Fannie Mae (FNMA) and Freddie Mac (FMCC) were called out by hedge fund giant Bill Ackman in February as big opportunities for investors. At the time, FNMA stock was up 1,000% in the previous 12 months and surged another 20% after that.
But this week, shares plunged on proposed legislation that would dismantle the government-controlled mortgage buyers.
So what’s the score? Are FNMA and FMCC stock doomed, or are there still ways to profit in the meantime, even if these two organizations could be unraveled slowly over the next year or two?
Well, it’s worth noting that this week’s plunge for Fannie Mae stock was a bit of a head-scratcher for many investors who have long expected legislators to take aim at Fannie and Freddie. After all, the pair have taken a lot of the blame for the financial crisis over the last five years … and anyone who didn’t see this kind of move as a risk simply hasn’t been paying attention.
In fact, details released Tuesday indicate a prior congressional proposal is the base of the plan — meaning the blueprint has been available for some time.
FNMA and FMCC still trade over-the-counter, but the government-sponsored enterprises have been defunct (officially “in conservatorship”) since the subprime mortgage loans on their books started to go toxic.
Lately, however, a rebounding housing market and the unwinding of bad debts have allowed Fannie Mae and Freddie Mac to actually repay the Treasury … and then some.
Bill Ackman of the hedge fund Pershing Square is on record as saying he believes Fannie and Freddie will escape liquidation, a scenario that would leave shareholders with some value even if lawmakers move to increase capital requirements or deploy other protections.
Of course, what does Ackman know? Even hedge fund managers can make big boo-boos … like Ackman’s bet on Herbalife (HLF) that has been roundly proven wrong in the last year. Even worse, he stubbornly has stuck to his guns through the losses and many are now questioning his motives.
It’s undeniable that the housing market has bounced back big-time, as evidenced by the rally in stocks from retailer Home Depot (HD) to builder PulteGroup (PHM) to supplier Lumber Liquidators (LL) over the past two years. But whether the housing market has more room to run is anyone’s guess.
And more importantly, whether Fannie and Freddie will survive liquidation is still an open question.
My advice: Investors should treat FNMA stock like what it is — a defunct company trading over-the-counter, which might be a creative arbitrage play should it be restructured in a way that could save it … but could go to zero if things sour.
Sure, some investors have cashed in on Fannie and Freddie over the last year or so. But these picks are undeniably the highest-risk plays that you can make since it’s very possible they could go to zero in the near future.
Remember that before you place a trade.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.