Be Wary of Buying When Shares Tank

By Michelle Singletary
Sunday, September 14, 2008

If you're thinking the stocks of Fannie Mae and Freddie Mac are bargains that may regain their highs of the glory days -- be very careful. You may not win this bet.

I've seen it before, the stock of a troubled but venerable public company that once traded for good money drops to penny stock territory. Investors, gambling that the shares will rise from the ashes like the mythical Phoenix, go on a buying binge.

But for the average individual investor, this is a place where only the well-heeled or experienced should go.

Fannie Mae and Freddie Mac were taken over by the federal government Sept. 7 in an effort to rescue the companies from further financial disaster. The two companies were chartered by the government to help increase homeownership in this country by buying mortgage loans.

The entities were also publicly traded companies that sold shares of common stock. In the past year, the stock has suffered significantly. Fannie Mae's stock declined from a 52-week high of $68.60 to a close of just 73 cents on Sept. 8, the day after the Treasury Department announced the takeover. Freddie Mac went from a 52-week high of $65.88 to 88 cents.

What many common shareholders fail to realize is that as the owners of a company, they are last in line for claims on assets. So if the company enters bankruptcy protection or conservatorship, as Fannie Mae and Freddie Mac have, there's a good chance your shares will become worthless.

"One would be speculating if they were to buy the stock now in hopes that it would increase in value," said Fred Joseph, Colorado securities commissioner and the president-elect of the North American Securities Administrators Association, which represents state securities regulators.

Fannie Mae and Freddie Mac are not under bankruptcy protection. I just want to make that clear. Instead, the companies are under conservatorship, which is the legal process in which a person or entity is appointed to establish control and oversight of a company to put it in a sound and solvent condition.

In this case, the newly formed Federal Housing Finance Agency (FHFA) has been appointed as conservator of the two companies.

Here's where it gets interesting, if you own or are thinking about buying the stock. As part of the takeover, the Treasury and FHFA have established "preferred stock purchase agreements." These instruments essentially put the government in a preferred position. The action was taken to ensure that each company maintains a positive net worth, said James Lockhart, director of the new independent regulator.

The agreements were also necessary to provide security and clarity to debt holders -- senior and subordinated, Lockhart said.

"Under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares," he said.

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