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Meme investors should heed ‘manic’ lesson of Fannie-Freddie collapse


The smart money thinks it’s only a matter of time — weeks, maybe days — before the meme-stock craze finally evaporates. But if history is any guide, this mania hasn’t quite run its course.  

For proof, look no further than the strange, decade-plus-long investment mania over shares of the bailed-out mortgage giants, Fannie Mae and Freddie Mac.

That F&F mania came to an abrupt end Wednesday (for reasons I will describe in a bit), but not before suckering hordes of small investors to mortgage their retirement savings on what are now penny stocks.

It should serve as a lesson to the meme-stock fanatics, though my bet is that it won’t.

Fannie & Freddie would appear to be weird companies for a stock mania to take hold, but then again, so is AMC Theatres, the money-losing, debt-laden movie chain that for some reason has become a darling of the meme-investor movement on Reddit.

Manias work that way: They defy logic. If they last long enough, the suckers listen only to themselves so that no amount of rational discourse can pierce their cult-like investment thesis.

Such was the case of Fannie & Freddie, companies created through acts of Congress. Their goal: To help facilitate housing for the masses. Banks like to avoid making 30-year fixed mortgages (popular among first-time home buyers) because they’re risky, given the vicissitudes of the economy.

That is where Fan & Fred step in: They purchase the mortgages from banks and package them into bonds sold to investors looking for yield.

Seems like a win-win. Banks can now make loans that they wouldn’t normally want to; middle-class people can spread the cost of owning a home over several decades. The government helps facilitate wealth creation for average Americans through homeownership.

Then something strange happened: Congress decided that they should both become public companies, answering to both shareholders who demanded a profit and government housing bureaucrats who wanted everyone to own a home.

The dual purpose of Fan & Fred spelled trouble. The companies were magnets for fraud. They could make money seamlessly for public shareholders because they could borrow at government rates to ­finance their operations.

Once upon a time, investors brought endless hype into Fannie Mae and Freddie Mac until they plunged the housing market into the 2008 financial crisis.
Once upon a time, investors brought endless hype into Fannie Mae and Freddie Mac until they plunged the housing market into the 2008 financial crisis.
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That government support also meant they took outsized risks. Over time, the entities helped spawn the 2008 financial crisis by purchasing mortgages from people with a pulse but maybe no job, leading to massive defaults. Just before Lehman Brothers collapsed, Fan & Fred were about to fall into insolvency, and were taken over by the federal government.

To save Fan & Fred from themselves, taxpayers pumped around $200 billion into the entities. Through 2009 to early 2013, their shares were trading below $1 as the government seized any profits they earned.

Seems like a couple of stocks you might want to stay away from, right? Again, manias defy logic. An absurd investment thesis was born out of the notion that the government ­really didn’t need to take over Fan & Fred — they did so because the big banks wanted their business.

Adding to the mania, at some point not long after the government takeover, Fan & Fred became profitable again, more alleged proof that these were great businesses. A couple of hedge funds and investors including Perry Capital and Fairholme Funds sued the Treasury Department because they argued ongoing conservatorship was illegal and the money the Treasury was taking out of Fan & Fred was thus illegal.

It belongs to the shareholders, they argued for most of the past decade. Overlooked was the little detail that made Fan & Fred profitable throughout their existence: Since they are so-called Government Sponsored Enterprises, they can borrow cheaply at government rates to finance their operations. If they were real public companies borrowing at market rates, those profits would disappear.

But the proverbial mania train had left the station. Fan & Fred developed a cult following on social media (sound familiar?) known as #Fanniegate to underscore the ­Watergate-style alleged corruption of the government takeover. 

Retail investors began to flood into the stock. Shares no longer stalled well below a buck; they began to surge off and on, occasionally trading to around $5 a share on the expectation that miraculously the court cases would prevail, or the Trump administration would return the profits to shareholders as part of broader ­privatization.

Even when the Trump administration signaled that it was not going to do what the shareholders wanted, the cult kept hope alive that the lawsuits, and one before the Supreme Court, would prevail.

Wrong again. On Wednesday, the Supremes ruled as sober-minded investors knew they would: That what the government giveth, it could ­legally take away.

As this column goes to press, shares of Fan & Fred are heading back where they belonged from the beginning: Below a buck. It took 10 years or so to demonstrate that the madness of crowds is a lousy investment thesis.

If history and common sense are any guide, like Fan & Fred the meme mania for GameStop, AMC and others could also continue for some time.

And also with the same disastrous ­results for investors.



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NypTechtek
NypTechtek
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