What To Do About Freddie Mac and Fannie Mae

Includes: FMCC, FNMA
by: J. Christoph Amberger

Troubled mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) are being placed in a government conservatorship. What does that mean for traders on Monday?

Contrarian investing means going against the trend -- buying low when everyone's selling and selling high when everyone's buying. Today, Monday, September 8, 2008, you will have just such an opportunity to buy low -- with the potential of doubling your money in a few weeks.

Of course, you've heard about it already: The U.S. government announced that it would seize troubled mortgage giants Fannie Mae and Freddie Mac, backing up the ailing behemoths with as much as $200 billion in taxpayer money. Both institutions are being placed in a government conservatorship.

Since the U.S. government is now explicitly guaranteeing mortgage debt, Uncle Sam has become the nation's mortgage lender.

Futures on all major stock indexes are up around 2 percent in electronic trading as I am writing this. But what will this do to FNM and FRE stock prices tomorrow and in the short term?

Pundits have been warning that the government bail-out would occur on the backs of common stock investors. And indeed, after-market trading indicates that both stocks will plunge close to 30% on Monday morning.

The question is: What investors will be suffering?

Certainly those who bought FNM and FRE at $68 or $65 are standing a snowball's chance in heck seeing their investment bounce back from Friday's close of $7.04 or $5.10 any time soon. But those who bought in the past couple of weeks may lose only 20-40 cents a share, respectively. And that only temporarily.

Death, where is your sting?

You can bet that there will be record volume Monday morning. But those who bought recently purchased shares into which the probability of a loan default -- and a share price of $0 -- and dilution had been factored into the stock price already.

That risk is now off the table.

Both FNM and FRE are now investments that that are explicitly backed by the United States government, with the goal to return the company to profitability. My recommendation: Buy FNM at or below $6 and FRE at or below $4.50. Depending on how low prices go -- remember, FRE was trading as low as $2.80 just 2 weeks ago! -- you could double your money on these most pedestrian of all stocks in less than 3 weeks.

Buy a small contingent of shares if you're uncertain: You'll be able to buy blocks of 100 shares for $300-500 bucks tomorrow.

Disclosure: Long FNM, FRE.