Fannie and Freddie: Profitable Ghosts

Investors bet against the odds that the mortgage giants will survive | “I tell them it’s a lottery ticket at best,” says a senator

Clea Benson, Jody Shenn, and Kathleen M. Howley

A Speculative Surge


Shares in Fannie Mae and Freddie Mac, the mortgage-finance giants, have mostly traded for pennies since the U.S. government seized them in 2008. The companies’ bad investments in risky loans in the runup to the credit crisis led to a $188 billion taxpayer bailout and enshrined them as symbols of housing market excess. It seemed like they’d never climb back.

Instead, both companies have been posting record profits as the housing market recovers and mortgage defaults drop. Investors are even speculating that Fannie and Freddie could one day repay their bailout debt to taxpayers and exit government control. Fannie Mae shares have climbed from 29¢ in March to a peak of $4.08 on May 28. Freddie Mac shares rose from 30¢ to $3.75 during the same period. The gains briefly gave the companies a combined market value (including shares owned by the government) of nearly $48 billion — as much as Starbucks and money manager BlackRock.

The problem is that both Democrats and Republicans in Washington are set on liquidating Fannie Mae and Freddie Mac to avoid future bailouts. Senator Bob Corker, a Tennessee Republican, and Senator Mark Warner, a Virginia Democrat, are finishing work on a bill that would put them into receivership, which would probably leave little or nothing for shareholders. “There is a giant disconnect between investors and Washington over whether there is any value,” says Jaret Seiberg, an analyst at Guggenheim Securities.

Regulators didn’t anticipate a recovery when they seized Fannie Mae and Freddie Mac five years ago. The bailout includes no provision for the companies to repay the U.S. or become independent again. Lobbyists for hedge funds including Paulson & Co. and Perry Capital, which own preferred stock in Fannie and Freddie, are urging lawmakers to keep the companies alive. They arrive at meetings with detailed financial analyses contending that selling off the government’s shares and recapitalizing the companies could be more profitable for taxpayers than winding down the companies. Corker, who’s been in some of the meetings, says he’s been blunt. “I tell them it’s a lottery ticket at best,” he says. “I just don’t see any appetite in Congress for Fannie and Freddie ever being returned to the private market.”

Big financial companies aren’t the only ones agitating for a plan that would return profits to shareholders. Ralph Nader has been making the case that mom-and-pop investors who own the common stock also should reap a share of Fannie’s and Freddie’s record gains. At about the same time the government bailed them out, it also extended aid to American International Group, Citigroup, and other Wall Street banks. “There are some pretty bewildered people — retirees, people who invest through mutual funds — wondering why AIG shareholders get restored while they lose everything, even as the companies return to profitability,” says Nader, who owns Fannie Mae stock.

Fannie and Freddie spur home lending by buying mortgages from banks and packaging them into securities on which they guarantee payments of principal and interest. That frees up the banks to make more loans. Fannie Mae had its best year ever in 2012, reporting net income of $17.2 billion, outpacing companies such as Wal-Mart Stores, General Electric, and Berkshire Hathaway, according to data compiled by Bloomberg. Freddie Mac reported earning $11 billion last year. Both say they expect to remain profitable.

Lawmakers for years have delayed tackling a housing finance overhaul that would determine the companies’ future. The record returns may finally prod them to act. “If they make too much money, there may be a sense of, ‘Well, let’s not mess with them anymore,’ ” says Warner. “We need housing finance reform.”

The bill Warner and Corker are writing would replace Fannie Mae and Freddie Mac with a new agency known as the Federal Mortgage Insurance Corp. that would bear any catastrophic losses on mortgage bonds after private investors or insurers are wiped out. The legislation is a first step in what may be a long process. Congress is unlikely to act on any housing finance legislation before next year. The approach Corker and Warner are taking reflects a mounting consensus in Washington that the government should only assume mortgage losses during an economic catastrophe and that Fannie and Freddie should be abolished.

Investors may be getting the message. Shares in Fannie and Freddie dropped sharply after news of the bill broke on June 4. “The speculation is wild,” says Anton Schutz, president of Mendon Capital Advisors. “I would never engage in owning any security like that, where the government makes the rules.”

The bottom line The combined market value for Fannie and Freddie briefly hit $48 billion, even as lawmakers aim to shut them down for good.


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