Fannie, Freddie Down on Closure Bill - Analyst Blog

Shares of Fannie Mae FNMA and Freddie Mac FMCC were down 7.5% and 8.0% respectively on Thursday, following the passage of the bill to shut them down. The Senate Banking Committee approved the bill supporting elimination of these two government sponsored enterprises (:GSEs).

Though the bipartisan bill received support from 13 of 22 members of the Senate Committee, several Democrats and Republicans voted against it. Hence, with the lack of full support from the Democrats, the chances of legislation passing the full Senate are slim.

The bill to wind down Fannie Mae and Freddie Mac was framed by Republican Senator Mike Crapo and his Democratic colleague Tim Johnson. The main aim of the bill is to ensure that taxpayers' money will not be at risk in case Fannie Mae and Freddie Mac require a bailout again.

In Sep 2008, the government had taken over Fannie Mae and Freddie Mac in the wake of the housing market collapse. The companies were infused with around $188 billion of tax-payers money.

Under the terms of the bailout, the U.S. Treasury suspended the dividend payments by Fannie Mae and Freddie Mac to non-government stakeholders. Though shares of these two companies continued to be publicly traded, the stocks lost much of the value as investors doubted whether the GSEs would turn profitable again. Nevertheless, these GSEs did turn profitable, thanks to recovery in the housing sector.

Despite turning profitable and aiding in lowering the federal deficit (through significant dividend payments), Fannie Mae and Freddie Mac are still considered a risk to the government. Hence, the bill aims to shift the mortgage financing risk to the private sector.

The idea is to create a new system of federally insured mortgage securities similar to the Federal Deposit Insurance Corporation (:FDIC). The Federal Mortgage Insurance Corporation will build a mortgage insurance fund to protect taxpayers from future bailouts. Additionally, private insurers will bear the initial impact in case of losses, before the government guarantee is triggered.

At present, Fannie Mae and Freddie Mac own or guarantee nearly 60% of all the U.S. residential loans. These loans are then packaged into securities and sold to investors. Therefore, any plan to close them could again lead to housing crisis as the U.S. economy is still struggling to recover fully.

Moreover, the bill requires approval from both Houses to be made into a law. However, chances of the bill being passed before mid-term elections in Nov 2014 appear to be dim. Further, even if the decision to close Fannie Mae and Freddie Mac is taken, it would be a long-drawn process.

Currently, Fannie Mae carries a Zacks Rank #3 (Hold), while Freddie Mac has a Zacks Rank #5 (Strong Sell). Some better-ranked stocks in the finance sector include Home Loan Servicing Solutions, Ltd. HLSS and Affiliated Managers Group Inc. AMG. Both of these sport a Zacks Rank #1 (Strong Buy).