Fannie and Freddie Common Getting Interesting

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) and Freddie Mac ( FMCC) common shares hit their lowest level in four months Friday, suggesting it may be time to take another look at these admittedly speculative securities.

While big-name investors including Bruce Berkowitz, Perry Capital, Paulson & Co. and Claren Road Asset Management have tended to favor the junior preferred stock in the government sponsored enterprises (GSEs), Perry acknowledged in a July 7 lawsuit that it also owns common shares.

Perry's arguments in its suit, one of several filed by GSE shareholders in recent months, takes issue with an Aug. 17, 2012 amendment to preferred stock purchase agreements that sweeps all GSE profits into the Treasury's coffers.

While the claim from Perry attorney Ted Olson of Gibson Dunn & Crutcher argues the amendment "enriches the federal government through a self-dealing pact, and destroys tens of billions of value in the Companies' preferred stock," it also contends the deal illegally "destroys value in the Companies' publicly held common stock."

Betting on either preferred or common shares of Fannie and Freddie is largely a wager on politics and law, rather than the more traditional investing metric of profitability. The government sponsored entities have plenty of profits. The question is whether private investors have any right to those profits.

Public officials have indicated in recent months that they don't believe private investors are entitled to much if any of the profits. Nonetheless, preferred shares have marched steadily higher in value.

The Fannie Mae "S" Series ( FNMAS) shares were quoted at $5.65 on Friday morning -- 18% below their 52-week high of $6.90. Freddie Mac "Z" Series ( FMCKJ ) were also at $5.65 on Friday, roughly 22% off the 52-week high. Both issues are up about 20% over the last month, and trade at roughly 25% of face value.

The movement suggests investors have some faith the lawsuits brought against the government will succeed.

But if that is the case, the common shares should also get a lift. Instead, they have essentially gone straight down since hitting 52-week highs in late May of $5.44 for Fannie and $5.00 for Freddie. Fannie shares hit $1.03 in early trading Friday morning but rebounded later to $1.15, a 6% gain on the day. Freddie hit a low of $0.98 before climbing to $1.07, a 7% gain on the day.

Much of the disparity in the performance of preferred and common shares in recent months may be attributed to a correction from an earlier period of outperformance by the common. During a stretch in May, the common shares exploded on little more than the words of a few investors such as Berkowitz, who made clear at the time he didn't even own the common shares (though he acknowledged he saw some potential value in them).

The preferred shares, which despite their deceptive name have more in common with bonds than stock, still trade at just about 25% of their value at the time they were issued. They will ultimately need to be paid in full before common shares are worth a penny. That's why my colleague Phil van Doorn and I have argued during past run-ups in the common stock that investors should focus on the preferred shares.

But at a certain point the common shares start to look like an interesting gamble.

How much should the preferred be worth relative to the common? It's difficult to say. But by and large, what benefits one should benefit the other, since both will require a legal change in their status so they can claim a share of Fannie and Freddie's profits.

While not all the lawsuits argue on behalf of the common shares, Perry attorney Olson, a former U.S. solicitor general under the George W. Bush administration, may be the best in the business when it comes to winning lawsuits against the U.S. government. In other words, common shareholders could hardly ask for a better advocate.

-- Written by Dan Freed in New York.

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