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What's Behind The Move in Fannie Mae and Freddie Mac?


Apparently the "market" is adjusting its tolerance for risk and has decided to demand better terms on the loans being made...

Fannie Mae (FNM) and Freddie Mac (FRE) have rallied significantly in the last week. The reason: several senators in a panic to aid borrowers who want to buy houses are demanding that curbs be lifted on these companies ability to buy mortgage paper.

Apparently the "market" is adjusting its tolerance for risk and has decided to demand better terms on the loans being made (including not making them to unworthy borrowers). Banks, with their own money, have decided that they would like to reduce their risk in the paper they already hold. So certain senators, in their infinite economic wisdom, have decided that the market is wrong and they are right. FNM, which are not government institutions when the government doesn't want them to be, but are when they do, should step in and buy the crappy paper and make the loans that the market doesn't want.

So investors believe the "revenue opportunities" have increased for the companies and have decided to bid up the stock prices. This ignores something that Minyans should understand by now: RISK.

Yes, if these companies buy the paper that investors have decided is too risky they may make more "revenue" in the near term, but that ignores the fact that they must take much higher risk to do so. If I tell you I will pay you an extra dollar today at the risk of you losing $20 tomorrow, is that a good deal?

The government, of course, probably won't let these companies fail if they truly get in trouble as a result (which I believe they will). But what does that have to do with the stock? The stock is an option on profits; if the company loses money on their positions the bondholders will get bailed out by the government but the stockholders will not.

These companies already own trillions of dollars in loans. In reality, U.S. taxpayers probably own them. We have gotten ourselves into this mess because we have let the government foster artificial credit prices for years. Is the answer really to let them continue to do so?
No positions in stocks mentioned.
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