Don't listen to 'unscrupulous dealers' promoting this Trump trade, analyst says

By Chris Matthews

Fannie Mae and Freddie Mac shares have both rallied in anticipation of privatization

Investors in mortgage-finance giants Fannie Mae and Freddie Mac have made a killing this year, as the penny stocks have been bid up on hopes that Donald Trump would end the federal government's conservatorship of the companies during a second term in office.

Fannie (FNMA) and Freddie (FMCC) were brought into government conservatorship in 2008 in the wake of the financial crisis, and are required under current policy to remand all their profits to the U.S. Treasury.

Mark Calabria, who oversaw Fannie and Freddie as the head of the Federal Housing Finance Authority during Trump's first term, has been a strong advocate for privatization. He has argued that he would have been able to accomplish that goal if it weren't for the outbreak of the COVID-19 pandemic.

"From everything we did, and what I believe needs to be finished, it can be done," Calabria, now a senior advisor at the Cato Institute libertarian think tank, told National Mortgage News in March.

These comments have fueled the interest of some investors, including Chris DeMuth Jr. at Rangeley Capital, who wrote in a recent blog post that Fannie and Freddie have "suffered under Biden, but could have a route to realizing value under Trump."

Fannie Mae stock is up 27.1% year to date, while Freddie Mac's has gained 50.6%, according to FactSet. Both securities are unlisted and are only sold over the counter.

Christopher Whalen, chairman of Whalen Global Advisors, wrote Monday in a client note that he believes this reasoning to be flawed.

"Through the end of last week, the two leading stocks in the world of mortgage finance were unlisted penny stocks issued by Fannie Mae and Freddie Mac," Whalen wrote. He concluded that investors in these shares "take short-term trading profits rather than playing the long game that certain unscrupulous dealers are promoting."

Whalen argued that Trump, if elected, would ultimately decline to privatize the entities because the move would seriously disrupt the mortgage market, with unpredictable results for the American middle class.

Fannie Mae and Freddie Mac back upwards of 70% of new mortgage issuance in the U.S., and have an even greater market share of homes bought by low- and middle-income families.

"If President Trump releases [Fannie and Freddie] from conservatorship, they are likely to fail again," he wrote, arguing that these companies only advantage against would-be competitors is their ability to borrow money at low rates that are typically only available to sovereign, government entities.

Whalen predicted that the only way Fannie and Freddie could be privatized without causing a "catastrophe for the housing market, banks and U.S. economy" would be to forge an agreement with the U.S. Treasury to backstop the mortgage-backed securities that they issue.

It would be difficult to justify backing loans by Fannie and Freddie as private entities while not also doing the same for the competitors that would flood into the market to take over their business.

Therefore, even if the companies were made private, there's little reason to believe they would return to making the fat profits of their pre-2008 existence, when a government backstop was only implied rather than explicit.

"The nonbank mortgage issuers led by Rocket (RKT), United Wholesale Mortgage (UWMC) and PennyMac Financial (PFSI) are orders of magnitude more efficient than the GSEs when it comes to buying loans," Whalen wrote.

"Smaller bank issuers, like Western Alliance (WAL) and their AmeriHome Mortgage unit, will also be bidding aggressively for loans in a volume constrained market," he added. "Given the cutthroat competition for conventional loans, just how do advocates of release expect [Fannie and Freddie] to survive?"

Whalen blamed Wall Street brokers for continuing to push the idea that Fannie and Freddie can somehow return to their pre-2008 glory as the quasipublic mortgage guarantor.

"Today the lofty share prices for Fannie Mae and Freddie Mac are a function of the pump-and-dump game played by certain Wall Street firms over more than a decade," he wrote.

"Our view is that the long-suffering shareholders in [Fannie and Freddie] ought to take advantage of these periodic episodes of speculative exuberance" by selling those stocks now, Whalen said.

"That said, if a future Trump Administration disregards the advice of the Treasury and is foolish enough to release the GSEs as they are today," he added, "then we think both enterprises will stand a very good chance of returning back to conservatorship within a year."

-Chris Matthews

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07-22-24 1528ET

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