Warren Buffett, Charlie Munger and Berkshire Hathaway may not be fans of Fannie Mae and Freddie Mac today, but in the past, they’ve been some of these businesses largest owners. Indeed, in 1999 while Buffett owned around 9% of Freddie Mac, a position worth nearly $3.9 billion at market value.
This was a hugely lucrative position for Berkshire Hathaway. Between 1990 and 1998, the value of the position rose from around $100 million to $3.9 billion representing a return of almost 1200% on cost. During 2000, Buffett sold the entire position and has since stayed away from the company.
Why Munger and Buffett controlled entities took a liking to Freddie Mac is laid out in the Wesco Financial Corporation 1988 annual report. Wesco, a financial holding company, run by Charlie Munger, was majority-owned by Berkshire at the time but was not brought entirely into the Berkshire fold until the year 2011 when Berkshire acquired the 19.9% of the company that it did not already own.
The Story Of Wesco, Mutual Savings, Buffett, Charlie Munger and Freddie Mac
In 1988 Wesco had three principal subsidiaries, Mutual Savings, Precision Steel and Wesco Financial Insurance Company. It was the Mutual Savings subsidiary that held the position in Freddie Mac and in the annual report, Charlie Munger explained why:
“The savings and loan association described in the foregoing paragraphs, quite different from most other associations for a long time, added a significant new abnormality during 1988. Mutual Savings increased its position in preferred stock of Federal Home Loan Mortgage Corporation to 2,400,000 when-issued shares. This is 4% of the total shares outstanding, the legal limit for anyone holder. As this letter is written, all of these 2,400,000 shares have been issued and paid for. Mutual Savings’ average cost is $29.89 per share, compared to a price of $50.50 per share in trading on the New York Stock Exchange at the end of 1988. Thus, based on 1988 year-end trading prices, mutual savings had an unrealized pre-tax profit in the Freddie Mac shares of about $49.5 million. At current tax rates, the potential after-tax profit is about $29.2 million, or $4.10 per Wesco share outstanding…
At Freddie Mac’s current dividend rate ($1.60 per annum per share), Mutual Savings pre-tax yield is only 5.35% on its $29.8 average cost per share. Post-tax, the dividend yield is a 4.4%. But Freddie Mac is a very credible history of raising its earnings and dividend rate, thus contributing to increases in the market price of its stock.”
What follows this description is a table showing Freddie Mac’s growth between 1985 and 1989. Over this period, the entity’s earnings per share grew from $2.98 to $5.73 by 1988. Dividends per share rose from $.53 to $1.60, and the average return on equity was around 28% per annum. Between 1985 and 1998 the year-end market price per share rose from $9.19 to $50.50.
The explanation of why Wesco initiated the position continues:
“Freddie Mac is now regarded in the mortgage, mortgage securities in debt issued market as a virtually risk-free government agency, even though its obligations not technically backed by the full faith and credit of the United States. With this enormous advantage, Freddie Mac’s controllers can almost always get socially constructive and financially rewarding results, provided they refrain from taking a significant risk of ruining Freddie Mac’s credit. The annual dividend to private owners is peanuts, a small fraction of 1%, compared to the financing Freddie Mac provides to the buyers of housing. The need for the dividend safety and growth disciplines the system in exactly the right way. There is no reason to change course. Moreover, the right course, involving continued tough credit standards, has been clearly demonstrated by the recent terrible home loan experience in oil production dependent areas. Conventionally sound home loans then went sour in massive quantities, despite having been made by wise and honorable lenders to homebuyers with good jobs and loan payment histories who made substantial down payments. Such experience reinforces the margin of safety principle required of highly leveraged institutions that guarantee credit. Just as bank credit standards remained sound for a long time after the horrors of the 1930s, home lending standards enforced by Freddie Mac when may remain sound from a long time after the good home loan losses of the 1980s. If so, an interest rate change risk is scrupulously minimized, Freddie Mac stock could be a good long-term investment for Mutual Savings.”