Freddie, Fannie Recapitalization Plan Rejected

Recently, Miami-based equity fund manager Fairholme Capital Management LLC’s plan to recapitalize Freddie Mac (FMCC) and Fannie Mae (FNMA) was rejected by the White House. The National Economic Council Director Gene Sperling stated that recapitalization would create two new ‘too big to fail’ financial institutions.

Last week, Fairholme had announced its intention to acquire the insurance businesses of these two Government Sponsored Enterprises (GSEs) – Freddie Mac and Fannie Mae – through exchange of equities worth $52 billion. Fairholme is the largest stakeholder of preferred shares in these two GSEs.

This recapitalization plan would have resolved the uncertainty related to the future of Freddie Mac and Fannie Mae and freed them from government control. However, any proposal to recapitalize these GSEs requires government approval.

Freddie Mac and Fannie Mae, that own or guarantee nearly 67% of all the U.S. residential loans, were on the brink of collapse in 2008. The U.S. government bailed out the companies by taking approximately 80% stakes in both. Though an aggregate of $188 billion of capital was infused in these GSEs, the major part of it has been returned to the government in the form of dividends.

Additionally, if Freddie Mac and Fannie Mae were recapitalized, they would have likely dominated the mortgage market and possessed economies of scale. All these would restrict the entry of new firms in the market.

The government is against such a duopoly and wants to build a stronger mortgage market with scope for healthy competition among firms. Further, the government intends to restructure the entire housing mortgage market through housing finance reforms.

At present, both Freddie Mac and Fannie Mae have a Zacks Rank #3 (Hold). Some better-ranked finance stocks include BankUnited, Inc. (BKU) and Comerica, Inc. (CMA). Both these carry a Zacks Rank #2 (Buy).