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A Look at the US Government Bailout of Fannie Mae (FNM) and Freddie Mac (FRE)

This past weekend saw the federal government bail out the mortgage agencies, Fannie Mae (FNM) and Freddie Mac (FRE). These two agencies combined either own or guarantee over $5 TRILLION worth of mortgages.

Why did the government step in? Because they had to! Over the past year, Fannie and Freddie have racked up a combined $14 billion in losses and write-downs. Both agencies, particularly Freddie Mac, were technically insolvent.

Foreign banks of all types, who own billions in Fannie Mae and Freddie Mac bonds, became aware of this. They became worried about getting paid back the value of those bonds when the bonds matured. These foreign banks told the US Treasury that unless something was done, they would immediately stop buying these bonds. That would have had devastating effects on the US mortgage markets.

So the Treasury acted. Both the common and preferred stocks of Fannie and Freddie are now nearly worthless. This has serious consequences for a number of financial companies.

First, many mutual fund companies owned millions of dollars worth of Fannie and Freddie stock. For instance, Bill Miller of the Legg Mason funds owned 12% of Freddie’s stock. Ouch! Other mutual fund companies which are greatly affected include: Fidelity, Dodge & Cox, Alliance Bernstein (AB), Lord Abbott, Citibank (C), and Capital Research.

Fannie Mae and Freddie Mac stocks were also broadly owned by major insurance companies such as AIG (AIG). Also both money center banks such as Bank America (BAC) and regional banks (ETFs would include KRE, IAT, and RKH) owned a lot of Fannie and Freddie stock. This probably means even more write-downs and further strains on the US financial sector.

Any winners from the Fannie and Freddie bailout? Yes – renowned bond fund manager Bill Gross, of the PIMCO Funds. Mr. Gross invested heavily in mortgage bonds issued by Fannie and Freddie. These bonds are made whole by the government bailout. His flagship fund, the Pimco Total Return Fund (PTTCX) reaped a $1.7 billion payday on the day following the bailout.

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