Fannie Mae and Freddie Mac


A

Aex

I'm a first time poster who wants to learn the basics of stock
analysis.

How does a governmet bailout wipe out stockholders? Are Fannie and
Freddie really on thin ice financially?

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J

John A. Weeks III

Aex said:
I'm a first time poster who wants to learn the basics of stock
analysis.

How does a governmet bailout wipe out stockholders? Are Fannie and
Freddie really on thin ice financially?
There are several ways that the stockholders can lose.

1) the company can file for bankruptcy, resulting in the value
of the stock to go to zero, and the courts canceling dividends
and eliminating entire classes of stock.

2) the firm can get new investors. They invest by buying
stock. The existing stock goes down in value because it has
been diluted with the new stock. In addition, reverse splits
are common, such as 10,000 to 1 reverse. That means that
someone who owned 1000 shares now only owns 1/10 of a share.

3) the firm simply doesn't perform, so the forces of supply
and demand push the stock price down into the penny stock
range, and then the firm is eventually delisted from any
major exchange.

-john-

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John A. Weeks III           612-720-2854            (e-mail address removed)
Newave Communications                         http://www.johnweeks.com
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
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E

Elle

Aex said:
How does a government bailout wipe out stockholders?
Are Fannie and Freddie really on thin ice financially?
These are good questions. As a caveat, though, remember that
Fannie and Freddie stocks are highly anomalous companies.
They may help one to understand the nuances of stocks, but
being so odd, they are a poor way to become grounded in the
fundamentals of what a stock is, why buy stocks, what a good
stock is, etc.

To review, Fannie Mae (FNM) was created during the
Depression ultimately to assist the public in the purchase
of homes. This worked for decades. Then FNM became a "for
profit" company in 1968. At the same time, it was still
"government sponsored." What "government sponsored" means
precisely has long been anyone's guess. FNM's business model
walks an odd, really undefinable and arguably oxymoronic
line between socialist and capitalist concepts. On the
socialist side, FNM's operations are more affected by the
political climate than ordinary banks. (For example, five of
FNM's 18 directors are appointed by the U.S. President, and
Congress enacts laws specific to FNM.) The government has
long given FNM substantial regulatory breaks, so that it
could operate much more loosely (recklessly?) than banks. On
the capitalist side, anyone could buy shares of FNM,
hopefully based on its performance. (But a person then owns
shares of the government? Or they own a share of a
socialist-run, far from free, mortgage market? Very
confusing.) Unfortunately, investors often presumed that, as
a government sponsored entity, the government would never
let FNM fail. This has long been a factor in helping
investors believe the stock was a good buy. In the last few
years the public also learned that FNM executives had fudged
profit figures for some time. By about 2007, despite
improvements in presenting company data to the public, FNM's
executives were running what I think one might reasonably
call a ponzi scheme: Hit by defaulting mortgages, they had
to raise money, so they bought more mortgages and then
repackaged and resold them. FNM's debt worsened.

To keep the U.S. mortgage market strong, the government may
either bail out Fannie and Freddie or take them into
conservatorship (under a 1970s law). Either way, this would
use taxpayer money to deal with some of their debt problems.
Being taxpayer money, those running Fannie and Freddie will
shore up the two companies as cheaply as possible, meaning
Fannie and Freddie will cease to operate for profit. Without
profits, investors will have no interest in the stock. Also,
it is said that a bailout (or else conservatorship) will
likely take the form of issuance of a new preferred stock.
One site reports that the new stock will have seniority,
dividend, and convertibility rights that will make existing
Freddie and Fannie stock worthless.

Some articles I found helpful:

http://money.cnn.com/magazines/fortune/fortune_archive/2005/01/24/8234040/index.htm

http://ml-implode.com/ailing/lender_FannieMae_2008-07-11.html

http://www.nytimes.com/2008/07/11/business/11fannie.html

Again, these stocks are not the best to use to learn about
stock investing. Maybe start another thread to ask about
stock investing in general.

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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
guidelines include a request for brevity and another for trimming posts to
which we respond. For all of the other tips and suggestions, see "FROM THE
MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the
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M

Michael

My advisor suggested 3months ago that I buy some Fanny Mae preferreds
stating that he was sure the gov't wouldn't let them fail. Then I found
out that if the gov't does step in common shares would be worthless and
that preferreds would take a sizable haircut. Four weeks later we had
to sell them at a 40% loss. I am now looking for a new financial
advisor!
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
guidelines include a request for brevity and another for trimming posts to
which we respond. For all of the other tips and suggestions, see "FROM THE
MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the
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A

Aex

Thanks for your replies! They were really helpful!

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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
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which we respond. For all of the other tips and suggestions, see "FROM THE
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T

Tad Borek

Aex said:
I'm a first time poster who wants to learn the basics of stock
analysis.

How does a governmet bailout wipe out stockholders? Are Fannie and
Freddie really on thin ice financially?
Since your interest is stock analysis, I'd suggest getting an
intro-level finance textbook and learning about balance sheets - how to
analyze a company's capital structure (the ways they raise the money
they need to operate). Once you understand that you'll have a much
better idea of why raising capital can be detrimental to current
stockholders, and the circumstances where existing stock can become
worthless or nearly so.

Cliffs notes version: Whether you're talking about a small local
business, or a publicly traded company like IBM, all money-raising falls
into two categories: equity and debt. Equity is common stock and
preferred stock, and the holders of that stock collectively own the
company, taking on the risks of its failure as an owner would. Debt is
borrowing, done mostly by issuing bonds. Lenders (including bond owners)
are not owners of the company, rather they have a contractual kind of
relationship with fixed terms (such as: lend $10k for 5 years at 7%
interest). These "creditors" do not take on the same risks as owners,
and are treated differently if the company goes bankrupt.

If capital is erode due to losses, a company needs to find new capital
to continue operating. And it only has those two broad options: equity
and debt. If the new capital is common stock, that dilutes existing
shareholders (e.g. doubling the stock outstanding means a former owner
of 1/5th of the company now owns 1/10th of it). And distressed companies
can't always raise capital by selling stock, because investors aren't
willing to buy it - if they are, it's often on lousy terms (high
dilution of prior shareholders). If the new capital is in the form of
bonds, that should be better for shareholders, unless it happens in
bankruptcy - where typically old stock is canceled and only creditors
get anything.

Exactly how Fannie/Freddie recapitalize remains to be seen but as Elle
said these are tough companies to begin your stock analysis with. Their
financial statements have been in limbo for years, and their balance
sheets are unusually complicated. Heck, Capital Research & Management
(which manages American Funds mutual funds) was one of the biggest
owners of these stocks, owning over 20% of each late last year. If their
team of highly-trained expert analysts couldn't see the risks, what hope
does a beginner have?

-Tad

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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
guidelines include a request for brevity and another for trimming posts to
which we respond. For all of the other tips and suggestions, see "FROM THE
MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the
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