dick Bove said he expects Lehman to cut its dividend by up to 90%. Senior executives are richly paid to make difficult decisions that show foresight and independence -- and that didn’t occur here.
Fannie Mae: long or short?
The answer to that question is neither. I think the government will ultimately be forced to recapitalize Fannie Mae (and Freddie Mac), wiping shareholders out. Sounds like an obvious short, right? The reality is, I’m not comfortable handicapping this situation, and I certainly think it’s possible (though unlikely) that shorts will get badly burned here. The smartest thing I can do in a situation like this is proclaim my ignorance and walk around the minefield.
I strongly recommend you do the same -- unless you’re looking for the same thrill and enjoyment as you would get from your annual weekend in Vegas (and the same outcome). Otherwise, stick to the Strip; you’ll get the same or better odds at a blackjack table, and the cocktails are free.
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