The Irony Of A Fannie Mae And Freddie Mac Stress Test

| About: Fannie Mae (FNMA)


In an absolute worst case scenario Fannie and Freddie need $190 billion.

Treasury has swept more than $200 billion for deficit reduction.

Fannie and Freddie employees cannot participate in reform.

This week, the FHFA provided results from a stress test at Fannie Mae (FNMA) and Freddie Mac (FMCC). The conclusion of the stress test was that in a worst case economic scenario the entities would need between $84.4 billion and $190 billion to cover expected losses. This is an absolute worst case scenario for them, one with 10% unemployment rates and double digit percentage drops in the stock market and housing prices. The irony of the situation is that the government has swept more than $200 billion off of the entities' balance sheets through their net worth sweep, leaving them with practically no capital at all.

Respected market analysts are saying that if the government had not enacted the net worth sweep, then the entities would have adequate capital and earnings to be released from Conservatorship now. This would include a 4% capital buffer, strong operating earnings, and a consistent business model. Over a period of time, if dividends remained suspended, that capital buffer could even grow into something much more substantial.

Mr. Richard Bove, of Rafferty Capital, even put an $18 price target on the common stock, meaning that the government's warrants would be worth more than $120 billion. This would be a baseline scenario for recapitalization, based on earnings per share and conservative earnings multipliers.

So, what exactly was the purpose of the 3rd Amendment again? It appears that the 3rd Amendment was intended to remove all equity capital from the entities to ensure that they never emerge from Conservatorship.

Oh, but that's not what the FHFA says. They say:

The Senior Preferred Stock Purchase Agreements were designed to ensure Fannie Mae and Freddie Mac maintained positive net worth, be able to meet its outstanding obligations, and continue providing liquidity to the mortgage market."

And here is the main reason why shareholders are angry with Treasury. In the beginning, Treasury promised one thing. Then, later on, their actions proved that they had no intention of keeping their promises. (Prove us wrong, Mr. Lew.)

Now, we have a situation where Congress is left to recreate the mortgage market. Something that hardly any congressional staffer is qualified to do without the help of market experts.

Thursday, on an Investors Unite media call, Former U.S. Rep. Eva Clayton said that any bill that originates in one side of Congress is likely to be dead on arrival in the other side, even if it passes. Then, any bill would need to go through several rounds of mark-up. We are several years away from having a bill that stands any chance of being passed by Congress.

Remove the Gag Order on Fannie and Freddie Employees

Tim Pagliara, of Investors Unite, also mentioned that Fannie Mae and Freddie Mac employees and executives have no voice in Washington. They have been in the thick of the mortgage meltdown for several years now. Why doesn't congress enlist their help to resolve the mortgage market problems? Instead, since 2008, they've been under orders to stay silent. What exactly are we afraid they will say?

It's possible that they will simply say there is nothing wrong with the existing model and that all the policy reforms were put into place in 2008. This is reflected in the companies' operating earnings.

This type of epiphany is slowly making its way into the analyses of market analysts, including Brian Gardner at KBW, who said that the companies being released from Conservatorship is "increasingly plausible."

New Ads Running in Support of Shareholders

Several groups are running political ads in key states, targeting specific Senators. One from the 60 Plus Association tells voters that the current GSE reform legislation will put the largest banks in charge of the housing market. Another advertisement, from United for Homeownership, has run extensively on news channels and talks about preserving and strengthening the GSEs.


At a minimum, the common stock of these entities is worth close to $18 per share and restructuring of the equity is imminent, due to the fact that taxpayers have been paid back and the entities are dangerously close to needing another bailout, if the housing market goes into another downturn.

Disclosure: I am long FNMA, FMCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.