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Market Overview

Is There Any Hope For Fannie And Freddie Shareholders?


It has been a rough month for shareholders of Federal National Mortgage Assctn Fnni Me (OTCBB: FNMA) and Federal Home Loan Mortgage Corp (OTCBB: FMCC), more commonly known as Fannie Mae and Freddie Mac.

Last week, a judge dismissed 10 claims on behalf of Fannie and Freddie shareholders against the Federal Housing Finance Agency, or FHFA. These claims asserted the "net worth sweep" that funnels every cent earned by Fannie and Freddie into the government's pocket was a violation of shareholders' Fifth Amendment rights.

The Story

The Fanny and Freddie story is a roller coaster that goes all the way back to pre-financial crisis days, when both government-sponsored mortgage aggregators were earning a combined $8 billion in profits, and shares of each company were flying high above the $65 mark.

During the most recent financial crisis, massive losses -- resulting from Fannie and Freddie's guarantees on sub-prime mortgage-backed securities -- required the U.S. Treasury department to step in and provide over $187 billion in bailout money to keep them afloat.

In exchange for this liquidity, the Treasury received warrants representing nearly 80 percent ownership of the two entities, as well as $1 billion in preferred shares that pay an annual dividend of 10 percent.

Related Link: Financial Crisis Bailouts: What Did They Actually Cost Taxpayers?

Understandably, government takeover and the resulting dilution of common shareholders led to a rapid decline in share price by more than 95 percent between October 2007 and October 2008. Only when the economy began to finally stabilize did Fannie and Freddie return to profitability.

The FHFA changed the game in 2012 by amending the terms of the bailout agreement so that, instead of the 10 percent dividend, the new dividends on the government's preferred shares would amount to 100 percent of Fannie and Freddie's profits from that point forward.

After being de-listed from the NYSE in 2010, Fannie and Freddie shares both fell below $0.20 on the news of the government's "net worth sweep."

Is There Any Hope?

Despite the government essentially deeming Fannie and Freddie shares to be worthless, the two companies' share prices gained over 1000 percent in 2013 after the filing of a series of shareholder lawsuits against the government.

One of the highest-profile lawsuits was filed on behalf of Bill Ackman's Pershing Square Capital. Ackman and fellow shareholders were betting a court would find that the government acted illegally by changing the terms of the initial bailout agreement.

Unfortunately for Ackman and others, Judge Royce Lamberth recently ruled that, from a legal standpoint, the language in the Housing and Economic Recovery Act (and the language on the government's preferred stock certificates) allow the FHFA to take every cent of Fannie and Freddie's profits.

Both stocks are down more than 50 percent this month, as many shareholders threw in the towel after the recent lawsuits were thrown out.

At this point, the only hope remaining for Fannie and Freddie shareholders is that one or more of at least 15 remaining lawsuits, which includes Ackman's, will persuade a court to rule favorably for shareholders.

Given the latest development, though, the already bleak outlook for Fannie and Freddie shareholders is looking even worse these days.

Disclosure: At the time of this writing, the author had no position in the equities mentioned in this report.


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