Fannie and Freddie rescue, a bailout for whom?

NEW YORK (Reuters) - The rhetoric from the Washington backers of the Fannie Mae-Freddie Mac rescue effort has been consistent on one front: this is no shareholder bailout.

The corporate logo for Freddie Mac is seen at its headquarters building in McLean, Virginia, July 23, 2008. REUTERS/Larry Downing

But that message seems to have been lost on the stock market, particularly holders of Fannie Mae and Freddie Mac shares. After being on an apparent trajectory toward zero just over a week ago, both stocks have more than doubled since the beginning of last week when the Bush administration unveiled its plan to shore up the two lynchpins of the U.S. housing market.

“The real winners are the investors who bought Fannie and Freddie shares last week,” said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

True, many long-time shareholders are still reeling, with both stocks still down by some 80 percent since the credit crisis erupted last summer. And no one argues that the primary goal of the plan’s architects is to put a floor under a shaky mortgage market. Fannie and Freddie are two biggest U.S. providers of mortgage finance.

“This is a bailout for the mortgage market -- not for Fannie and Freddie shareholders,” David Dreman, chairman of Jersey City, New Jersey-based Dreman Value Management, LLC, said in an interview on Wednesday. Dreman is one of the largest holders of Fannie Mae and Freddie Mac shares.

On Wednesday afternoon, the U.S. House of Representatives approved the measure, sending it on to the Senate. The White House earlier had dropped a previous threat to veto the legislation.

The plan allows Fannie and Freddie, which are chartered by Congress but are privately run companies, to have access to an expanded credit line from the Treasury Department and even access to money from the Federal Reserve if needed. Also, it would permit the Treasury to make unlimited equity purchases in Fannie and Freddie to prevent a collapse in the firms.

Even if the government does not find it necessary to buy shares of the two companies, both will likely have to raise billions in new capital, which would likely dilute the holdings of existing shareholders.

Since these sweeping measures were announced on July 13, securities in Fannie and Freddie have been on a tear. For instance, Fannie and Freddie shares are each up more than 100 percent since their lows on July 11, when fear over their fate was at its peak. Fannie closed Wednesday at $15 compared with less than $7 at its July 11 low, while Freddie ended at $10.80, almost triple its July 11 low of $3.89.

Last August, Fannie shares were trading at around $70 and Freddie shares were around $66.

Against the backdrop of the Fannie and Freddie government rescue package, the U.S. Securities and Exchange Commission last week also limited naked short sales of stock of Fannie Mae, Freddie Mac and brokerages, helping to exaggerate moves to the upside. In short sales, investors sell borrowed stock in a bet that a company’s share price will decline. In a naked short sale, speculators sell shares they haven’t secured first.

Still, a real threat to shareholders remains: the possibility of a government intervention to buy stock could leave them high and dry.

Shareholders in Fannie and Freddie could effectively get wiped out as a price for putting taxpayers at risk for the protection of the trillions of dollars of debt issued and guaranteed by Fannie and Freddie, said Greg Peters, head of global credit strategy at Morgan Stanley in New York. “This is not a bailout for shareholders by any means.”

Fannie Mae and Freddie Mac, both government-sponsored enterprises, buy mortgages from banks and other primary lenders with money they borrow in the global capital markets, thus taking the loans off the banks’ books and freeing them to make more mortgages. Fannie and Freddie also package home loans into mortgage-backed securities which they guarantee, as well as buying mortgage-backed securities for their own portfolios.

“Fannie and Freddie have become an instrument of Congressional and administrative policy,” Dreman said. “They have now become the only viable buyers of mortgages and the government is pushing them to buy many categories that really are more dangerous.”

“I don’t think that is much of a bailout,” Dreman said.

That said, the mid-July announcement by the government “allows Fannie and Freddie to continue to write new business -- at that point, they were no longer in imminent danger.”

Dreman began adding to his existing positions in Fannie and Freddie after that Sunday, implying that he has profited handsomely on last week’s move into battered Fannie and Freddie shares.

He said: “I made a lot of money in tier two..tier one is somewhat under water.”

Editing by Leslie Adler