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Fannie and Freddie Stocks Are Still Hot (Update 4)

Stocks in this article: FNMA FMCC BAC

In that event, the preferred prices would, of course, recover quite a bit, enabling a quick killing. It would be wonderful to face the quandary of taking a huge profit or sitting back and collecting a huge dividend yield, based on a paltry investment price for the preferred.

The Way Forward for the U.S. Mortgage Market

For now, investors see a light at the end of the tunnel for Fannie and Freddie. But the big question remains: Will Fannie and Freddie survive? Why not? They dominate the U.S. secondary mortgage market to a greater extent than ever. Both firms and the FHFA are likely to stick with much stricter underwriting, investment and risk management policies than they did during the real estate bubble.

Over four years after the bailout, neither President Obama nor Congress has pushed hard for true GSE reform. As House Financial Services Committee Chairman Jeb Hensarling (R., Texas) said at a hearing on Tuesday, reforming the mortgage finance system with a divided government will be "a heavy lift."

FHFA acting director Edward DeMarco said during testimony before Hensarling's committee on Tuesday that the companies would not return to their previous private form. The FHFA in October proposed a common securitization structure for Fannie Mae and Freddie Mac, to include "greater participation of private capital in assuming credit risk.

The FHFA proposal "is premised on the idea that Fannie Mae and Freddie Mac are one and the same, but clearly they aren't," according to Timothy McTaggart, a partner in the Washington office of Pepper Hamilton.

The FHFA needs to continue doing what it can to preserve assets within the conservatorship. While most of the focus on Fannie and Freddie is on their backing of single-family mortgage loans, "multifamily is very profitable for both GSEs," McTaggart says. Spinning off both companies' multifamily businesses could help the FHFA "claw back money for the conservatorship," he says, adding that such a move "is a stronger pathway to go, rather than the idea of pursuing the common securitization platform."

In regard to the continuing debate over a government role in the housing market, the Obama Administration is considering a move to an insurance-based model, rather than the previous implied government guarantee that was enjoyed by Fannie and Freddie. The old model "is the exact formula people hate about the GSEs, as the costs are borne on a collective basis, but the upside is spread among the private sector," according to McTaggart.

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