Shares of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are well off their summer highs, though it’s not clear if that’s because shareholders are losing confidence that the courts will eventually rule in their favor or if many of them have decided they’d rather put their money to use somewhere else as the cases grind on. But unlike most stocks, a hard-to-explain dip in prices doesn’t really change the logic for or against investing.
Matthew Frankel at The Motley Fool gives a solid breakdown of the current situation for those who haven’t been following it too closely, but the conclusion he arrives at will surprise most Fannie Mae shareholders.
“That’s just what this is: a bet. It’s certainly a more attractive bet now that the share price has dropped, but that doesn’t change the fact that you’re buying a lottery ticket,” he writes.
Fannie Mae stock is practically a binary option
As we’ve written on this site in the past, legislative progress on GSE reform is dead until at least next year, and probably until the end of President Obama’s term in office, which is probably good for Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) shareholders considering the bills most likely to pass. It’s also clear that the FHFA has no intention of engaging with shareholders, even though Mel Watt isn’t in a rush to wind down Fannie Mae and Freddie Mac either.
So it probably depends on the outcome of a series of court cases against the government, with Bruce Berkowitz’s Fairholme Funds being one of the main litigants. Shareholders have valued the stocks at 5x their current market value or more, but if the courts decide to that FHFA and the rest of the executive branch can do what it wants, shareholders may never see a penny.
This binary situation (the stocks are either worthless or incredibly undervalued) is true whether they’re currently trading at $3 or $4. Even if they fall to $2, whether you want to get involved depends on your assessment of what the government will do, not your valuation of the GSEs themselves.
Binary situations come up fairly often
Frankel decides that this is no better than gambling, but that would only be true if our legal system is completely random, which you’d like to think isn’t the case. This might seem like nitpicking, but this sort of situation actually comes up fairly often, and the stakes are usually significant. To take another example, the value of Herbalife Ltd. (NYSE:HLF) stocks depends on whether or not you believe the company is a pyramid scheme. For a buy-and-hold investor, Herbalife is either unfairly depressed or an absolute trap, but that doesn’t make it a bet.
GSE reform and the lawsuits surrounding it are complex, and if you don’t want to dig in then it is probably best not to take a position, but that doesn’t mean the people who have done their research are playing slots.