Another Week With Fannie Mae and Freddie Mac

Another Week With Fannie Mae and Freddie Mac

The story of Fannie Mae and Freddie Mac reached another milestone this week, as the two government-sponsored enterprises reported massive earnings. Let's look at what happened in this week in review.

Big profits again
Not too surprisingly, both Fannie and Freddie reported billions in profits. Fannie Mae's net income hit $8.7 billion, making for a sharp increase over the previous year's $1.8 billion. But the big story was Fannie's smaller sibling Freddie Mac, which reported a net income topping $30 billion.

In all fairness, we need to take into account that around $24 billion of this was due to tax-related assets and that the figure for comparison with Fannie Mae is a more modest (but still gigantic on its own) $6.5 billion. Fannie Mae had a similar tax-related situation when it made use of $50.6 billion of tax deferred assets earlier this year.

Big payments again
There is one party that's cheering these gains, and it isn't average shareholders. Uncle Sam has become the primary beneficiary of Fannie and Freddie's success. After all, the Sweep Amendment has redirected the GSEs' profits from average shareholders and into the Treasury.

And the payments by Fannie and Freddie have an impact on government finances. Back in May, Treasury Secretary Jack Lew noted that the nearly $60 billion payment from Fannie Mae in connection with the GSE's tax-deferred assets would push the debt-ceiling deadline until at least Labor Day.

This quarter, the payments continue, as Fannie Mae will pay $8.6 billion in dividends to the Treasury alongside Freddie Mac's $30.4 billion dividend.

Nearing a milestone
When Fannie Mae and Freddie Mac bled billions in cash in the immediate aftermath of the mortgage market collapse, the prevailing view was that the GSEs would never be able to pay back their massive obligations to the Treasury.

But thanks to a major turnaround, both GSEs are nearing the point of giving the government back 100% of its investment. According to Reuters, Fannie Mae's latest payment will put it within $2.2 billion of this milestone, and Freddie Mac's payment will actually have the government ahead by a small $9 million.

More payments coming
If Fannie and Freddie were under the same bailout agreements as the now-fully privatized financial institutions that received bailout money, these payments would be of major financial significance. But the GSEs are now under what is known as the Sweep Amendment, through which all of the GSEs' excess profits are paid as dividends to the Treasury, and these dividends don't count toward repurchasing the government's senior preferred stakes in the GSEs.

Legal battles
The government now faces a plethora of lawsuits relating to the bailouts of Fannie and Freddie, but among the highest profile and most relevant to the Sweep Amendment is the challenge by Perry Capital.

In short, the lawsuit seeks to stop enforcement of the Sweep Amendment. This litigation is likely to take a long time to play out, leaving Fannie and Freddie shareholders in an uncertain position for at least the near future.

If Congress can cooperate, there is a chance it could begin winding down the GSEs, making recovery for common and preferred shareholders far more difficult. I discussed this possibility further here, alongside the situation involving Congressional action on GSE reform.

Preferred shares update
As common shares have risen in the past month, preferred shares have followed. As one example, Fannie Mae Preferred S Series Shares now trade at around 32 cents on the dollar. Dividends are still suspended and are unlikely to be restored while the Sweep Amendment remains in effect, but they do offer another way to play the GSEs.

Fannie Mae and Freddie Mac are top speculative investments, with big potential gains if Perry Capital wins the lawsuit and total losses if the government acts to wind down the GSEs. But the Fool has found another great play among financials with the potential to revolutionize the banking industry. Our brand-new investor alert "Big Banking's Little $20.8 Trillion Secret" lays bare every banker's darkest secret for the world to see. Simply click here for instant access!

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Alexander MacLennan owns shares of Freddie Mac. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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