Thoughts on the Fannie and Freddie IPO – The Daily Tearsheet

Vital Statistics:

Stocks are flat despite a hotter-than-expected PPI print. Bonds and MBS are down.

Inflation at the wholesale level rose 0.9% MOM in July, which was much higher than the Street estimate of 0.2%. On a YOY basis, prices rose 3.3%. If you exclude food and energy, the numbers were even worse: a 0.9% MOM jump and a 3.9% YOY increase. The core rate, which excludes food, energy and trade services rose 0.6% MOM and 2.8% YOY.

June’s numbers were unusually low, showing zero monthly inflation, so perhaps the July numbers were exhibiting some “catch up.” Trade services were the big driver, which represents retail and wholesaler margins. Machinery and equipment accounted for 30% of the jump. On the goods side, about of a quarter of the increase came from vegetables.

While some of the increase can be traced to tariffs (the equipment and machinery probably is), it appears a lot of it (hotels, portfolio management, investment advice, trucking) are not. Note this reading is the first with a new methodology which eliminated some 350 categories it used to track. As a result, the numbers are not really comparable to previous readings. So you might want to put an asterisk next to this.

The initial reaction in the bond market is negative, with the 10 year down about 3 basis points since the report came out.

Treasury Secretary Scott Bessent made some comments regarding Fed policy and possible replacements for Jerome Powell when he steps down. When asked about Powell’s replacement, Bessent laid out a laundry list of names including the two Kevins (Warsh and Hassett), along with Michelle Bowman, Laurie Logan and a few other names.

Bessent’s comments on monetary policy urged rate cuts: “If we’d seen those numbers in May, in June, I suspect we could have had rate cuts in June and July. So that tells me that there’s a very good chance of a 50 basis-point rate cut,” in September, Bessent said in an interview on Bloomberg television.

“Rates are too constrictive…We should probably be 150 to 175 basis points lower,” Bessent said, adding to the Trump administration’s penchant for public criticism and detailed policy advice for the independent central bank. While Trump would like to see rates around 1%, Bessent was arguing for a 2 handle on the Fed Funds rate, which is below neutrality (r*).

Next week is the Jackson Hole Summit, and markets will be anticipating a signal that rates are coming down in September. The Fed Funds futures see a cut as a certainty and are pricing in a small chance of a 50 basis point cut. The December futures are starting to price in a small chance of 100 basis points in cuts this year.

The Trump Administration teased the idea of IPO-ing Fannie Mae and Freddie Mac “I am working on TAKING THESE AMAZING COMPANIES PUBLIC, but I want to be clear, the U.S. Government will keep its implicit GUARANTEES, and I will stay strong in my position on overseeing them as President,” Trump added.

Generally speaking the term “taking a company public” means an IPO (initial public offering). If you issue stock for a company that is already trading, it is called a secondary offering.

Fannie Mae trades already on the OTC Bulletin Board Exchange (aka the pink sheets). Freddie Mac does as well. Fannie Mae’s ticker is FNMA and Freddie’s is FMCC. These stocks have been on a tear since Trump got elected, and trade nearly 10 million shares a day. The companies have a market cap of about $12 billion.

So if Trump wants to sell Fannie and Freddie stock to the public, why would he characterize it as “taking these companies public” and not as a secondary offering? That language implies that a new stock is coming, not a sale of additional shares of FNMA or FMCC. So if that is the case, what happens to the older stock that is currently trading? It is helpful to remember how we got here.

During the Great Recession and Financial Crisis, the government took over 80% of Fannie and Freddie and placed them in conservatorship. Why did they take over 80% and not 100%? Because then the government would have had to consolidate all of Fannie and Freddie’s outstanding MBS into the national debt. This would have added trillions of liabilities to the US balance sheet. Instead, it is treated as a contingent liability – a form of off-balance sheet financing. The Fannie and Freddie stock currently trading exists solely as an accounting convenience for the government. The government is entitled to all of Fan and Fred’s profits, and FMCC / FNMA shareholders have no claim to it nor do they have voting rights. This isn’t a normal stock, like owning shares of Apple.

The Obama Administration was adamant that if the GSEs were ever released from conservatorship that the extant shareholders should get nothing. The company was insolvent when it was taken over and under a normal bankruptcy / reorganization the shareholders would have been wiped out. Granted Trump isn’t Obama, but the logic hasn’t changed and the use of the term “taking the companies public” should be taken as an ominous sign.

So if there is an IPO, what would become of the old stock? It probably won’t be fungible with the new stock and won’t be entitled to dividends, a vote, or have a claim on the profits / assets of the company. If the government declares the old stock worthless, it will become a litigation lottery ticket as activist hedge funds sue the government to force them to give the shareholders something. But anyone getting excited about Fan and Fred going public should keep in the back of their minds that the current FNMA and FMCC stock might not participate in the emancipated entity and could be worthless even if Fan and Fred thrive.

Nobody knows what Trump is thinking here, but if this was happening under Biden or Obama the stock would be worthless.