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Jonathan Poland
Jonathan Poland
Articles (419)  | Author's Website |

The Fate of Fannie and Freddie

The US government continues to keep shareholders in the dark

August 09, 2018 | About:

The rising housing market hasn’t translated into recovery for these two stocks at all, but getting them out of conservatorship will help.

The Federal National Mortgage Association (FNMA), or Fannie Mae, is a government-sponsored enterprise (GSE) that was founded in 1938 during the Great Depression as part Franklin Roosevelt's New Deal with the purpose of securitizing mortgages, via mortgage-backed securities, to help lenders keep lending. Its brother organization, the Federal Home Loan Mortgage Corp (FMCC), or Freddie Mac, was created in 1970 to do what seems like the exact same thing as Fannie Mae: buy mortgages, repack them and sell them to the open market in order to increase the supply of money available for mortgage lending and increase the money available for new home purchases.

The main difference between Fannie and Freddie is who they buy mortgages from: Fannie Mae mostly buys mortgage loans from commercial banks, while Freddie Mac mostly buys them from smaller banks, often called "thrift" banks.

The first domino of the Great Recession was toppled on Sept. 7, 2008, when James Lockhart, the director of the Federal Housing Finance Agency (FHFA), put Fannie and Freddie into conservatorship. Eight days later, Lehman Brothers collapsed, and we all know what happened next in the stock market.

Today, nearly 10 years later, the stock prices of both these once-great institutions have crumbled and remained stagnate.

However, both of the companies have recovered and are in a significantly better position today. In the last year alone, Freddie Mac provided $422 billion in funding, reported $7.2 billion in net income, and 99% of homeowners were current on their mortgage. In total, it returned over $112 billion to taxpayers since 2008, and took steps to create a single MBS platform with Fannie by 2019, who has also paid the Treasury over $167 billion since 2008 and continues to rank high on places to work across the U.S. Maybe the government doesn’t want to get rid of this cash cow, but it will have to very soon.

After paying back the government for almost a decade, it’s about time for these two to stand on their own. Guru investor Bruce Berkowitz (Trades, Portfolio) still owns preferred stock in both, but the common stock is what matters now as the public should be able to take part in the financial prosperity of these organizations.

Housing may be the one area that will flourish during the Dot-Com Bust of 2020, as investors foolishly take their money out of stocks and put it into hard assets. Both of these companies are likely to benefit from the next decade of housing growth. It’s still not clear what will be done with them and investing in FNMA or FMCC remains highly risky, however. The market would like to see them out of the government’s hands, especially since both are highly profitable, and could possibly free up hundreds of billions of dollars of increased lending each year.

Is there upside on FNMA and FMCC stock? It does seem like momentum is building for something to finally happen this year or early next with Treasury Secretary Steven Mnuchin.

The risk is that common shareholders could be wiped out because there are preferred shareholders ahead of them, who are already receiving 10% of the profits. So there is a very real risk of going to zero. But there is also potential for Bill Ackman’s 2014 plan to be put into action. There will be dilution for exisitng shareholders, but with the amount of cash these companies are producing and the need for them in the market, it’s worth a flyer.

Disclosure: I am not long/short FMCC or FNMA.

About the author:

Jonathan Poland
Thanks for reading! I'm a former money manager, publisher and stock analyst who helped investors produce market-beating results for over 15 years. Today, I run a private membership for business leaders dedicated to profit and progress.

Visit Jonathan Poland's Website


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