Can Anyone Explain Freddie and Fannie to Me These Days?

The Washington Post's Zachary Goldfarb notes in a story today that Fannie and Freddie shares - yes, despite being in conservatorship (receivership by any other name) by the US government -the common stock still trades, although the New York Stock Exchange has threatened to de-list - have surged in active trading in the past few months. (The story has a couple of good graphs as well as excellent reporting.) (Update: Interesting series of posts on exactly this subject at Bronte Capital. Link to post I and then see sidebar for rest.)

On Monday, Fannie Mae jumped 41.7 percent, to $1.70 per share, with nearly 824 million shares bought or sold during regular trading hours. Freddie Mac rose 18.5 percent, to $2.05 per share, with almost 384 million shares trading hands. Activity in the two companies' stocks accounted for nearly a fifth of trading on the New York Stock Exchange on Monday, when 6.3 billion shares were bought and sold.

This presents something of a question, given the economic fundamentals of the two companies. In terms of the fundamentals of each company, well, Freddie has announced it won't need a new round of government financing (but I have questions still about the longer run); Fannie sought billions more. In terms of the ability of common shareholders to access any improvements in the company, well, they stand a long way behind other parties, starting with the USG; don't hold your breath. As Goldfarb says,

The government took a nearly 80 percent stake in each company, but left the stock outstanding. The shares of each settled below $1, and the New York Stock Exchange warned the firms that they'd be removed from the exchange if their stock did not rise above that threshold.

In recent months the firms' shares have risen steadily with the overall market. There have been occasional pieces of good news. For instance, Freddie Mac said earlier this month that it does not need more government aid for now, after receiving $50 billion since November.

Still, most analysts say that because the companies owe the government far more than they are able to generate in profits, the real value of the shares is zero.

So why the rush to buy? The obvious explanations are: (1) the investors know something the rest of the world, including the experts, don't know, (2) irrational noise trading, mostly by retail investors and day traders playing with trends, or (3) risky but not necessarily in all circumstances irrational bet on the political economy of the GSEs rather than their economic fundamentals.

The last two, particularly, are not inconsistent with each other. Moreover, what constitutes efficient processing of information means something different in markets that are driven by politics and political considerations than otherwise; rather than focusing on the quality of the underlying portfolio, one concentrates upon the Mind of Barney Frank, which requires a different sort of inputs altogether.

But Goldfarb has been writing excellent coverage of the big picture questions of the future of Fannie and Freddie as well. They were conspicuously not discussed in the recent Treasury White Paper on financial reform - but then Goldfarb noted a flurry of inside comments on what might happen, rumors later denied by the administration. It does not appear that a final resolution of them will be proposed before the beginning of 2010. And yet, in the meantime, Ginnie Mae has picked up much of the slack, along with slack underwriting standards for mortgages to rival those of the meltdown, and Fannie and Freddie are still being used to prop up the market. (Update: Further to one of the comments, see this WSJ piece for an entry into the Ginnie Mae question.) It matters hugely to the shape of the mortgage and securitization markets what the long term roles, if any, of Fannie and Freddie will be.

The general possibilities, in any case, are what they have always been - (1) fully privatize; (2) fully convert to being a full government agency (again); or (3) the mixed GSE format that Fannie and Freddie have now. (There is a further question, on any of those scenarios, as to where their portfolios, meaning the toxic parts, winds up.) The answer can't wait forever insofar as it is a core component to getting securitization markets moving at a more efficient level; perhaps the worst result is no real policy except by default, in which no true decision is made with a restructuring of regulation, but just ad hoc drifting, using the convenience of the GSEs for short term government policy and/or Congressional political desires, and building up new long term risks.