Fannie, Freddie rescue plan could be costly for many

August 23, 2008
Fannie, Freddie rescue plan could be costly for many
It may affect scores of companies with preferred shares

(WASHINGTON) A government rescue of Fannie Mae and Freddie Mac could
be costly for scores of investment, banking and insurance companies
that hold billions of dollars in preferred shares in the mortgage
finance giants.

Speculation has been building on Wall Street that a government
investment to rescue Fannie and Freddie would come in the form of a
cash infusion through the acquisition of preferred shares in the
companies.

Preferred shares usually pay a fixed dividend and have priority over
common stock when it comes to dividends and bankruptcy liquidation.
While slightly riskier than bonds, which have the highest priority in
times of trouble, companies often invest in preferred shares for
certain tax advantages.

Investors appear to believe existing common stockholders could be
wiped out if there is a government bailout.

Fannie and Freddie's shares have lost more than 90 per cent of their
value this year.

But what happens to preferred stockholders is less certain.

'That depends on how big Fannie and Freddie blow up,' said Michael
Shedlock, an investment adviser for SitkaPacific Capital Management.

On Wall Street, investors think it could be big. Fannie and Freddie's
existing preferred shares are trading like junk bonds: yielding
around 17 per cent to 19 per cent instead around their 6 per cent
dividend levels. The higher yield is an inducement to investors to
accept the higher level of risk that the companies won't be able to
pay their dividends.

'There's enormous investor concern,' said Bert Ely, a banking
industry consultant.

Fannie Mae has 17 classes of preferred stock, with more than 600
million shares outstanding. Freddie Mac has 24 classes of preferred
stock, with about 460 million shares outstanding.

Congressional analysts estimate a government rescue of the mortgage
giants could cost taxpayers US$25 billion, with the exact amount
based on how far the US housing market falls and how severe their
financial situation turns out to be in the long run.

Another uncertainty is political: The final resolution of Fannie and
Freddie's future is likely to be determined after the Bush
administration leaves office in January. It remains unclear how much
in taxpayer resources the next administration and Congress would be
willing to commit.