Why AIG and Citigroup Investors are Doing Better Than the Shareholders of Fannie and Freddie
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When the housing bubble burst in 2008, the Wall Street Titans went to the federal government for everything from maintaining capital ratios to avoiding imminent bankruptcy. A core part of many of their portfolios had simply fallen apart and the market took notice by hammering their stock values. In a scene of panic, the government stepped in but even that did not stop the falling prices. Citigroup (NYSE: C) shares fell below ten dollars split adjusted and even insurance giant American International Group (NYSE: AIG) fell to less than $8 per share even after factoring in the 1 for 20 reverse split which occured later. As the market began to recover, shareholders of the Wall Street Titans can look back and say at least one thing: their primary investments were not in shares of Fannie Mae or Freddie Mac.
The Flexible and Non-Flexible Terms
During the bailout of AIG, the interest charged on the credit facility established for the company was the three month LIBOR plus 8.5 percent. It was quite a high interest rate but AIG really had no other options if it wanted to remain solvent. AIG accepted the terms of the $85 billion credit facility, but the rate was later changed to the three month LIBOR plus 3 percent. The change in the interest rate was money in the bank for AIG. Since then, the government's preferred stock in AIG has been converted to common shares and AIG is reaching the point where it will again be largely in private hands.
The story of the Citigroup bailout is more similar to that of AIG than the ongoing conservatorship of Fannie and Freddie. Through a series of multi-billion dollar loans, the federal government came to own billions in Citigroup preferred stock which payed a dividend of around 8 percent. Citigroup shareholders became victims of dilution when the preferred stake was converted to 7.7 billion common shares. The stock fell 40 percent that day. Before the 1 for 10 reverse split there were enough Citigroup shares outstanding for every person in the world to have four. But what separates Citigroup from Fannie and Freddie is that Citigroup is now free from government ownership and its future remains far less in doubt. While Citigroup shareholders from before the crash did get burned, the damage was more than ten times less severe than what Fannie and Freddie shareholders saw.
The story of the bailouts of Fannie and Freddie are much different from the turnaround story of AIG. Like AIG, the government took a 79.9 percent equity stake in the firms. (The size of the equity stake is not a coincidence. According to the New York Times, federal officials thought that surpassing the 80 percent level would put the company on the federal balance sheet but have since changed their position as they now consider the bailouts to be emergency measures.) But the interest rate on Fannie's and Freddie's preferred stock issued to the Treasury did not change and remained at 10 percent, much higher than AIG's rate. Since the two GSEs are taking longer to get their houses back in order, the government's equity stake continues to remain a controlling 79.9 percent.
From Treadmill to Takeover
As the mortgage giants Fannie and Freddie continued to lose money they would draw funds from the Treasury to make up the shortfall. Of course the Treasury charged interest on these funds. When the GSEs actually began to become profitable again the huge dividends owed to the Treasury caused them to post losses and in turn, draw more Treasury funds.
In August 2012 it was announced that the Treasury would end the required dividend payment but with an important side note. Fannie's and Freddie's profits would be scooped up by the Treasury automatically. This further tightened the Treasury's grip over the GSEs and has been yet another message to common shareholders that they do not matter. As if taking the company's profits every quarter was not enough, additional demands were made to have the GSEs shrink their portfolios even faster than previously planned.
A "Safe" Investment Turned Speculative
Most of the big banks and Wall Street trading firms were considered to be fairly safe investments prior to the downturn due to their massive size and track record of earnings. There were of course contrarians who predicted the collapse but they were largely the minority of investors. However one of the safest investments was considered to be GSEs Fannie Mae and Freddie Mac because of their implied government backing. Regional banks were even told to buy the GSE's preferred stock in a way that implied it was a stable investment with a solid dividend. In the end, the government did back the stability of the companies in the face of collapse but not their shareholders' interests. Instead shareholders have been left in limbo with a huge dividend to pay and then moved to another limbo with all profits taken.
Privately Held Citigroup vs. Soon to Be Private AIG vs. Virtually Nationalized GSEs
When AIG and Citigroup were bailed out they were given much more favorable terms than the GSEs, terms that helped them to recover to where the companies are today. But the companies were meant to be only temporarily government owned and were still supposed to end up as private institutions. As GSEs, Fannie and Freddie remain in limbo until a decision is made to determine the value shareholders will realize. Neither AIG nor Citigroup are close to blue chip territory, but Citigroup is no longer government controlled and AIG is getting stronger and could soon exit majority government ownership. By contrast, the GSEs' futures remain uncertain making them highly speculative at this time. Both investments have a chance of making profits for their shareholders; just AIG and Citigroup have a better developing track record of doing so.
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