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) --

Fannie Mae



Freddie Mac


common shares are up 200% in four days on hopes they could offer a payoff similar to that seen in



but there is a key difference investors need to keep in mind.

Fannie and Freddie differ from AIG in that the shareholders in the government-sponsored enterprises -- both common and preferred stock -- currently have no rights whatsoever.

That's right. It sounds hard to believe, but that is what happened on Aug. 17, 2012, when the Treasury

announced it would

"replace the 10 percent dividend payments made to Treasury on its preferred stock investments in Fannie Mae and Freddie Mac with a quarterly sweep of every dollar of profit that each firm earns going forward."

Among the objectives that Treasury announced would be achieved by this move is "making sure that every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms."

You weren't hallucinating, and you aren't in China. If every dollar of earnings goes to taxpayers, that means nothing goes to investors.

To change that situation, it requires an act of Congress or the Obama Administration or the courts, and there are currently no proposals -- none that have been made public anyway -- to compensate investors in the GSEs.

Not only haven't any proposals been made, no public official has said a word about the rights of investors in Fannie and Freddie.

While AIG investors weren't a priority either, there was never anything controversial about it being a public company. The controversy started when it got bailed out. Returning it to the private sector was hailed as a triumph.

Fannie and Freddie's status as semi-private-semi-public companies, on the other hand, always reeked of corruption, so no politician wants to take credit for the idea of returning it to that state.

That could change. Lots of investors, including a few hedge funds, are betting that it will.

Still, assuming it does change, Fannie's and Freddie's profits won't be determined by the free market. How much Fannie and Freddie charge for guaranteeing mortgages, for example, or what type of mortgages they agree to guarantee are determined in large part by policymakers.

In other words, half the profits could disappear tomorrow if policymakers decide they want to use them for any purpose whatsoever.

Of course such a move would have to be within reason. If they used the profits to double the pay of every member of Congress, it would be a huge scandal. But let's say they used the profits to reduce the principal on underwater mortgages. That would be controversial, but it seems less far fetched.

Regardless, whatever government officials decide to do with those excess profits, making sure there is enough money left over to benefit investors in penny stocks is likely to be pretty far down on the list.

Maybe the courts will get involved,

as hedge fund investor John Hempton of Bronte Capital argues.

There are lots of potential variables. That's why if I were going to speculate, I'd rather be first in line with a chance to make eight times my money, as preferred shareholders currently are, before the common shareholders earn a cent. That's especially true when the common shareholders, in the rosiest of outcomes, won't get a much better return than that.

Fannie Mae has 16 preferred issues outstanding, while Freddie has 24, according to a report published Wednesday by CRT Capital Group. Most of these trade at roughly 12 cents on the dollar. In other words, if you buy them today and they recover their initial value, you can make more than eight times your money.

Unless they recover all of their initial value, common shareholders get zero. Preferred shareholders must be paid in full before common shareholders see a penny.

Bronte Capital's Hempton argues that Fannie and Freddie traded at about $50 each per share in good times, which equates to $10 today since the government owns 80% of them. That's about nine times the $1.08 price where they closed on Wednesday. So even if you believe that Fannie and Freddie will return to their pre-crisis level of profitability, which seems like a rather large leap, you make nine times your money. That's just a little bit better than the preferred, with considerably more risk.

Fannie and Freddie have been political footballs throughout much of their exisence, and that status isn't likely to change any time soon. As long as it doesn't, the risk to investors remains high.


Written by Dan Freed in New York


Follow @dan_freed

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.