Shares of two government sponsored enterprises (GSEs) -
) - tanked on Tuesday following the release of a new bipartisan
plan to shut them. Fannie Mae plunged 30.8% from the previous
day's closing price to $4.03 while Freddie Mac was down 26.8% to
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The announcement of the new reform plan, framed by Republican
senator Mike Crapo and his Democratic colleague Tim Johnson, did
not disclose the timeline for the proposed closure of Fannie Mae
and Freddie Mac. However, the draft of the legislation will
expectedly be revealed soon.
Moreover, the bill requires approval from both Houses to be made
into law. However, chances of the bill being passed before
mid-term elections in November appear to be dim.
Further, the legislation will likely face opposition as majority
of Democrats and a few other community groups favor government
backing to mortgage loans for stabilizing the housing market.
However, the Republicans want to end government involvement and
allow the private sector to dominate the market.
In spite of the considerable time which the plan might take to
get implemented, retail investors started fleeing from the stocks
The main purpose of the reform plan is to ensure that taxpayers'
money is not at risk in case Fannie Mae and Freddie Mac require a
bailout again. In Sep 2008, the government had taken over these
two GSEs in the wake of the housing market collapse. The
companies were infused with around $188 billion of tax-payers
Under the terms of the bailout, the U.S. Treasury suspended
dividend payments by Fannie Mae and Freddie Mac to non-government
stakeholders. Though shares of these two companies continued to
be publicly traded, the stocks lost much of the value as
investors doubted whether the GSEs would turn profitable again.
Nevertheless, Fannie Mae and Freddie Mac turned profitable,
thanks to recovery in the housing sector. With the payment of
dividends later this month, these two would have paid nearly $199
billion as dividends to the U.S. government.
Despite turning profitable and aiding lower the federal deficit
(through significant dividend payments), Fannie Mae and Freddie
Mac are considered a risk to the government. Hence, the reform
plan aims to shift the mortgage financing risk to the private
The idea is to create a new system of federally insured mortgage
securities similar to the Federal Deposit Insurance Corporation
(FDIC). The Federal Mortgage Insurance Corporation will build a
mortgage insurance fund that will protect taxpayers from future
bailouts. Additionally, private insurers will bear the initial
impact in case of losses, before the government guarantee is
Other than senators, many other non-government stakeholders might
not want Fannie Mae and Freddie Mac to be closed. Many hedge
funds including Pershing Square, Perry Capital and Fairholme
Funds have made significant investments in these two to reap huge
Further, some of the non-government investors have joined hands
and filed lawsuits challenging the bailout terms that require all
profits from Fannie Mae and Freddie Mac to be paid as dividends
to the Treasury. They are demanding a share of Fannie Mae and
Freddie Mac's significantly improved fortune.
So we believe that the fall in share prices on Tuesday will not
likely be repeated again as shutting down Fannie Mae and Freddie
Mac will be a long, drawn-out process. There are many issues to
be considered before any final decision is taken.
Currently, both Fannie Mae and Freddie Mac carry a Zacks Rank #3
(Hold). Some better-ranked stocks in the finance sector include
Home Loan Servicing Solutions, Ltd.
Fifth Third Bancorp
). Both of these have a Zacks Rank #2 (Buy).