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Fannie and Freddie Vultures Need a Facelift

Stocks in this article: FNMA FMCC CNOB

NEW YORK ( TheStreet) -- Fannie Mae (FNMA) and Freddie Mac (FMCC) investors who have ridden big gains in both common and preferred shares are looking pretty smart these days, but they aren't the most sympathetic lot.

Whether it's giant hedge funds, day traders chasing the latest penny stock craze, ex-government officials looking to cash in on their expertise, or even Ralph Nader, who despite a storied legacy as a consumer advocate has made lots of enemies on the right and the Obama/Clinton left, these aren't the kind of constituencies politicians are going to want to cite to make their case for taking GSE profits out of the Treasury and putting therm in private hands.

But that's what has to happen in order for Fannie and Freddie investors -- at least those in it for the long haul -- to claim a piece of those companies' profits. The courts are another option, but that will likely take longer.

However, there appears to be a group of GSE shareholders that may attract more sympathy from the public. Community banks -- at least the abstract "It's a Wonderful Life" idea of them -- are the type of institution politicians of all types like to say they support.

And community banks lost an awful lot of money on their investments when the U.S. Treasury put Fannie and Freddie into conservatorship and suspended dividend payments on preferred shares in September 2008. The decision caused GSE preferred stock to become essentially worthless overnight. An estimated 600 depository institutions suffered "at least $8 billion in investment losses" on GSE preferred shares, according to a Federal Reserve paper published in March 2012.

"In addition, fifteen failures and two distressed mergers either directly or indirectly resulted from the takeover," the Federal Reserve said in the report.

Regulators, including the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., in many ways encouraged banks to own GSE preferred shares "even when the investments were large relative to their other investments," according to the report.

Community banks were given favorable tax treatment on their GSE losses, and Paul Merski, chief economist at the Independent Community Bankers of America, estimates about half of the trade organization's members that owned GSE preferred shares in 2008 have since sold them.

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