Bailout concerns slam Freddie, Fannie shares

Monday August 18, 4:45 pm ET
By Lynn Adler

NEW YORK (Reuters) - Investors dumped shares of Fannie Mae and Freddie Mac on Monday after a newspaper report said government officials may have no choice but to effectively nationalize the U.S. housing finance titans.

A government move to recapitalize the two companies by injecting funds could wipe out existing holders of the largest U.S. home funding companies' common stock, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.

Shares of Fannie Mae sank more than 22 percent to a 19-year low on Monday, closing at $6.15, while Freddie's shares plunged 25 percent to $4.39. Some of their bonds sharply underperformed Treasuries. A $4 billion sale of new Freddie Mac debt drew weak bids compared with similar issues last week.

A spokeswoman for the U.S. Treasury said the department has no plans to use its authority to backstop the two funding agencies. That authority was greatly increased by a rescue plan approved at the end of July.

"The Barron's article overstated Freddie Mac's financial situation," Sharon McHale, a Freddie Mac spokeswoman, told Reuters. "We continue to be adequately capitalized."

My feeling is that in the long run Freddie and Fannie will either have to be nationalized or fail in the old school style of capitalism. This current strategy of blindly supporting the companies with an unlimited line of credit is downright foolish and is not at all sustainable. Given the trend of current events, if I were a betting man I would say that there's a very likely chance that Freddie and Fannie will become nationalized businesses. Clearly the government won't let them fail, but today's bailout strategy is only encouraging poor decisions rather than punishing them. There's only so much the Fed and Treasury can do without getting more heat than they already are, so in all likelihood I would expect the government to make it official and nationalize the businesses. Don't stop at watered down socialism, go for the real deal!

I still can't stop laughing when I hear that the companies are "adequately capitalized". How's that working out for you, guys? I guess on one hand there is a bright side to this, we know the market can and will weed out the loser businesses even if they are monopolies like Freddie and Fannie (without the bailout from the Treasury both companies would almost certainly fall apart). The way I see it the market will eventually win out, whether the companies are nationalized or not. All attempts at socialism will inevitably fail anyway, the "invisible hand" is still at work over the long-term regardless of the system. The free market is almost always blamed for the problems created by government intervention and those problems are used as an excuse for more interventionism still. Having the government meddle in the affairs of the market may sound fantastic in the short-term, but the price must be paid sooner or later.

I've already repeated things I've said quite a bit over the past couple months, so I'll stop here for now. This is a very important topic at the moment and at the rate things are going we haven't seen the last in the short or long run.