Recent comments from one senator suggest Fannie Mae and Freddie Mac (NASDAQOTH:FMCC) will be left in conservatorship for at least the next few years. While it might not seem so, this is good news for the agencies' shareholders.
The federal government has controlled Fannie Mae and Freddie Mac and their profits since the end of 2008. Shareholders are pushing for the agencies to be allowed to recapitalize and be restored as publicly traded companies, but many lawmakers want to do away with them for good.
Why isn't anything likely to happen?
To put it simply, no one in the government seems to agree on what to do with the agencies.
Republican leaders in the House of Representatives tend to favor privatization of Fannie and Freddie, but are reluctant to do anything that would be perceived as a bailout to shareholders. Others feel Fannie and Freddie should be dismantled and replaced by another government entity that would regulate and provide liquidity to the mortgage market.
Senator Richard Shelby (R-Ala.) recently said that he would rather leave the agencies in conservatorship than pass a bill that includes explicit government support for the housing market. That is exactly what a bipartisan bill introduced last year would have done. Since they are under government control, the agencies are already providing an explicit guarantee. And, they are profitable and functional, so why change the current arrangement? Shelby simply thinks there are more pressing matters that need his attention than an overhaul of the housing finance system.
So it appears that while lawmakers settle on a course of action, which could take years if not decades, Fannie and Freddie will remain as they are.
The current state of Fannie and Freddie, and the options for moving forward
Fannie Mae and Freddie Mac are both under government conservatorship as a result of the bailouts given during the financial crisis. Shareholders are suing to change the arrangement and return Fannie and Freddie to the private market, claiming that investors and the government stand to make more money by doing so. For a thorough explanation of the Fannie and Freddie drama, check out this article.
Basically, there are three things that could ultimately happen with Fannie and Freddie:
- Nothing. Fannie and Freddie remain in conservatorship with 100% of profits diverted to the Treasury Department. The problem here is that both agencies' capital reserves are being gradually depleted, which could eventually force the need for further bailouts.
- Fannie and Freddie could be returned to the private market. Under this scenario, the U.S. Treasury Department would retain control of about 80% of the agencies' stock, but Fannie and Freddie would be allowed to recapitalize and share profits with investors. It has been estimated that shares could be worth about 10 times their current value (or more) in this scenario, and that the government could make up to $600 billion.
- Fannie and Freddie could be wound down and eliminated. It's unclear what would replace the agencies and what would happen to shareholders. Additionally, because these two agencies account for the vast majority of mortgages being underwritten today, I view this as the least likely of the three scenarios.
Why the indecisiveness is good for shareholders
As long as Fannie and Freddie remain in conservatorship, shareholders can continue to be hopeful about recapitalization and a more equitable profit distribution arrangement.
Several bills introduced in Congress over the past few years called for winding down Fannie and Freddie and replacing them with a new centralized agency or agencies that would guarantee mortgages. However, none of the bills have made clear what would happen to Fannie and Freddie shareholders in the event the agencies are eliminated. In fact, under all of the bills introduced (none of which came particularly close to passing), the most likely scenario seemed to be that Fannie and Freddie shareholders would be completely wiped out. So, if a bill were to pass that eliminated Fannie and Freddie, shareholders would likely lose any hope of reaping future profits from their investment.
Thus, as long as the agencies remain in their current state of conservatorship, the legal process will have time to play out and shareholders have a chance at getting their way. It's still a small chance, but that's why Fannie and Freddie shares trade so cheaply.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.