WALL STREET – Shares in Fannie Mae and Freddie Mac rallied yesterday, after securities regulators tried to rein in short sellers who had driven down shares in the two secondary mortgage market companies to all-time lows.
Fannie shares surged almost 31% on the day, to close at $9.25, while Freddie shares also rose 30% to a $6.83 share. Shares in the two companies have fallen more than 70% since the start of the year as investors are speculating on the need for a government bailout.
Yesterday’s gains, after the Securities and Exchange Commission passed an emergency rule to ban naked short sales, erased billions of dollars of gains by speculators betting on the fall of the companies’ shares, but it may be a temporary respite as Congress begins debate on proposals to shore up the two troubled mortgage giants.
Those proposals make it clear the government will be there to guarantee Fannie and Freddie bondholders, a good sign for credit unions, which hold tens of billions of dollars in debt issued by the two government sponsored enterprises. But the battering of the shares seems to put stockholders on the line in any bailout. “If anybody needs to be concerned, it’s the equity holders,” said Steve Brewer, chief financial officer for Michigan Schools & Government CU.
The SEC issued the rule on naked short-selling – the selling of shares an entity does not own – to curb the speculative pressure on financial stocks that has bewitched the market for financial shares over the past few weeks.
The SEC has subpoenaed as many as 50 prominent hedge funds and investment banks, demanding information on e-mails and trading records to determine whether rumor-mongering contributed to the fall of Bear Stearns and the recent rout of Lehman Brothers’ shares.
Meantime, the emergency order on naked short-selling is designed largely to protect Freddie Mac and Fannie Mae from the same practice the SEC is investigating.
Fannie and Freddie shares each sunk nearly 30% on Monday as word of a government bailout fueled short-selling in the two issues. The rout accelerated after hedge fund manager William Ackman, who said he is short both Fannie and Freddie, issued his own plan to restructure the two mortgage companies.
Short sellers make money by borrowing stock at a high price, then returning it at a low price, and pocketing the difference. This process creates a financial incentive for a person shorting a company's stock to spread damaging information about that company. If a short seller spreads information he or she knows is false, he has broken the law. The SEC is investigating whether this took place at Lehman Brothers and Bear Stearns.
Congress has indicated it will be at least week until it is able to debate Bush administration proposals to backstop the two companies. The resolution of these initiatives may not be until the middle of next month.
The proposals would replace the implied government guarantee of Fannie and Freddie debt with an explicit guarantee by extending the guaranteed line of credit for each to as much as $300 billion and authorizing the federal government to buy stock in one of the two to stem a liquidity crisis.
“There’s no way it’s going anywhere this week,” John Magill, chief lobbyist for CUNA, said yesterday.
