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Why Fannie and Freddie Mac Shares Are Soaring -- Again

Jordan Wathen, The Motley Fool

What's happening?

Shares of Fannie Mae (NASDAQOTH: FNMA) and Freddie Mac (NASDAQOTH: FMCC) are rallying again on Tuesday, rising by roughly 13% and 10%, respectively, as of 2:35 p.m. EST. Shares of the two mortgage giants are building on Friday's surge , rising as investors become increasingly hopeful that they could soon be freed from government conservatorship.

So what

Fannie Mae and Freddie Mac make a lot of money and have made a lot of money for several years, but since 2012, none of it has made its way into their shareholders' pockets. In 2008, the U.S. Treasury bailed out the two government-sponsored entities (GSEs), injecting $187.5 billion of capital in exchange for preferred stock that entitled the Treasury to a high yield on its investment, plus warrants that gave it nearly 80% ownership of each of the GSEs.

Photo of a "sold" sign in front of a suburban home.

Image source: Getty Images.

In 2012, when it became obvious that Fannie Mae and Freddie Mac would return to profitability, the U.S. Treasury amended the terms of its emergency investment in the two GSEs, installing a "net worth sweep" that sent all of their profits straight to the Treasury.

As a result of the net worth sweep, the GSEs would not receive credit for paying back the preferred stock investment, and thus they could never exit conservatorship. Instead, the GSEs would be arms of the government. For as long as the net worth sweep exists, all the profits earned by Fannie Mae and Freddie Mac flow to the U.S. government, and only the U.S. government.

Both GSEs publish schedules that document that total amount drawn from and paid back to the U.S. Treasury since the 2008 bailouts. The table below reflects these draws and dividend payments since 2008.

Company

Draws From the U.S. Treasury

Payments to the U.S. Treasury

Fannie Mae

$119.8 billion

$171.8 billion

Freddie Mac

$71.6 billion

$114 billion

Data source: Company presentations; figures shown are cumulative amounts from 2008 to the third quarter of 2018.

Investors rightfully take issue with the U.S. Treasury changing the rules and sweeping all of Fannie and Freddie's profits. At times, certain government officials have also made it public that they favor returning the GSEs to private ownership.

Most recently, Joseph Otting, current acting director of the Federal Housing Finance Agency (FHFA), which oversees the GSEs, has suggested that the Treasury and White House will release a plan to return Fannie Mae and Freddie Mac to the hands of public shareholders.

On Friday, an FHFA spokesperson told MarketWatch that Otting had "mentioned, as he previously has, that Treasury and the White House are expected to release a plan for housing that will include details about reform and will likely include a recommendation for ending Fannie Mae and Freddie Mac conservatorships."

Now what

Otting's desire to return Fannie and Freddie to the ownership of public shareholders may not translate into a timely reprivatization of the GSEs, if it happens at all. It's notable that Otting is only temporarily head of the FHFA, serving in that role until the Senate confirms his more-permanent replacement. Donald Trump has already nominated Mark Calabria as the FHFA's next director.

There are practical roadblocks standing in the way of a timely reprivatization of Fannie Mae and Freddie Mac, particularly one that is put in place by an FHFA director who wasn't confirmed by the Senate. More importantly, details of Otting's plan are few and far between, and the market knows only of his broad goal to return the GSEs to private ownership, not what that plan might look like for the GSEs' current shareholders.

Even still, Wall Street is happy to bid up shares of Fannie Mae and Freddie Mac on news that at least one person in the FHFA is taking the view that the GSEs' profits should be the property of all their shareholders, not just the U.S. Treasury. Whether that Hail Mary bet proves lucrative ultimately depends on who wins in a trillion-dollar game of political football.

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Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .