What Will Happen After FRE and FNM Collapse?

Tough to make real positive headway with the curtains of doom surrounding Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take).

But remember: There are two pieces of the puzzle with these two monsters. There's the companies' stock and then there's the companies' business.

So let's reflect on this for Fannie Mae. This company, because of the "implicit' guarantee its debt has, is able to borrow money cheaply and buy mortgages and pocket the difference. This is a great business given the preferred rates that FNM borrows at.

Nobody is questioning that.

But what Fannie Mae is buying is awful paper. And it can't hedge nearly enough to make it better. It has to have reserves against that paper. It will always make the mortgage bonds it issues to investors bonds money good (as opposed to the bonds it issues to fund its own operations, which are not being questioned by most), meaning it can simply buy bonds that have a lot of mortgage defaults in them and retire them.

But if the company runs out of equity, will it still be able to buy those bonds back when the mortgages default?

I think that we have to begin thinking about a new world, where FNM and FRE will continue to buy mortgages, pool them, and issue them and insure that they get paid off at par. We will still see FNM and FRE issuing bonds to buy those mortgages to pool them.

But I question whether the administration wants this to be a public company at all. I think there can be an entity that does exactly what FNM does, but maybe it won't be public.

Or, if it is public, I don't know if the people who own the company that is trading will be owning the new company as I envision it.

In other words, the losses are so great in the portfolios that they will overwhelm the capital that Fannie Mae has. (Barron's outlines that issue.) I don't think the government can afford to walk away from the job that Fannie Mae does. If it backs away from the implicit guarantee, it is pretty fair to say that we will have a depression, not a recession, given that homes represent our biggest assets as a country.

I have seen a lot in my life, but I do not believe that the people in charge of the government ever want their legacy to be a depression as a byproduct of trying to teach the Democrats a lesson about the wayward ways of Fannie Mae.

Nevertheless, unless the Treasury comes out and says that while it may not back the common stock holders of Fannie Mae, it does back the "function" of what FNM does, we are not going to be able to get through the collapse of these two stocks -- which I believe is going to happen -- without a depression.

Sorry, I cannot be more forceful than that statement about these two stocks.

At the time of publication, Cramer had no positions in the stocks mentioned.

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