Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) have attracted increasing attention over the last few weeks, despite the fact the US government still intends to keep all of the companies’ profits for itself and wind them down between now and 2018. Earlier this month, Rafferty Capital Markets LLC vice president Richard X. Bove decided to examine Fannie and Freddie as possible investment opportunities in a series of newsletters, and what seemed surprising at the time is starting to look prescient.

Bove sees much uncertainty, risk

A week after Bove’s first newsletter, Bruce Berkowitz-led Fairholme Capital Management sent a letter to the Treasury outlining its plan to take the lead in a buyout of both companies, infusing $52 billion into them and taking them private. Almost immediately, hedge fund manager Bill Ackman filed 13-Ds showing that he had taken a 10% stake in each companies’ common stocks. Now Bove has released another newsletter analyzing the investment argument, but the risks are as high as they ever were.

Bove doesn’t take a strong position for or against government intervention in the housing market, but it’s clear that he doesn’t think everyone understands the implications of simply liquidating Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC).

“The current option will increase the cost of owning a home; reduce housing values; shrink the available funding for homeownership; and reduce the size of the housing market impacting economic growth. It will return housing to being a highly cyclical industry; and it will return the United States to a policy of supporting semi-public housing or the creation of instant ghettos,” writes Bove, referring to the political options currently in play in Washington.

Fannie and Freddie have made housing available

Delving into the history of the US housing market, Bove argues that Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) has effectively made housing available to many Americans, and that the company’s structure is tried and true; there was a breakdown in the company’s management in the run-up to the housing crisis, but that can be, and arguably has been, fixed.

If Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) were private companies, you’d expect their stocks to be soaring, but the government has laid claim to all of their profits. Fairholme has previously sued the government for some sort of compensation but “Congress has given Fannie Mae’s conservator the right to ignore any court decisions that interfere with the rights listed above,” explains Bove, referring to its sweep of profits. “This is important. The government is using its sovereign authority as a right to ignore the law – despite the separation of powers.”

Political factors to play huge role

The main issue to anyone investing in Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) is political: their liquidation is supported by President Obama and a bipartisan bill in the Senate. It’s one of the few issues on which the two parties generally agree, and investors have to hope that they can convince the government to change course. But Fairholme’s offer to buy them out seems to meet everyone’s goals: the government exits the secondary mortgage business, shareholders get to earn money on their investments, and the country hopefully avoids the housing crunch that Bove predicts if the companies are shut down. Now it’s only a question of whether the government will agree.

“Sizable positions are now being established in the stock reflecting the possibility that the government will change its position. It is a reasonable but extremely high risk speculation,” writes Bove.

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