Fannie, Freddie Find Legs in Shorts

Fannie Mae(FNM Quote) and Freddie Mac(FRE Quote) shares recovered in a volatile session on Thursday after sinking to new lows, as short-sellers likely sought to cover their bets.

Fannie shares were up 7.7%, at $4.74 after earlier sinking as much as 20% to a new low of $3.53. Freddie was up a fraction of a percent, paring earlier declines of more than 30% to a new low of $2.26.

Short positions in both mortgage giants have accelerated rapidly as investors questioned their viability and profit-seeking speculators stepped into the fray.

Short-sellers accounted for 18.5% of outstanding Freddie shares at the end of July, according to the most recent Bloomberg data available, more than double the 8.2% portion at the end of April. Shorts rose to nearly 14% of Fannie's stock, up from 8.1%, during the same period.

Short-sellers borrow stock to sell it at the current price, betting it will decline. If it does, short-sellers profit by buying back the shares at a lower price and pocketing the difference. The Securities and Exchange Commission recently lifted a temporary ban on so-called "naked" short-selling of Fannie, Freddie and some other financial firms. Naked short-sellers do not borrow the shares first, and this sometimes forces them to scramble for equity to cover their bets.

Fannie and Freddie shares have plunged dramatically in recent sessions after a Barron's article cited anonymous source who said the firms will likely be taken over by the government, wiping out shareholder equity. The naked shorts ban was lifted on Aug. 13, causing some to speculate that short-sellers are also causing an overstated decline in market value of the two companies.