Expectations Versus Reality

The day after the Fed and the Treasury announced their plan to support the two mortgage giants, early investor confidence turned to investment reality. The shares of both companies were up approximately 20% in pre-market trading. However, prices declined through the balance of the day with Freddie Mac closing at $7.11 down 8.94% on the day. Fannie Mae followed the same path closing at $9.73 while losing 5.07% for the day.

Things started equally well on the bond side as Freddie Mac looked to raise $3 billion in three and six-month paper. Demand for the notes exceeded expectations; leading yield spreads between comparable treasuries and agency paper to narrow by 5 or 6 basis points earlier in the day. The early morning euphoria quickly dissipated as spreads closed the day 3 basis points wider than the previous close.

It is clear that bondholders are in much better economic position than shareholders. Secretary Paulson has talked about acquiring congressional approval to purchase equity interest in the company that has operated as a growth company sponsored by the government – is that a classic definition of an oxymoron? Shareholders will of course be diluted and regulators will begin their process of tightening regulatory guidelines and limiting the future growth of the company. Citing uncertainty regarding the potential for future credit losses Merrill Lynch reduced Freddie Mac’s price target from $20 to $7 and concurrently reduced Fannie Mae’s from $22 to $9 in an otherwise bold move.

Stay tuned.

Bob Andres

Chief Investment Strategist

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