I would like to pose three questions related to the relative value of Fannie Mae (FNM) and Freddie Mac’s (FRE) common stock price:

1. Does the up-front 79.9% dilution by the Treasury represent the final dilution?
2. How much of the dilution was already factored into Friday’s closing stock prices?
3. Are the GSEs safer enterprises now?

I will leave it to the professional analysts to determine the enterprise values and the value of future earnings if and when the GSEs leave conservatorship. I am more interested in how the market will treat them in the intermediate term.

The entry price of the “deal” for the GSEs is to give the Treasury warrants covering 79.9% of their fully diluted common stock for a nominal price. The nominal price is not defined, but I assume that it is greater than zero. In exchange for the warrants, Treasury agrees to purchase up $100B in senior preferred stock. The purchases would be made on a quarterly basis, as required to keep the net worth of Fannie and Freddie above zero.

The Treasury’s initial purchases are for $1B in each GSE, paying a 10% dividend, rising to 12% if dividends are in arrears. The “FACT SHEET: TREASURY SENIOR REFERRED STOCK PURCHASE AGREEMENT” does not state that any additional warrants are to be issued with any subsequent capital infusions by the Treasury. Both the fact sheet and Treasury Secretary Paulson did not say that the Treasury’s senior preferreds are convertible. So excluding political risk in Congress and the new Administration, can I assume the dilution is complete?

The second question is more difficult. Is 79.9% dilution greater or less than the market expected? I think the market focused more on the binary question for the common stocks - all or nothing. Now the market has to evaluate the GSEs common stock relative losses, along with future political risk.

In the third question, the debate is have common shareholders traded the majority of their equity to get more stable enterprises? Will the GSEs leave conservatorship as stronger companies, worth much more to make up for the dilution? Floyd Norris’ New York Times “Having It Both Ways” questions the conservators intentions when they want to avoid risk taking, but promote mortgage availability and lower fees charged by Fannie and Freddie. The new straight jacket is actually going to get less revenue for insuring the same level of risk. The capital case is improving, but the business case appears to be weakening.

Treasury Secretary Paulson made it clear that Fannie and Freddie’s missions are more important than building value for shareholders. But at the same time the warrants won’t be worth much without building shareholder value.