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Avoid Fannie, Freddie & AIG
Shares of AIG, Fannie Mae, and Freddie Mac
are trading at a fraction of their former highs. Also, according to
Yahoo, AIG
is paying a 25% dividend yield. Should I buy
these stocks?
That is the most common question I’ve heard
from readers in recent days. In a nutshell, my answer is no. Here’s why,
starting with AIG.
AIG
American International Group, the U.S.’ largest insurance company, tripped
up when it insured billions worth of mortgage loans against default. That
type of insurance would have logically been termed “credit default
insurance.” However, to avoid scrutiny by insurance regulators, the
issuers substituted the term “swaps” for “insurance.” Hence the
indecipherable term “credit default swaps” that we hear bandied about on
the news everyday. Having that insurance allowed the mortgage securities
to be rated investment quality by bond raters. Unfortunately, those
insured mortgages defaulted in droves, and AIG suffered huge losses,
draining its cash reserves, and by mid-September, AIG faced bankruptcy.
On September 16, the Federal Reserve, fearing
that an AIG bankruptcy would do serious damage to the global financial
system, stepped in and gave AIG an $85 billion revolving credit facility
for two years. The idea was that during that time AIG would raise enough
money from selling assets to pay back the loan.
Help Didn't Come Cheap
But the Fed’s help didn’t come cheap. For starters, the U.S.
government received warrants (options) allowing it to assume an 80% equity
stake in AIG. If the government exercises those options, the current
shares outstanding would only represent a 20% ownership position.
But that wasn’t all. AIG had to pay a
2% commitment fee and annual interest amounting
to around 12%. Then, last week, evidently realizing that the original $85
billion wasn’t enough, the Fed granted AIG another $38 billion loan.
Risky Business
Here’s why I think buying AIG shares is risky business. For
starters, as part of the rescue deal, the Fed required AIG to stop paying
dividends on its common stock. So why does Yahoo say AIG is paying a 25%
yield?
The dividend yield shown on most sites
assumes that a firm will continue paying its last declared dividend, even
if that was month’s ago. It takes a long time for the database keepers to
get the word that a firm has eliminated its payout.
Dividend Data Wrong
For an example, look up MoneyGram International (MGI).
I checked three major financial sites and all showed MoneyGram paying
quarterly dividends equating to a 14% dividend yield. In fact, MoneyGram
hasn’t paid a dividend since January, and has said it doesn’t intend to
pay any more this year.
Dividends aside, by the time it finishes
selling assets to pay off the Feds, AIG will be a much smaller company.
Considering that existing shareholders will probably only hold 20% of
what’s left, AIG is, at best, a very speculative play.
Fannie & Freddie
Fannie Mae and Freddie Mac,
although originally formed by the U.S. government, were public
corporations that were in the business of buying mortgages from banks and
other originators and then reselling them to investors. When they sold
them, Freddie and Fannie guaranteed the payments.
Similar to the scenario for AIG, Fannie and
Freddie suffered big losses when the mortgages defaulted, and both faced
bankruptcy. The U.S. government stepped in, and essentially took over both
Fannie and Freddie on September 7. As it did later with AIG, the
government received warrants representing an 80% stake in each. Also, as
it did with AIG, the government ruled out paying dividends.
The government assumed a conservatorship
position. In theory, it would stabilize Fannie and Freddie and return them
to normal operations. However, in reality, Treasury Secretary Paulson and
many politicians believe that both firms were much too big. Thus, it’s
unlikely that either would return to anything resembling their former
size. Also, whatever form they do take, the U.S. government would own 80%.
Bargains Abound
Almost all stocks have
been beaten down by the relentless market selloff, so there are many
bargains out there. Thus, there is no point going with risky bets like
AIG, Fannie Mae and Freddie Mac. The time to start buying is when it
becomes evident that the credit market is stabilizing. You’ll know that is
happening when you stop hearing about governments and other large
organizations rushing in to stabilize faltering banks.
published 10/12/08 |
