If You Go Long Fannie and Freddie, You’ll Lose

I recently read a column from a financial newsletter writer who, back in June 2008, had recommended that investors short Fannie Mae (FNMA) and Freddie Mac (FMCC). (Excellent call on his part, by the way – I give credit where credit is due.)

Now, however, he’s reversed his call and is recommending that investors buy FNMA and FMCC, on the expectation that shareholders will win their ongoing case against the government and the stocks will then shoot up as much as 1000%.

This is a speculative bet on the American judicial process. If Fannie and Freddie win, the stock will rise like a meteor. If the government wins, they will drop toward zero. His bet, of course, is on the meteoric rise.

Here’s why my bet is on the “zero.”

The Government Is Actually In The Right This Time (Sort Of)

If you’ve been following the F&F debacle, you recall that in 2012, the government made the decision to start collecting nearly all of Fannie and Freddie’s profits every quarter – an arrangement that “systematically drained these entities of all value, leaving in its wake two unsound and insolvent zombies-a golden goose for the Treasury and utterly worthless for the individuals and institutions who in good faith invested in them,” according to attorney Theodore B. Olson, who represented Perry Capital, one of the plaintiffs in the ongoing court proceedings.

Any investors who buy F&F now are banking on the fact that the government repeatedly lied in court and court filings – most notably, about the fact that they actually knew Fannie and Freddie were on the road to recovery when they began re-routing funds. (Treasury officials claimed the amendment that allowed them to commandeer Fannie and Freddie’s profits was initially put in place to avoid a “death spiral,” but unsealed documents show that they knew exactly what they were doing.)

In total, there are over 11,000 of these documents available in a case proceeding through the Federal Court of Claims (Fairholme Funds, Inc. et. al., v. The United States), showing that the government lied about its 2012 restructuring of its relationship with F&F.

The Court of Claims case is separate from the one brought in Judge Royce Lambeth’s court where Judge Lambeth ruled against shareholders claiming they were wrongfully deprived of the companies’ profits by the 2012 deal that directed all profits to be paid to the government. That case is now being appealed while the Court of Claims case proceeds.

Arguments for why the government will lose are not based on any solid data, but on the fact that these cases will be tried in the court of public opinion, and that, in the best of all possible worlds, “justice” and “common sense” will triumph.

Justice and common sense aside, the most compelling defense argument the government has is that it had a right to take the profits in the first place. It was not “stealing” from investors; it was using its own property.

The government (i.e. the American people) are entitled to the profits rather than investors who were nowhere to be found when Fannie and Freddie needed a bail out in 2008. The fact that the government lied about what it did does not change the fact that it had the right to take those profits, but the dishonesty highlights the ongoing crisis of leadership in this country and the inexcusable complacency of the citizenry.

Of course, the government’s plan to sweep all of these companies’ profits was foolish. Their period of profitability has come to an end and Fannie and Freddie find themselves with no capital, an intolerable situation. If (when) the U.S. housing market weakens again, the government will be back writing checks. (At some point, you would think our political leaders would be embarrassed by their actions but apparently they are immune to such feelings. When Donald Trump calls our leaders incompetent and stupid, he is right and he can point to the handling of Fannie and Freddie as Exhibit 1.)

The evidence showing that the government lied about Fannie’s and Freddie’s financial condition in 2012, portraying it as much worse than it was, certainly opens the door for a settlement. But it does not mean the government will lose its case. And any bet that it will do so is profoundly misguided.

Fannie and Freddie Have Been In My Short Column Since 2014

Fannie and Freddie are trading around $1.75, at a near-bankruptcy valuation of below 1x earnings.

But that is not a “buy” signal.

Could it be that Fannie and Freddie are priced near bankruptcy because they are, in fact, near bankruptcy?

I have been vocal in The Credit Strategist that these claims against the government will fail and I still believe that to be the case.  In December 2014, I put Fannie and Freddie on my “short list” for 2015, as you see here. They have kept right on plummeting since then – about a 15% decline for Freddie and a 17% drop for Fannie.

 

2015 Recommendations (Short) Symbol 12/23/14 Comments
Fed Home Loan Mort. Corp (Freddie Mac) FMCC $2.07 Lawsuit will fail; shares worthless
Fed Nat Mort. Assn (Fannie Mae) FNMA $2.11 Lawsuit will fail; shares worthless

 

I still recommend that you stay well away from Fannie and Freddie, because they are going nowhere but down.

Sincerely,

Michael

30 Responses to “If You Go Long Fannie and Freddie, You’ll Lose”

  1. Michael:

    I have great respect for most of your recommendations but I think you are wrong on recommending a short of Fanny Mae and Freddie Mac for several reasons.

    First, the Hedge Funds that have brought the suit have the staying power to keep their suit alive for years. The Government on the other hand does not have the current resources to fight this battle for a long time, and Congress will probably force them to reach a settlement. Third, when and if the case goes to the Supreme Court, they will favor the Hedge Funds (Big Business) over the Government (the public).

    Is it worth waiting 5-10 years for a payoff of $2.00 per share when you could stand to lose $10-20 per share?

    Steve Schoen
    Sjschoen@hotmail.com

  2. FORREST P WYMAN

    For doing their fair share to wreck the economy by doing the bidding of the titans of the Consumer Credit Industry, and condoning millions of liar loans, any agency who was part of that deserves to go as rapidly into extinction as possible.

  3. With today’s wonderful passage in the senate, steered by the great Mitch McConnell & Susan Collins, housing in the suburbs will be in trouble. Just wait until all these people who can’t afford to buy $200-$400,000 houses start defaulting on their payments just like what happened in 2008. Good call, Michael.

  4. Alastair Wallace Macdonald

    Mr STansberry usually makes good assessments. Probably this time I will not align myself. The whole of the NYSE is heading for the cliff with a 1000 foot drop. Freddie and Fanny will not be excluded from this lemming type carnage. They will be near the front of this lemming style leap slide over the edge. I have stopped buying all recommendations and even options. I hold gold stocks and silver- have had them since the bottom of the gold market. I get advice from amonst others Richard Smith at TRade Stops and mostly Jeff Clark and and their Daily wealth trader men at Stansberrys and go on gut instinct.

  5. Bryndon Fisher

    “Justice and common sense aside, the most compelling defense argument the government has is that it had a right to take the profits in the first place. It was not “stealing” from investors; it was using its own property. The government (i.e. the American people) [is] entitled to the profits rather than investors who were nowhere to be found when Fannie and Freddie needed a bail out in 2008.”

    Just out of curiosity, where were the investors when Citigroup, AIG, Bank of America, and General Electric needed a bailout? The disparate treatment that Fannie Mae and Freddie Mac have endured over other financial institutions should cause you to rethink your thesis. If the FHFA and Treasury Department followed the Housing and Economic Recovery Act of 2008, we wouldn’t need to have this conversation. The companies would have been rehabilitated and returned to their shareholders, like Citigroup, AIG, Bank of America and General Electric had been. You might do well to read some of the complaints filed in court before making unsubstantiated and factually-absent claims.

  6. I would have to disagree. 1. GSE’s didn’t meet the statutory requirements to be placed into conservatorship. 2. Conservator must preserve assets. 3. Regulatory body must act independently and at arm’s length of any other government agency. 4. Fairholme added 7% to their stake recently 5. Listen to the lambeth appeal (“you said you were going to salt the earth so it would never grow back..enough said ) 6. Just watch Sweeney, she is our knight in shinning armor (and knows it) 7. Last but not least, we all know what the Treasury was up to but can’t prove it but I bet the paper trail does which is why we see the things we see.

  7. Shareholders get a cut in receivership. By not declaring receivership, and creating a “net worth sweep” (worth not profits) the government directly deprived shareholders of value.
    Morally right or wrong, the government violated the shareholders contracts beginning in 2012.

  8. I agree with a lot of the points. However there is solid evidence that the GSEs never needed a bailout to begin with . I imagine that the whole story is probably contained in the 11,000 documents that the government refuses to turn over. I don’t care about the share price but as a taxpayer I want to know what they are hiding.

  9. Utterly misguided and baseless opinions of someone who takes prides in shorting and making money out of honest ppl. Oops did I just place you in the same league as the Govt? The one who steals from hardworking and honest folks. The same Govt who hides in secrecy in what they do in the false pretext of helping? If the rule of law do not applies to this country, and stealing is being described by you as self deserving, while faith and trust in the law and the honest investment in believing that truths and fairness must ultimately prevails to the great standing of this country,then yes, you will win. But still, you are nothing but an ignorance and greedy investor, and you can sleep together with the corrupt leaders that is so called protecting you.

  10. Your comments about the court of public opinion are laughable, as if the merits of the case will be discussed and won by the news media and not by the law, which you show no understanding of whatsoever! These companies make billions, were used to launder TARP money given to the banking industry, and then were blamed for the entire government engineered fiasco! How easy it is to fool eggheads such as yourself in a fraudulent game that is obviously miles over your head. Investors- Buy this stock before it rockets into the stratosphere!

  11. Nicely chosen set of facts. Please continue to ignore the entire case to make a point. Notably that UST chose to nationalize the GSEs and forced non GAAP accounting practices to do it by finding a later to be reversed and therefore false financial account to report. This effectiviely magnified the “crisis” allowing the coerced bailout which in this case was the senior preferred share purchase agreement which took an egregious 10% dividend on “bailout” funds that I would call takeover funds. Since the government could dictate when the GSEs would draw upon “bailout” funds it became a money machine that Jack Lew has publicly stated his enjoyment of. Miraculously in 2012 “record profits” were recorded which were nothing but a reversal of the false losses the GSEs were directed to report previously. It at that point the government decided to take all the net worth in a periodic sweep. There had been a memo circulating that stated the intent to cut out shareholders from any future value as an Obama administration policy. All of these facts are available to those who look as is the definition of racketeering on wikipedia.

  12. The net worth sweep was not legal. They did not have the right to alter the agreement. Further Lambert dismissed the case without discovery. Now we have discovery through the unsealed documents. Finally, do you really think congress will actually wind down the GSE’s? And replace with what? Not going to happen.

  13. The companies were forced to take the bailout – one that was probably neccessary to calm markets – but not needed under strictly fiduciary criteria. The Gov’s “rights” did not exist before the Gov created them. The Gov went on to disregard the well-established conservatorship laws by colluding with itself to create the sweep of all profits. I predict the Gov loses all of its cases – based on the law. You are wrong – but worse, you justify the actions of the Gov by your indifference to its dishonesty. You should be ashamed of yourself.

  14. I don’t understand how you could say the net worth sweep was legal. The original agreement entitled them to a set pay back. There is nothing in the law that gives them the legal right to sweep all profits as a conservator. Also, legal cases aside, do you really think congress will vote to get rid of the GSE’s as opposed to recapitalize? What other option would they have to realistically service 95% of U.S. residential mortgages?

  15. I don’t claim any special insight here, but the main issue is whether finding a stooge to accept the Treasury’s offer of allowing them to loot the profits of these entities does show how incompetent the Washington leadership is. And corrupt, also.

    I also will point out that Mr. Stansberry’s suggested advice for this pair was to only purchase a small amount, because of the complete uncertainty of the plaintiff’s case. This was hammered home when his newsletter said, “Don’t bet the rent money on this trade!” And yes: That was a direct quote. So that if the trade goes to $0, then you don’t lose more than 2.5% of your capital if they bust.

  16. Edouard D'Orange

    All I can add is that the government lawyers in Fairholme Funds, Inc. v. United States have “battled unusually hard to withhold evidence” and “forcefully fought discovery requests”, according to the Federalist Society. What is there to hide?

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