Harry CampbellThe mortgage giants Fannie Mae and Freddie Mac continue to astound — and not in a very encouraging way.
The share price of each company has tripled in the last few months, pointing to the foolishness of Wall Street, this time with an assist from the federal government. When zombie stocks show signs of life, you know you are in trouble.
Some of you may be scratching your heads, wondering how Fannie Mae and Freddie Mac can even have stocks that still trade. After all, weren’t Fannie Mae and Freddie Mac taken over by the government during the financial crisis, gobbling up almost $200 billion worth of federal money in the process? And hasn’t the Obama administration said it wanted the two companies wound down?
Well, yes. The weird half-life of the mortgage finance giants is a result of the hoops the government went through during the financial crisis to avoid having the $5 trillion in debt being held by or guaranteed by the companies added to the actual federal debt.
The government could have fully nationalized and liquidated the companies. But if it did so, the government would have been legally deemed the owner or guarantor of the debt.
To avoid having to put the two companies on the government’s balance sheet, the Treasury Department, led by Henry M. Paulson Jr., decided instead to put the two into a legal purgatory known as a conservatorship. Fannie Mae and Freddie Mac were placed under the supervision of their regulator. Despite being public wards, the companies have been largely run like private businesses, including paying their executives millions of dollars in compensation.
There was one exception, however. The government changed them from commercial entities with a goal of making money for stockholders into quasi-public service companies intended to help the housing mortgage market function. The government also expressly stated its goal was to eliminate the two companies and replace them with a new system of mortgage finance.
As part of all of this, the government lent the two entities almost $200 billion and received a right to acquire 79.9 percent of each company’s stock. (It was set at this limit to avoid that pesky debt consolidation problem.)
All of this meant that while the companies were now under the government’s thumb, the stocks still traded, left out there in an accounting maneuver worthy of the biggest multinational.
Since that time, the government has tried to damp down talk that the stocks might have any worth. They were delisted from the New York Stock Exchange, but still trade over the counter.
And boy do they trade. On an average day, Fannie Mae and Freddie Mac stock have a combined volume of about 25 million shares. If the stocks were back on the New York Stock Exchange, they would be top-traded stocks.
Until a few months ago, the shares of the two companies traded like penny stocks in a range of 20 cents to 30 cents. That’s a far cry from 2004, when both stocks were trading over $70 a share.
Since the beginning of the year, however, Fannie Mae shares have surged 238 percent, to more than 86 cents. Freddie Mac shares are up 211 percent year to date, at 81.9 cents. Both surges have come in the wake of Fannie Mae posting an annual 2012 profit of $17.2 billion and Freddie Mac also putting up a big profit number of $11 billion.
The companies’ combined equity value is now about $7 billion according to S.& P. Capital IQ, although $5 billion of that is attributable to the government.
Still, $2 billion is nothing to laugh at, and the number stands despite a government that has gone out of its way to make the stocks worthless. The companies have eliminated voting and dividend rights on the shares. Not only that, as Fannie Mae states in its public filings, “instead of being run for the benefit of shareholders, our company is managed in the overall interest of taxpayers, which is consistent with the substantial public investment in us.”
The federal government even has agreements with both Fannie Mae and Freddie Mac that say that through 2017 they will turn over a set measure of profits to the government. After that, they will give all of their profits to the government.
Let’s face it, what value is there in a stock where you have no vote, right to dividends or profits? Let alone the fact that each company is in debt to the government by over $160 billion. Then there is the government plan to shrink them, perhaps into nothing. The recent profits are rather meaningless in this light.
Yet the trading continues.
It’s not an entirely new phenomenon. There are companies in bankruptcy whose stocks trade until the bankruptcy process is completed. The old General Motors, for example, traded for a couple of years as the Motors Liquidation Company before becoming worthless. In most circumstances, the equity then disappears without value, but along the way trading continues and the company still files reports with the Securities and Exchange Commission. This practice has never been halted, and out of foolishness or pure speculation, shareholders continue to trade bankrupt shares.
Now, neither Fannie nor Freddie is in bankruptcy. But at least in bankruptcy cases there is a small chance that a shareholder may recover some money. With Fannie and Freddie, the government is deliberately allowing trading to go on in stock that the government is going out of its way to make worthless.
So here we have a situation where an investor buys something of no value in the hope of selling it for a greater amount to someone who believes the same. Isn’t that usually called looking for the greater fool?
It’s mostly day traders and small investors who are buying the Fannie and Freddie shares. Institutions hold only 0.26 percent of the two companies’ shares, according to Capital IQ. The largest institutional holder, according to Capital IQ, is the American Funds’ $78 billion Capital Income Builder fund, which owned about 12.5 million Fannie Mae shares as of Jan. 31.
Why is a mutual fund that says it specializes in buying income-producing securities and “companies with proven records of increasing dividends” owning these stocks, even if they are a pittance of the fund’s assets? When I asked a representative of American Funds, that person cited a policy of not commenting on particular investments.
In any event, individual holders of these stocks are most likely trading to speculate. It’s been quite profitable so far, but as we have seen again and again, trading based on froth and not on value almost always ends badly.
When asked for comment, Freddie Mac referred me to its regulator, the Federal Housing Finance Agency, which referred me to the Treasury Department. The department did not respond to a request for comment, nor did Fannie Mae. Perhaps you can see why we’re still having these problems.
The zombie stocks, meanwhile, lumber on. Fannie Mae and Freddie Mac played a part in the tragedy of the financial crisis. Now they are playing a part in a farce.