Don't Look Now But Fannie and Freddie Have Doubled (FNM, FRE)

August 28, 2008 6:05 PM EDT

After basically being left for dead on a Barron's report that a U.S. Treasury bailout was imminent and shareholder equity would be wiped out, shares of Fannie Mae (NYSE: FNM) has risen six straight sessions and sister GSE Freddie Mac (NYSE: FRE) is up four straight sessions. Both have now more than doubled from their lows. A number of analysts are now predicting the companies can actually survive in their current form.

There were a number of key developments over the past week that has speculators changing their tune - both on the long side and short side.

Here are some key things that happened this week that has helped change sentiment, at least temporarily: The GSEs have had successful note sales, Citi's analyst said shareholder interest can be preserved, Fannie Mae announced a management shake-up, the GSEs are earning their biggest profits on new investments since at least 1998, Lehman said capital and reserves positions are better than market expectations and they may not need to raise more capital. Also, the S&P/Case-Shiller Index for June showed annual declines of 15.9% for the 20-City Composite. However, the report noted that the acceleration in decline was only moderate from May, which showed annual declines of 15.8%.

Is there more upside? I don't know, but I think perception in this current insane market environment is the key. I think Treasury Secratuary Hank Paulson understood this when he quickly developed his 'BAZOOKA' back-up plan for the GSEs. He may have known that this would create major volatility in the common stocks, but was necessary for buyers of the Fannie/Freddie paper. As things calm down, not only could money get cheaper for Fannie/Freddie, but equity markets could actually open up for them again. If it is 'perceived' that all is okay, the GSEs will be able to replenish their capital bases as equity investors step-in. Then if home prices stabilize, the stocks can continue to skyrocket. On the flip side, one or two more quarters of major write-offs without access to non-US govenment capital and the Treasury will have to step-in and put both companies out of their misery.

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• Henry Paulson
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• S&P/Case-Shiller Home Price Index

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