I've never been a Fannie Mae or Freddie Mac shareholder, but I know people who are. They're not high-rolling speculators. On the contrary, they seemed to view Fannie and Freddie shares as being in pretty much the same category as U.S. Treasury bonds, and even safer than the typical utility.
This is because Fannie and Freddie debt carried with it an implicit government guarantee, ensuring low borrowing costs. I'm not sure many shareholders understood this, but they were encouraged in this belief by their brokers and financial advisers, who were in turn encouraged by Wall Street and Congress to believe that the big mortgage firms, in performing a vital national service, would be protected.
Now that their shares have lost more than 80 percent of their value this year, they're stunned and disillusioned.
Can you blame them? For years Fannie and Freddie followed prudent banking policies, limiting their mortgage purchases to those that met a reasonably strict list of criteria, including a minimum down payment, proof of income and a conservative loan-to-property-value ratio. They had no subprime, jumbo, Alt-A or other exotic and innovative mortgages in their portfolios.
When their overpaid chief executives were caught up in shameful accounting practices, they were ousted, previously lax government oversight was increased, and capital requirements were imposed.
Then came the mortgage and credit crises. Most financial institutions responded by tightening their standards. Fannie and Freddie should have done the same, or at least held to the status quo. Instead, with congressional encouragement, the mortgage buyers loosened theirs. Jumbo mortgages (and bigger risks)? No problem. Alt-A mortgages? Bring 'em on.The companies have an estimated $80 billion in what were once considered nonconforming mortgages – and are now considered toxic waste – on their balance sheets. As for the higher capital requirements meant to reassure investors, they were reduced.
All this was done in the name of propping up real estate values, a strategy that has been a manifest failure as home prices continue to plummet in most parts of the country. This was the flip side to Fannie's and Freddie's Faustian bargain with the federal government.
Having bought into the notion that the companies were quasi-government institutions, shareholders found no solace in last week's emergency rescue plan, which seemed aimed entirely at bondholders and lenders. The plan was ominously silent about equity shareholders, with only vague reference to possible equity purchases by the government if necessary, which would presumably dilute or even wipe out existing shareholders.
The plan may reassure lenders that they'll be repaid and it will surely keep credit lines open. But even an unlimited ability to borrow doesn't mean the firms will be profitable anytime soon or can avoid turning to the government for more capital.
It's no wonder there's been a crisis in investor confidence and that longtime shareholders have been fleeing, handing the company over to speculators. I won't be among them, and if I did own shares, I'd sell, even at current depressed levels.
Unlike Bear Stearns, which found a white knight in JP Morgan Chase, no one seems likely to come to the rescue of or speak up for Fannie and Freddie shareholders. The companies are too big and carry too much baggage to be rescued by anyone other than the government.
Politicians are interested in homeowners and borrowers, not shareholders, who aren't numerous enough to form a critical voting bloc and are in any event presumed to be affluent and able to absorb their losses.
I don't think anyone wants to see Fannie and Freddie nationalized, but if they manage to stay private, the government should allow the companies to maintain prudent lending standards and respond to market discipline, even if that doesn't always coincide with the political goal of expanding homeownership.
None of that will be much consolation to the conservative long-term investors who were many of Fannie's and Freddie's shareholders. We've all learned that quasi-governmental is only quasi-safe.
James B. Stewart, a columnistfor SmartMoney magazine andSmartMoney.com, writes weeklyabout his personal investing strategy.
