Freddie and Fannie Buck Market Trend

In spite of the beating the stock market took on Monday with the Dow Jones down 242 points and even though financial stocks were among the biggest losers, Freddie Mac and Fannie Mae shares came roaring back from their awful performance on Friday.

Roaring back is a relative description as the two stocks, battered and bruised after better than a year of bad news, write-downs, and reduced dividends, moved only fractionally in real dollars but saw significant percentage gains.

Fannie Mae, which opened Monday at $4.54, gained $0.65 to close at $5.19. The stock had lost $1.30 in trading Monday through Thursday of the previous week. Freddie Mac added $0.67 to close at $3.29 on Monday after dropping from 4.39 to 2.81 the previous week. Freddie Mac was up 16.41 percent in early trading on Tuesday and Fannie Mae had gained about 18 percent within one hour of the market opening.

It was surprising to see the sudden surge in confidence in the stocks of the two government sponsored enterprises (GSEs). The price increases followed week after week of speculation that the government would invoke their new powers granted by Congress to bail out, prop up, or perhaps even nationalize the corporations, probably wiping out common stock holders in the process. There were a couple of factors at work.

First of all, Freddie was able to sell $2 billion in debt to investors on Friday. This caused some on Wall Street to rethink the conventional wisdom that a government take-over is inevitable. The offering of short-term debt was well received on Wall Street but Freddie apparently had to sweeten the deal to get investors to bid, and the $2 billion sale actually pales in comparison to an estimated $295 billion in debt that Freddie and Fannie together will have coming due over the remainder of the year.

Jim Cramer said on NBC news Tuesday morning that Wall Street was actually anticipating that Freddie and Fannie would be taken down by regulators over the past weekend. When that didn't happen, investors came flocking to the GSE stocks.

Cramer is advocating that the Treasury Department act quickly to take over the corporations. In his opinion, oil is now priced low enough that the housing market should "fall in line." This, however, won't happen if the inventory of unsold houses continues to increase even as prices go down. That is exactly what happened to the sale of existing homes as reported by the National Association of Realtors (NAR) � on Monday. The NAR reported that the sales of existing homes in July increased at an annual rate of 5 million homes, up 3.41 percent from June. Inventories of unsold homes, however, jumped to the highest level in history with a supply that will require 11.2 months to absorb at the current sales rate. A number of other analysts agree with Cramer that the market cannot sustain a rally until housing recovers.

According to Cramer, the stock market will continue to suffer massive losses on a regular basis until the two entities are nationalized and their debt is formally guaranteed. He says, however, that the two GSEs are so well connected on Capital Hill that Treasury Secretary Henry Paulson is reluctant to take action until after the election.

The election, however, may not serve to grant Cramer his wish.

Democratic presidential candidate Barack Obama, speaking to voters in Iowa did not sound inclined to pull the plug on the two corporations. He said on Monday that the government cannot allow Freddie Mac and Fannie Mae to collapse. He criticized their behavior, saying that they enjoyed profits while the housing market was booming but now expect taxpayers to come to their rescue, but said that their role in the financial system is too crucial to permit them to fail. He advocated instead that regulators look closely at the structure of the two GSEs to see if there might be changes that would mitigate risks to taxpayers.

Reuters quoted the Illinois Senator as telling his audience, "I think long-term what we have to do is, we have to go ahead and make a decision, if these are public entities, then maybe they ought to get out of the profit-making business, and if they're private entities, that we don't bail them out." However, he added, "We're going to have to structure that carefully (how we make that transition) in order that we don't get the housing market even more spooked than it already is."