Stocks on Life Support : Fannie Mae and Freddie Mac

by | Jul 13, 2008 | Asset Management, Stock Market Comments

Let’s talk about Fannie Mae and Freddie Mac.

How could these two companies be “OK” a week ago — and now this week they seem on the brink of disaster? If you’ve heard of these two companies, but you’re not really sure who they are and what they do, just understand — these two companies underwrite, back up or guarantee nearly half of the mortgages in the United States today.

Here is the news from this past week…

The Financial Accounting Standards Board (FASB) is drafting a rule that will force all corporations to account for financial risks. They (FASB) would like to make it harder for corporations to keep things off their balance sheet. In theory, that “sounds” good.

Years ago, Fannie Mae and Freddie Mac used to be government agencies. They are now publicly traded companies. Remember in the 1980’s, the “era of big government” was ending. The mortgage business was something the Fed’s didn’t realy want to be in. And since this was a pretty profitable business (well, at the time, right?) these two businesses were sold off, went public. In theory, THAT “sounds” good, too…right?

Today they are considered GSE’s (government-sponsored enterprises). Since they are publicly traded corporations, they have to abide by the same rules as all corporations, no exceptions.

Now stay with me, because this is where things get a little complicated.

If this new rule is adopted, it would trigger a need for about $46 billion in new capital at Fannie Mae and $29 billion in new capital needed at Freddie Mac. Ummm, that looks like $75 billion with a “b.”

See, government-sponsored entities are required — by law — to hold more than five times the amount of capital for investments held in portfolio then for all of balance sheet assets. This would also force Freddie Mac and Fannie Mae to put assets back on their books that total somewhere between $3.5 and $4 trillion.

You read that right, between $3.5 and $4.0 trillion.
All kidding aside, that is a lot of money.

Still with me?

Remember, this is a proposed rule… and rules get proposed, and then shot down, all the time. And it also takes a very long time to get rules passed, and even longer still for rules to be implemented.

But you know Wall Street. When shareholders hear bad news, they run for the exits. Even if the show is still in the opening act.

Don’t get me wrong, I’m not recommending purchasing either of these stocks. Both charts look like they’re on life support. But the action this week in the stock market for these two stocks really appears to be an overreaction — at least temporarily. They could still go to zero someday.

But the news headlines this has created are making everyone freak out. The news media has taken the ball and is running with it, milking this for all the drama they can. And drama sells, mister.

Fannie Mae has raised about $14 billion the last few months to offset write-downs on mortgages that it guarantees. Freddie Mac has already raised about $6 billion in the same period. The thought of these two organizations needing to raise another $75 billion — just to meet some accounting regulations — just blew everyone away. That $75 billion doesn’t even bring into play any potential future losses or write offs that Fannie Mae and Freddie Mac could have.

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