There have been several efforts to get rid of Fannie Mae (FNMA -6.96%) and Freddie Mac (FMCC -6.62%) in Congress, but shareholders of the two companies weren't too worried because none of the proposals so far ever had a strong chance of passing. However, a new bill by three Democrats in the House of Representatives could change things a bit. This is significant because it's the strongest effort so far by Democrats to wind down the companies.
So, what's different about this proposal? What would take the place of Fannie and Freddie and the services they provide? And, will this proposal be fairer to shareholders of Fannie and Freddie? And why were shares of both companies up nearly 10% after the proposal was announced?
The bill and what it proposes
Basically, the Delaney-Carney-Himes bill has two main proposals.
First, it would establish an insurance program through Ginnie Mae that would require private capital to share the risk with the government by absorbing the first 5% of any losses sustained. This will help ensure responsible lending practices, as it adds an element of uninsured risk to lenders.
Second, it would wind down Fannie and Freddie over a period of five years, and this is where it gets a little interesting. The bill would wind down Fannie and Freddie's current activities and revoke their charter, but would allow them to be sold and recapitalized as new entities with new and different business plans.
Basically, the bill promises to maintain an accessible 30-year mortgage market, and to provide affordable housing options to the American public. It wants the new system to maintain pretty much all of the things Fannie and Freddie currently do, but at a much lower risk to taxpayers.
What about the shareholders?
It's a little unclear what this new proposal would mean for investors, but it's definitely not the "death sentence" for the common and preferred stock proposed under some of the previous bills.
The language is not completely clear and leaves some unanswered questions. As stated in the bill's summary, "they (Fannie and Freddie) will repay the government with interest for the government's investment in the institutions. The repayment must take into account both the injection of capital and the overall exposure to the government."
It is unclear exactly what this means for current investors, but it sounds a heck of a lot better than simply selling off both companies' assets and giving 100% of the proceeds to the Treasury, as proposed in some of the earlier bills.
What to do if you're an investor?
Before deciding what to do here, I'd want to hear a lot more about what the "repayment" to the government would require, especially since as far as I can tell, it's already happened.
As of the most recent quarter, Fannie and Freddie have paid the government back every dime they received from the bailout and then some. Fannie Mae has sent $126.8 billion to the Treasury, about $10 billion more than the $116.1 billion it received, and Freddie Mac has returned $86.3 billion, or $15 billion more than the $71.3 billion it received during the mortgage crisis.
Quite frankly, I'm somewhat confused by the language in the bill requiring a "payback with interest." Still, I have to say that this may be a good time for investors to start thinking about taking profits.
Fannie and Freddie shares are up more than tenfold over the past couple of years, and whether or not investors will ever see any of the companies' profits is still anyone's guess. Personally, I would embrace the pop this new legislation provided and enjoy my gains, but if you stay in, realize you're gambling, not investing.
