Should I Buy Fannie or Freddie Stock Today?

 |  Includes: FMCC, FNMA
by: Gaurav

Should I buy or sell Fannie or Freddie stock today? It is an interesting puzzle. On the positive side, the US government is now backing the debt of these companies. On the negative side, Paulson's track record with Bear Sterns shareholders will give a pause to punters in Fannie and Freddie.

This is what Paulson is saying in his news release:

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction."

So far in the news release, it seems shareholder survival of the troubled entity is crucial - this is not Bear Sterns. And later:

"Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed."

The Treasury is not buying equity today. They want the stock to go higher and see if these two can raise money through public markets. If the two stocks recover to $25 levels, there might be one new round of equity raise possible through public markets.

Are there brave people out there willing to put more equity into these black boxes at $25? My guess is there are - at least for one more round. After that, if there is further need, US govt will be forced to step in and nationalize.

The point is - if Paulson wants to prevent shareholders from enjoying the benefits of his largesse, he needs to nationalize Fannie and Freddie today. If he is too worried about moral hazard, he should clearly state that Treasury will invest in these companies but at $1/share. From the opening of his press release, it appears he wants these two to remain public entities owned by shareholders.

I think this is like Lehman on March 18. I dont know about the long-term future of these companies. But the chances they double or triple in next 24 hours is high. There is a huge short interest in them, and short covering itself will propel them higher.

It is a very confusing situation. If Paulson wants to avoid moral hazard, he has to extinguish current shareholders. He has done that once to Bear Sterns shareholders. Will he do the same with Fannie and Freddie shareholders? If these stocks stay where they are, there is no way these companies can raise the requisite equity. So the Treasury will step in, which will involve wiping out existing shareholders.

Now, logic might not work and Paulson might change tracks. But I will go with logic.

The survival of existing shareholders is contingent on the stock going up. The stock price is driving the fundamentals. Interesting stuff. I don't think I will, can or should punt.