What's Next for Fannie Mae and Freddie Mac?
The Federal Housing Finance Agency (FHFA), the federal regulator charged with overseeing Fannie Mae and Freddie Mac , recently announced a plan to reform the housing finance market. The plan calls for establishing a new securitization platform. How the plan will actually work in practice is unclear, so I think investing in the common stock of the housing finance giants is not worth the risk of uncertainty.
What's the plan?
The FHFA's plan aims to resolve the problems that initially welled up in the subprime mortgage market and triggered the economic crisis in 2008. In September of that year, Fannie Mae and Freddie Mac were placed in an FHFA-run conservatorship by the Treasury Department -- essentially nationalizing a key financing piece the housing market. And they are still there today.
Now, the FHFA has filed paperwork to create a new securitization platform. This new entity, Common Securitization Solutions (CSS), is described as an "equally owned subsidiary" of Fannie Mae and Freddie Mac. My take is that CSS will be a potential replacement for the agencies and could consolidate some of the functions considered to be redundant.
While the goal may be to replace the agencies, the question remains as to how to get this done. The agency's announcement offered little guidance and lacks assurances taxpayers will not be bailing out the institutions in the next crisis.
This step comes as congressional lawmakers wrangle over the government's involvement in the mortgage market. House Republicans are calling for the elimination or privatization of Fannie and Freddie, while a Senate bill (the Housing Finance Reform and Taxpayer Protection Act of 2013) would leave some form of federal backstop in place.
What does it mean for investors?
These developments create uncertainty, and this not a good situation for ordinary investors. The government takeover has really been another bailout paid for by the taxpayers. And I believe the turf battle on Capitol Hill will hinder the FHFA's plan. With so much cash at the fingertips of lawmakers, it's uncertain if the CSS will ever be a completely private outfit.
Moreover, Fannie and Freddie are not being run for the benefit of shareholders but rather the government and taxpayers. This is made quite clear in Fannie Mae's financial reports.
That being said, last year and 2013 have been profitable years for both enterprises. This is mostly due to the slow rebound of the housing market. But even though Fannie Mae and Freddie Mac have paid a significant sum to the Treasury, thanks to a 2012 amendment to the government's preferred stake, the path to fully repaying the government investment and exiting conservatorship is murky at best.
The bottom line
The FHFA's plan might not be bad news for institutional investors in the preferred stock. If there's money to be doled out after the CSS is up and running, preferred shareholders of Fannie and Freddie will be paid before common shareholders.
In short, it's unclear what the valuation of the common shares will be over time. So, I think this is an easy pass for ordinary investors considering placing a bet on the common. In the end, this is only the beginning of the long goodbye of Fannie Mae and Freddie Mac.
The article What's Next for Fannie Mae and Freddie Mac? originally appeared on Fool.com.
Kyle Colona has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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