Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.
Every investor would love to own a stock that doesn't have surprises, makes earnings grow every quarter and raises the dividend annually. At least sane investors do. Others go after hope and promises (no profits yet, but coming, we promise) and sleepless nights. This column isn't for them. It's for the ones looking for a stock that doesn't exist.
If there's ever been a final nail put in the coffin of the myth that there's a stock that couldn't possibly fail, it's Fannie Mae and Freddie Mac wielding the hammer. Every respected columnist and pundit wrote glowingly of these two a year ago. How well capitalized they were. How large they were. How they were the engine that made the mortgage market go. And above all else: they had the implied guarantee from the Federal Government behind them AND THAT THEY COULDN'T BE ALLOWED TO FAIL. There was no way they could fail. No way.
Now we know different. They haven't failed, but shareholders have a hard time finding solace in shares selling for 85 cents a share, ones they bought at $35 a share last year. Many people will say: serves them right. They took a risk, and it didn't work out. If these two giants had made money, shareholders would have made money as well. No question. In the stock market, you take a risk for the reward. Sometimes you take it for the loss.
But these two aren't quite the same as other stocks. There was always the implied government guarantee behind everything they did. They were even called Government Sponsored Enterprises, whatever that means. You can see the confusion that comes from the name. After all, if something says Government Sponsored, you would assume that it's, well, government sponsored.
Surprise! It is government sponsored in certain ways but not in every way. It turns out that the federal government did step in to stop the big lenders from going out of business, but it did so in a unique way: it almost, but not quite, wiped out the equity and the preferred shareholders. They suspended dividends on the common and the preferred stocks. In the future, if there are enough earnings, they will be reinstated, the preferred first, then the common.
So equity and preferred shareholders are left holding something that isn't really fish nor fowl. Yes, they still have equity in the company if they own the common stock, but it's almost worthless because the government is going to buy 80% of the common at very low prices. And the preferred holders have an option on a future source of revenues that may or may not happen. So what's that worth? No one knows.
If a GSE (Government Sponsored Enterprise) is allowed to shoot the shareholders, then there is clear evidence that no stock is safe. Most investors already knew this, but some newbies may think differently, may think Enron, MCI, Tyco and even Fannie Mae and Freddie Mac are anomalies, something that their homework wouldn't allow them to invest in. Don't think these are only exceptions. Bad things happen to good companies. Bad things happen to bad companies. There are no safe harbors in the stock market. That's been proven over and over. Never invest in any one stock more than you can afford to lose because you just might. It's the price investors pay for being rewarded when they get it right.
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Federal Reserve Ordered to Release Bail Out Documents
Reader Comments (Page 1 of 1)
9-10-2008 @ 3:59PM
Jason said...
I agree with you about never investing more in any one stock than you can afford to lose. When it comes to Fannie and Freddie, Jim Rogers called this long ago and he's of the opinion that this is still a good time to short some of the financials.
9-14-2008 @ 10:48AM
RAPHAEL said...
ALL THESE MORTGAGE PROBLEMS ARE THE CAUSE OF LURE UNQUALIFIED BUYERS W/1ST 5 YRS OF EXTRA LOW %, AND EASY QUALIFYING DUE TO THE HOUSE PRICE WERE ON THE WAY UP.
9-14-2008 @ 12:53PM
KEN said...
ALL YOU HAVE TO RESPOND TO IS THE POLITICIANS WITH THEIR HANDS OUT AND YOU ARE BAILED OUT WITH A GREAT GOLDEN PARACHUTE..
THANKS REPUKES AND DEMOCRUDS////
9-14-2008 @ 12:53PM
KEN said...
ALL YOU HAVE TO RESPOND TO IS THE POLITICIANS WITH THEIR HANDS OUT AND YOU ARE BAILED OUT WITH A GREAT GOLDEN PARACHUTE..
THANKS REPUKES AND DEMOCRUDS////
9-14-2008 @ 4:00PM
TuffDude said...
Bush says home depot is going down too Cant surive without them hammers and nails build this nation. He is organizing a home improvement rescue plan to bail out home depot. All texas bank account numbers please forward to IRS for bail out
9-14-2008 @ 4:05PM
TuffDude said...
Nothing was implied the bailout is a crime and theft of taxpayer money
9-14-2008 @ 5:36PM
paul s said...
You create wealth in this world by creating something from nothing. You make money in the stock market by buying and then selling stock. The brokers in my building, when I lived in Manhattan, had a bigger apartment, a more expensive car, and a beach house I could only dream of owning. None of them owned any stock!
9-14-2008 @ 7:21PM
JMorrow said...
FNMA and FHLMC had enough capital to survive borrowers that could not make their mortgage payments. However, neither they nor any other bank has enough capitla to survive borrowers that choose not to make their payments. It's a new world with no integrity.
9-14-2008 @ 8:20PM
William Witt said...
All in government are corrupt But there is hope on the way.McCain & Pailn
9-14-2008 @ 10:31PM
richard sullivan said...
To William Witt:
McCain and Palin are corrupt and imperialist war mongers too. They are all about causing pain and suffering, and death and destruction to those people that they perceive are a threat to their agenda. They are the same pig dogs that the Bush Boys are.
9-20-2008 @ 11:37AM
Gumby said...
Fannie and Freddy failed so that the brokers carrying the stocks in "street name" would be off the hook as they wiped clean the liabilities they owes to retail shareholders. This probably saved Merill Lynch as it is sold to Bank of America. Everyone still doesnt understand the critical functions of stock certificates. We thought it was always ok to leave them in street name (clearinghouses like State Street and many others.)
9-15-2008 @ 1:35AM
gumbo koontz said...
Fannie and Freddy failed so that the brokers carrying the stocks in "street name" would be off the hook as they wiped clean the liabilities they owes to retail shareholders. This probably saved Merill Lynch as it is sold to Bank of America. Everyone still doesnt understand the critical functions of stock certificates. We thought it was always ok to leave them in street name (clearinghouses like State Street and many others.)
9-15-2008 @ 9:24AM
henry said...
We bailed out 2 countries that are not true freinds of this country Russia and China.I have supported Bush in the past in every thing but not on these bail out of all of finiacial bailouts.Russia and China goverments hold a lot of failed finiacial paper.It is sad that this country is treating our almost enemies better than there own citizens.