Fannie Mae & Freddie Mac: A Risk Worth Taking

Up until a year and half ago, it would have been unthinkable to invest in Fannie Mae (OTCMKTS:OTCQB:FNMA) and Freddie Mac(OTCMKTS:OTCQB:FMCC), the two government-sponsored enterprises (GSEs) that were forced into government conservatorship in 2008 after suffering heavy losses from the bursting real estate bubble. The Treasury Department seemed intent on dismantling them and commandeering all their profits for itself, while shareholders seemed to have no promising way to fight back. However, investing in these GSEs has recently become much more attractive as Congress appears more willing to leave the GSEs intact and as a shareholder lawsuit against the government’s illegal seizure of assets is gaining steam.
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When Fannie Mae’s stock rose nearly 200% in March 2013, Steven Davidoff of the New York Times wrote: “When zombie stocks show signs of life, you know you are in trouble,” and joked that the only reason to invest in these two worthless companies was in anticipation of the “greater fool.” In fact, he made a very strong argument: The Obama administration had declared that it wanted both GSEs wound down, it eliminated shareholder and voting rights, and retained the right to take nearly all their profits indefinitely. Moreover, Fannie Mae’s management expressly said, “The future of our company is uncertain” and “instead of being run for the benefit of shareholders, our company is managed in the overall interest of taxpayers, which is consistent with the substantial public investment in us.”

However, when Fannie Mae announced in March 2013 that it expected “to report significant net income” for the previous year due to the recovering domestic real estate market, and when it became evident that Congress didn’t intend to propose any serious financial reforms for the secondary mortgage market, investors began to take interest. Then, in May 2013, when Fannie Mae reported that it would repay the U.S. Treasury $59.4 billion, the GSEs showed even greater promise and their stocks gained billion-dollar valuations, leaving penny-stock territory.

In July 2013, the hedge fund Perry Capital sued the Treasury Department for overstepping its conservator rights when it seized profits it was not legally entitled to. Many other hedge funds and activist investors, including Bill Ackman, Bruce Berkowitz, and Carl Icahn, have since invested in Fannie Mae and Freddie Mac, presumably demonstrating their shared belief that there is merit in Perry Capital’s lawsuit and that there is much unrealized value in the GSEs. Bill Ackman believes that if properly and fairly managed, Fannie Mae should be worth $23 to $47 a share, representing an approximate 10-fold increase from current prices. Of course, this tremendous upside depends heavily on a shareholder legal victory against the Treasury Department. Having big-name allies such as former Solicitor General Theodore Olson and consumer rights advocate Ralph Nader to advocate for shareholders should increase the lawsuit’s chance for success.

Of course, there is much risk in investing in Fannie Mae and Freddie Mac, as they are currently being operated to maximize government revenue and minimize shareholder value. However, that risk seems to be diminishing given the regulatory impasse in Congress and recent indications from the director of the Federal Housing Finance Committee’s (FHFC), Melvin Watt, that he plans to expand Fannie Mae and Freddie Mac, reversing previous efforts to wind them down. If Fannie Mae and Freddie Mac do, in fact, maintain their past and current importance in the secondary mortgage market and continue to post impressive profits, it will be highly unlikely that the government will be able to get away with depriving shareholders of their stake in the companies. Along those lines, the financial analysis firm, I Know First predicts that the two companies are becoming increasingly attractive investments in the short, medium, and long-term time horizons. Although investing in Fannie Mae and Freddie Mac may have once been precarious, I believe they’ve become much safer investments now that their futures look more certain.

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