Over the last year, BNL Finance has covered Federal National Mortgage Association (OTCMKTS:FNMA) and Federal Home Loan Mortgage Corp (OTCMKTS:FMCC), or more commonly referred to as Fannie Mae and Freddie Mac, quite often. We added FNMA stock to the BNL Portfolio at an average price under $2/share, and told BNL Members that both FNMA & FMCC stock were good speculative additions to their portfolio on eventual progress in the courts.
However, as explained in, “How To Play FNMA Stock & FMCC Stock & Potential GSE Government Separation“, there is now a very real chance for GSE reform. That shortens the outlook for major change, and greatly boosts the value of both FNMA stock and FMCC stock.
At the time of our last writing, Fannie stock and Freddie stock were in the midst of a major rally. Since then, FNMA stock dipped from a high of $5/share to a low of nearly $3. Currently, FNMA stock sits at $4.14. FMCC stock has followed a similar pattern. Furthermore, volume in both Fannie Mae and Freddie Mac has significantly declined, implying fewer wild price swings moving forward.
In other words, now looks like a great entry point for those willing to bet on GSE reform. It’s clear that $5 is the new $2 for FNMA stock. This reflects the increased likelihood of reform with Trump as President and Steven Mnuchin as Treasury Secretary. Both believe that GSEs can not be government owned.
Understanding Fannie Mae & Freddie Mac reform
One thing that new Fannie Mae and Freddie Mac stock owners must realize is that both FNMA stock and FMCC stock are going to be volatile. Moreover, breaking free from conservatorship and finding a free market solution will be a difficult fight. Fact is the dealings between the government and GSEs is more reminiscent of a scene from American Gangster than the actual conducting of business.
Specifically, past Fannie Mae and Freddie Mac stock owners have placed their hopes in the court. The FHFA (Federal Housing Finance Agency) has effectively argued that it can drain Fannie Mae and Freddie Mac of all its capital; have no fiduciary duty to shareholders; and can essentially do whatever the hell it wants with Fannie and Freddie. In fact, the FHFA actually argued in court that it can do whatever it wants without justification.
Investors argue its fraud, and have tried desperately to put an end to Net Worth Sweeps where the government can drain all of Fannie Mae and Freddie Mac’s liquidity and profits to the tune of $100 billion since being placed into conservatorship.
What’s worse is that after the government drains all the capital, its handed out as part of risk sharing transactions. By doing so, it kills the investor’s argument that the net worth sweep is illegal, because it drains Fannie and Freddie of their profits and liquidity.
So, if the government has themselves a nice cash cow that has produced $100 billion over the last six years, why would Trump and Mnuchin want to separate government and GSEs? After all, Trump is going to need money to make good on past promises. The answer is that Fannie Mae and Freddie Mac have become a shell of themselves under government ownership, go figure, with the highest levels of capital in history before conservatorship and now at its lowest.
In other words, the government is killing Fannie Mae and Freddie Mac, and has done nothing productive with the $100 billion it stole. This really is like an Old Western tale, an absolute joke, and new leadership is smart enough to see it. The big issue is that Fannie Mae and Freddie Mac will need capital. How does that happen?
Will the government give back some of what it stole? Probably not. Will the government let Fannie & Freddie keep their own earnings to regain capital? Probably not. Will the government seek a private market solution that allows investors like Bill Ackman, you, me, and other FNMA stock and FMCC stock owners to give GSEs money? You better believe it!
What about long-term for FNMA stock & FMCC stock?
Ultimately, the government won’t pay for it, investors will. But honestly, for the chance to get out of conservatorship, and for Fannie & Freddie to start creating billions among billions in quarterly profit, I’d gladly lend money. My guess is that others would too. And if so, $20/share for both FMCC stock and FNMA stock is likely a near-term reality after GSE reform, and $30-$40 several years later without “Negan taking half”.
Just to be clear, we believe GSE reform is coming and this is a very likely scenario. Investors are no longer betting on the courts and the interpretation of laws. There is now political pressure at the highest level, and that’s what Fannie Mae and Freddie Mac stock owners need for real change.