Does This Milestone Mean You Should Buy Fannie Mae and Freddie Mac?

Does This Milestone Mean You Should Buy Fannie Mae and Freddie Mac?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks rose today, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 1.3% and 1.1%.

Which large-capitalization stock has risen more than 700% this year, all the while remanding the near totality of its (considerable) profits to the federal government? Mortgage agency Fannie Mae , which has experienced a remarkable revival after having been at the brink of collapse at the height of the credit crisis in 2008.

The government was ultimately forced to step in to prop up Fannie Mae and its "fraternal" agency Freddie Mac with an aggregate $187.5 billion in taxpayer funds (incidentally, shares of Freddie Mac have produced a similar year-to-date return of roughly 700%). Under the terms of the conservatorship, the government began appropriating all of the agencies' quarterly profits last year beyond a $3 billion net worth cap.

A staggering $185 billion in dividend payments
However, Fannie and Freddie announced separately today that they will make a combined $39 billion in payments to the government before the end of year, which would put total remissions at $185.2 billion -- within $2 billion of the amount taxpayers fronted them (note, however, that these payments, which are technically dividend payments on the government's senior preferred shares, do not qualify as repayments of the taxpayer aid per se).

So do Fannie Mae and Freddie Mac's enormous profits indicate that they are good common stock investments? Clearly, returns this year have been stratospheric -- albeit with huge volatility, Fannie Mae's stock has suffered a peak-to-trough loss of roughly three-quarters along the way. However, both organizations present some highly unusual risks: Their common equity may be in private hands, but, for now, the government calls the shots and takes all the profits.

Current profitability is unsustainable
Second, even Freddie Mac's CEO, Donald Layton, warned against using the past couple of years' bumper earnings as a benchmark of future profitability, telling reporters that the level of these earnings "is not sustainable in the long run." He added, "It's a reflection of the housing cycle coming back. I would not ever characterize the next few years as ones in which there would be steady earnings necessarily, or in any way promise steady earnings."

Finally, it's not even clear that the mortgage agencies are going concerns! Lawmakers in both houses of Congress are working on legislation to wind them down. In truth, though, I don't expect anything concrete on this front for a number of years -- I don't see anyone stepping in to fill the enormous void Fannie Mae and Freddie Mac would leave in the mortgage market in the immediate future.

Fannie Mae and Freddie Mac are no blue chips
Bottom line: Fannie and Freddie may look like blue-chip stocks, but they are, in fact, special situations that require much knowledge, experience, and intensive monitoring to invest in. At the 2001 Berkshire Hathaway annual meeting, when Warren Buffett was asked why he had sold nearly all of Berkshire's shares of Fannie Mae and Freddie Mac, he replied: "We felt the risk profile had changed." While the agencies are now safer than they were five years ago, common equity holders' position remains fraught with uncertainty. Fannie and Freddie's profits may have some luster, but these are shares that could quickly tarnish a portfolio's performance.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool has no position in any of the stocks mentioned, either. 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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