Hedge Funds Weary to Invest in Freddie, Fannie: Government Bailout May be Inevitable

New York (HedgeCo.Net) – While the U.S. Treasury has done all it can to stave off rumors of a government bailout of Fannie Mae and Freddie Mac , some say the inevitable rescue is bound to take place after attempts to raise capital for the two mortgage giants have proved futile.

Preferred shares of the two companies are trading as low as 19 cents on the dollar, fueled by assumptions that their dividends will be suspended. This belief was the reason behind Moody’s recent ratings downgrade of their preferred stock to Baa3, the lowest possible investment-grade. Meanwhile, shares of both companies have experienced month after month of sharp declines, with Freddie down 93 percent and Fannie down 89 percent since November.

Together, the two companies account for over $5 trillion of outstanding U.S. mortgages. As the number of foreclosures reached record heights thanks to defaults on mortgages by subprime borrowers, Freddie Fannie have taken a beating since last summer, writing down almost $15 billion and forcing some to believe they will not be able to weather this housing crisis without the help of Uncle Sam.

Both Freddie and Fannie make money by offering mortgage-backed security bonds to investors. By selling these bonds, they assume the risk involved in the repayment of these loans. In exchange, they get to keep a guarantee fee that investors pay upon purchasing the bonds. It is easy to see, then, how the two companies that were believed to be “too big to fail,” started to experience problems. As more and more borrowers were unable to pay their mortgages, the responsibility fell on Freddie and Fannie. As they tried to stay afloat in their sea of debt, values of their securities started to plummet.

Recent attempts to try and find investors have been unsuccessful. Hedge funds like the Carlyle Group and Blackstone both expressed interest, only to rescind until further action by Treasury Secretary Henry Paulson.

"I think it starts with the constant doom and gloom, which makes investors quick to react when there is any sign of trouble ahead, and rightfully so," explains Michael Facchini, Portfolio Manager for Chicago-based Regent Global Funds.  "Right now, investors are only interested in the cream of the crop when it comes to the MBS markets."

Federal Reserve Chairman Ben Bernanke has spoken several times about increased regulation of the companies, thanks to the widespread belief that Freddie and Fannie are government-backed. While both were created by Congress in an effort to increase homeownership and profits through the sale of their mortgage backed securities, they are in no way guaranteed by government funds.

In July, the Treasury and Federal Reserve outlined a plan to save Fannie and Freddie in order to prevent any chance of a Bear Stearns-like debacle. Among the suggestions, Paulson’s plan allowed for the Treasury to purchase shares of the two companies, should it prove to be necessary. That time has come, with some estimating the government may have to purchase about $60 billion worth of preferred shares.

Shares of Fannie Mae closed on Monday at $5.19, up 4 percent, while Freddie Mac rose 17 percent to close at $3.29.

Julie Scuderi
Senior Editor for HedgeCo.Net
Email: julie@hedgeco.net

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