If you like trading off volatility, disgraced government-sponsored enterprises Fannie Mae and Freddie Mac may be just the stocks for you.
In another sign of the continuing recovery of the U.S. housing market, shares of the two entities have taken off in the last two months after flat-lining below $1 for most of the last three years. Shares in Fannie Mae (FNMA) rose from about 25 cents at the beginning of March to just over $5 in trading Wednesday morning. That's a gain of about 1,900% in less than two months. The shares, however, were down to around $3 by the end of the afternoon session, a drop of nearly 26% on the day.
The over-the-counter-traded shares of Fannie's smaller competitor, Freddie Mac (both companies' stocks were delisted from the New York Stock Exchange in 2010), have had a similarly wild ride of late. Near the end of trading on Wednesday, Freddie Mac stock was at $2.71. Its 52-week low is 14 cents.
Trading in the publicly traded preferred securities of both entities has also been extremely volatile.
“Some people see the shares as an option on the housing recovery,” said Isaac Boltansky, a policy analyst at Compass Point Research & Trading LLC. “But no matter how profitable these businesses have become, Fannie Mae and Freddie Mac are still dirty words on Capitol Hill.”
The two entities, which buy residential mortgages and package many of them into mortgage-backed securities to sell to investors, are frequently blamed for contributing to the housing bubble, although Wall Street firms have come in for their fair share of blame for the explosion of credit to subprime borrowers prior to the financial crisis. Fannie and Freddie were placed in conservatorship by the government in 2008, and received $188 billion from taxpayers to help stabilize the mortgage market in the last several years.
At the time of the bailout, it was assumed that the two financial services companies would never get back on level footing, and that Congress would ultimately legislate Fannie and Freddie out of existence, permanently reducing the government's role in subsidizing homeownership. Amendments to the preferred-stock agreement between the government and the two GSEs made last year prevent the pair from paying down the government's senior preferred position. And all the Capitol Hill proposals for GSE reform currently point to eventually replacing the two enterprises with a single structure, said Mr. Boltansky.
Investors, however, now seem willing to bet that the two entities still have a future as investor-owned companies. Fannie and Freddie have already reportedly paid $132 billion in preferred dividends back to the government — private holders of the preferred shares do not receive dividends. And with the housing market improving, the financial numbers keep getting better. Fannie Mae, for example, reported a staggering $58.7 billion in profits in the first quarter. Over $50 billion of that was from income tax benefits, but it did earn $8.1 billion in pre-tax profit in the quarter. The Congressional Budget Office recently increased its estimate of dividend payments from Fannie and Freddie to the government this year from $29 billion to $95 billion.
The bet for investors is that the housing market continues to improve and that Fannie and Freddie continue to benefit. However, they are also betting that the two quasi-governmental enterprises are not scrapped by the government after they repay the bailout money they have received. That's a very long shot, suggested Mr. Boltansky. “The idea that they can survive in their current structure is inconsistent with political reality at this point in time,” he said.
The explosive mix of economic and political risk, however, sure makes for some volatile price action on the shares.