Fannie Mae and Freddie Drop 39% Over Two Days

NEW YORK (TheStreet) -- Fannie Mae (FNMA) and Freddie Mac (FMCC) were once again the big losers among financial stocks on Wednesday.

Common shares of Fannie Mae were down more than 12% to close at $3.54. The shares have dropped 39% over the past two days, as investors have reacted to the announcement by Senate Banking Committee Chairman Tim Johnson (D., S.D.) and ranking committee member Sen. Mike Crapo (R., Idaho), that they had agreed on a new bipartisan proposal to wind-down the two government-sponsored enterprises, or GSEs.

Freddie Mac's common shares declined nearly 17% on Wednesday to close at $3.35, for a two-day drop of 39%.

GSE junior preferred shares also declined for a second-straight day. Fannie Mae's preferred Series S shares (FNMAS) were down over 8% to $10.90, while Freddie's preferred Series Z shares were down almost 8% to $11.30. Both issues have face values of $25, with investors hoping the junior preferreds will trade up to par if their dividends are restored.

Fannie and Freddie were taken under government conservatorship at the height of the U.S. housing market meltdown in September 2008. The GSEs' common and preferred stocks remained publicly traded, but values plunged because dividends to non-government shareholders were suspended, and because it appeared highly unlikely at the time at the GSEs would eventually return to being highly profitable.

There seems to be some confusion over the difference between having the GSEs pay dividends to the U.S. Treasury on government-held senior preferred shares, and possibly having the GSEs "pay the government back."

The government's original bailout agreement with the GSEs required Fannie and Freddie to pay the U.S. Treasury 10% annual dividends on the government-held senior preferred shares. However, in August 2012, after the GSEs had returned to profitability and after they had stopped increasing their borrowings from the government, the bailout agreement was changed so that all GSE profits were paid to the government, in excess of minimal capital cushions.

Following their March dividend payments, Fannie and Freddie will have paid total dividends of $199 billion on $189.4 billion in senior preferred shares held by the Treasury. Factoring in warrants that were handed to the government to acquire up to 79.9% of the GSEs common shares, Rafferty Capital Markets analyst Richard Bove last week estimated the government's return on its investment in Fannie and Freddie was $238 billion.

But paying dividends to the government for amounts exceeding the government's -- or U.S. taxpayers' -- investment doesn't mean the government has been, or is, being paid back.

There's actually no mechanism in place allowing either Fannie or Freddie to repurchase any of the senior preferred shares held by the government. Their revised bailout agreements with the Treasury do not allow the GSEs to buy back any of the senior preferred shares, and Fannie and Freddie under the revised agreement can never build enough capital even to consider doing so.

This situation has continued since the bailout agreements were modified in August 2012, and the status quo suits the Obama administration and many members of Congress quite well, since the result is a significant lowering of the federal deficit.

Another reason there has been no hurry over winding-down Fannie and Freddie is the fear of a major disruption to the U.S. mortgage finance market. Fannie and Freddie purchase the great majority of newly originated fixed-rate mortgage loans in the United States.

Rafferty Capital Markets' Bove in a client note on Friday summed up a very negative possibility if the GSEs are done away with: "Since Fannie and Freddie are the only entities in the country willing to purchase 20 and 30 year fixed rate mortgages, their elimination would have meaningful impacts on the mortgage markets. The monthly cost of owning a home would rise and the size of the market itself would shrink."

The bill that is expected from Sen. Johnson and Sen. Crapo this week will "start with" the provisions laid out in last year's GSE reform bill from Senate Banking Committee members Bob Corker (R., Tenn.) and Mark Warner (D., Va.) which would replace Fannie and Freddie with a new Federal Mortgage Insurance Corp., funded by private investors and the mortgage industry.

The Corker-Warner bill provided nothing to common and junior preferred shareholders of Fannie and Freddie, and the statement from Sen. Johnson and Sen. Crapo on Tuesday also made no mention of any consideration for private investors.

At least 20 lawsuits have been filed against the Treasury by investors seeking a seat at the table as the future of Fannie and Freddie is decided. Judge Margaret Sweeney in the U.S. Court of Federal Claims last month rejected the Treasury's motion to dismiss a high profile lawsuit by an investor group that includes Bruce Berkowitz's Fairholme Funds. This means the court case will move to the discovery phase, enabling the plaintiffs' lawyers to question government witnesses.

Please see these key stories for full coverage of the history of the GSE bailouts and the controversy over the amendments to the bailout agreements:

Were Fannie, Freddie Negotiations Done in Good Faith?

Ralph Nader Discusses Fannie and Freddie Shareholder Fight

Fannie and Freddie Plaintiffs Eye FDIC Share Sales

Despite the difficult two days for non-government GSE shareholders, the stocks are way up over the past year:

FNMA Chart data by YCharts

Senator Stumbles in Fannie and Freddie Shareholder Defense

Banks' Excess Capital Is 'Absolutely a Reality'

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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