Street Capitalist: Event Driven Value Investments

According to the Wall Street Journal the Treasury is going to release the details of the bailout plan for Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) Sunday afternoon. It looks like they want to announce it before Asia commences trading Sunday evening, a bit like they did with the news release about Bear Stearn’s acquisition.

Here is some specific news regarding shares and dividend payments:

The Federal Housing Finance Agency, Fannie and Freddie’s regulator, is to use its legal powers to put the companies under conservatorship. Those powers allow the FHFA to run the companies indefinitely, under certain conditions, such as when the regulator finds that they are likely to be unable to meet their financial obligations. Fannie and Freddie have run up combined losses totaling about $14 billion over the past four quarters and face heavy additional losses amid the worst surge in U.S. home-mortgage foreclosures since the 1930s.

Fannie and Freddie own or guarantee more than $5 trillion of U.S. home mortgages, nearly half of the total outstanding.

Dividends on the companies’ preferred stock are likely to be suspended, people familiar with the plan say, and those on common shares to be eliminated. Any injection of capital by the Treasury would likely greatly reduce or wipe out the value of common shares currently outstanding.

Treasury to Outline Fan-Fred Plan (WSJ)

Just who owns Fannie and Freddie’s debt?

Asian investors were among the most important groups to soothe because central banks, financial institutions and funds in the region own $800 billion of Fannie Mae and Freddie Mac’s $5.2 trillion in debt, according to data compiled by the Treasury. U.S. officials were concerned that sales from the region would push lending rates higher, said the people, who declined to be named because the discussions were confidential…

Freddie and Fannie rely on foreign institutions. Investors and central banks outside the U.S. own about $1.3 trillion of Fannie and Freddie’s corporate and mortgage bonds, according to the Treasury. Chinese institutions are the biggest holders in Asia. European investors own $300 billion of the securities.

“If they stop buying the agency debt, then yields would increase,” Ajay Rajadhyaksha, the head of U.S. fixed-income strategy at Barclays Capital in New York, said in reference to Asia investors. “The costs would get passed to the consumers.”

Fannie’s Mudd Soothed Asian Investors as Yields Rose (Bloomberg)

The US Government’s backing is key here. Without it, we’d likely see the kind of selling that the Bloomberg article describes as a possibility. From the way the plan looks to me, bond holders (our foreign friends) will be completely protected which should keep rates from rising and assuage some fears about our creditworthiness. The WSJ still paints a mixed picture for the equity holders – it does mention however that if the Treasury chooses to recapitalize Fannie and Freddie with a new class of shares, the shares will fall to near $0 while limiting moral hazard and tax payer losses.

Politicians from both sides of the aisle are explicitly talking about using plans that would protect tax payers, so the probability of a scenario like this occurring should be high. All of the language used to describe the plan thus far seems worded to leave no doubt that the government will completely protect bondholders, which makes me believe Fairfax’s credit default swap positions on FNM and FRE will go to 0.

I found this chart at the Los Angeles Times that I thought is nice, it breaks down issues on the economy and provides us with both of the candidate’s views on it. As an investor, some areas of interest to me at least are Obama’s inclination to raise the tax on capital gains. While not necessarily a terrible idea, I would hope that he tries to at least tax areas like green investments less.

The other area I like to watch is the federal budget, I’m a big believer that one of the reasons for the poor performance of the dollar is our ballooning deficit. McCain appears to be a classic fiscal conservative on this end, but his plans seem much less concrete. He just says he’ll reduce earmarks but does not give us any idea on how much. Obama on the other hand at least wants to assure that we have the revenue available for new spending while also cutting earmarks.

Source: McCain and Obama have contrasting economic plans (LA Times)