Fannie Deserves Another Haircut

On Wall Street, scandal-hit Fannie Mae (FNM - commentary - Cramer's Take) never went out of fashion. Not even for a minute.

In fact, investment banks are now mounting a zealous propaganda campaign aimed at bringing buyers back to the government-sponsored mortgage giant, which is likely to recognize billions of dollars of losses in its earnings after its regulator and the Securities and Exchange Commission severely criticized its accounting.

But of all the big sales pitches being made by Wall Street now, the "buy Fannie" campaign is perhaps the most preposterous. Brokerage analysts are using stock price targets that are conjured out of thin air and that ignore the damage to be done by an estimated $9 billion reduction to past earnings. Indeed, the investment banks' pro-Fannie case is often so bizarrely flimsy that investors must cynically assume that they are being put out to win large banking fees from Fannie, whose securities issues have padded Wall Street's profits for years.

For example, Lehman Brothers, which has an absurd $100 price target on Fannie Mae, earned a stunning $75 million in fees for handling a giant issue of preferred stock for the company at the end of last year. (Lehman rates Fannie overweight.)

Other brokerages in the bullish chorus include Citigroup's Smith Barney and Merrill Lynch, which both issued bullish investment advice on Fannie Tuesday. These two research notes may have been sparked by the recent sharp decline in Fannie's stock, which is now nearly 30% below its 52-week high. Tuesday it fell $1.10 to $57.80.

The decline is well overdue, and should continue. Detox can easily show that the company's true net worth -- a good yardstick for valuations -- is much less than the net worth (or book value) that Wall Street analysts are using for their price targets. In addition, Fannie has no defense against the many enemies it made in Washington with its heavy-handed tactics. The Bush administration, along with key Republican members of Congress, is compiling tough new reform bills for Fannie and its rival Freddie Mac (FRE - commentary - Cramer's Take) that are almost certainly going to pass. And Fed Chairman Alan Greenspan has raised the idea of capping, or even cutting, the size of Fannie and Freddie's mortgage portfolios.

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In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to [e-mail].