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Fannie Mae and Freddie Mac: On Sale For a Limited Time

By Alexander MacLennan - Mar 17, 2014 at 9:00AM

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A market overreaction to legislation unlikely to pass creates a near term buying opportunity in these GSEs.

Last Tuesday, investors in Fannie Mae ( FNMA 1.27% ) and Freddie Mac ( FMCC 2.56% ) were greeted with an unpleasant surprise. But it wasn't the actual news that was surprising so much as it was the 30%+ drops in the GSEs share prices and how the market reacted. As a holder of GSE shares myself, I view this drop as a buying opportunity and soon after the big move lower, I added to my GSE positions.

Death of the GSEs?
Fannie and Freddie have been great targets for politicians from across the political spectrum since the mortgage meltdown in 2008. But while almost all politicians want to end Fannie and Freddie, like so many other things in Congress, they can't agree on how to do it. So political compromise seems to be the worst possible thing for GSE investors but in this Congress, it has not been a present threat so far.

Investors were startled Tuesday when Senate banking committee members Chairman Tim Johnson (D-South Dakota) and ranking member Mike Crapo (R-Idaho) crafted and put forth a proposal to wind down Fannie and Freddie.

But what are the chances of this proposal going anywhere in the near term? Based on the negligible progress of the Corker-Warner bill (the proposal that formed the basis for the Johnson-Crapo proposal) the Johnson-Crapo proposal has a long uphill battle against it. Despite support from President Obama, and the Corker-Warner bill being a compromise worked out between a Republican and a Democrat, the bill has not even passed the Senate.

Johnson-Crapo comes at an even worse time for chances of passage than the Corker-Warner bill. With only eight months until mid-term elections, much of Congress' efforts over the next several months will be directed to serving their constituents through constant campaigning rather than getting major legislation passed.

And even if the Senate can come together and pass the Johnson-Crapo proposal, it would still need to pass the House to be implemented. Being under Republican-control, the House is looking to remove the government from the housing market as much as possible; a goal that clashes with Johnson-Crapo's plan to create a new federal entity to fill some of Fannie and Freddie's duties.

Investment opportunity
Since returns for Fannie and Freddie investors are almost certain to come from the courts rather than Congress, political gridlock, upcoming elections, and other delays are friends of the GSE investor. Considering past examples, future obstacles, and less than optimal timing, the threat from the Johnson-Crapo proposal seems greatly overblown and unlikely to cut down on the time GSE investors have to fight their battles in court.

Market reaction to the Johnson-Crapo agreement was highly unusual. With most negative news, a company's stock plunges immediately as day traders, market watchers, and automated computer trading systems all put in their sell orders. But with Fannie and Freddie, the news took hours to take its big drop; enough time for the armchair investor to see the headline, grab a coffee, and read several news articles about the proposal.

After bottoming out in the low $3 range, shares of the GSEs have been on the rebound gaining for the final two days of the week to close back above $4, even with Thursday and Friday being negative days for the broader market. This movement shows panic selling to be largely over with the shares possibly being driven back up as investors run a more complete analysis on the situation.

Still speculative, but at a better price
At the core, shares of Fannie Mae and Freddie Mac remain a highly speculative bet given their government conservatorship, but looking at the proposal's chances of passing more closely, it's far from a near-term threat.

With the proposal likely to be held in place until at least the mid-term elections, I believe the original thesis for investing in Fannie and Freddie still applies. Furthermore, I see this drop as a chance for new and existing investors to increase their positions if it still fits within their risk profile.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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