Powerball Investing: Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corp (FMCC)

Of course, this can only happen if the Sweep amendment is repealed, and Congress wouldn’t want to give up a cash cow. That is why legal action is necessary if the Sweep amendment is to be repealed and the GSEs freed from government ownership. The lawsuits have already been filed with such plaintiffs as Perry Capital and Bruce Berkowitz, the manager of the Fairholme Fund with large stakes in many financial institutions.

By going long on Fannie Mae or Freddie Mac (preferred or common), investors are buying warrants on the results of these lawsuits. The strike price: the cost of the Fannie/Freddie shares. The expiration: when the lawsuits are finished. But there is another factor at play. Congress could pass legislation to wind down Fannie and Freddie before the lawsuits are finished. If this is done, getting value for shareholders will become a lot more difficult — but not impossible. A court could conceivably order the government to retroactively compensate Fannie and Freddie shareholders even after the GSEs have been dissolved. It’s less likely but, again, not impossible.

GSE Powerball
The trading of Fannie and Freddie shares is Wall Street speculation at its finest. A double-digit percentage swing on a no-news day is commonplace among these securities, with actual news causing sharp pops or drops. Despite being an example of speculation, Fannie and Freddie shares are a multi-year investment as we wait for court rulings on the legal cases at hand. Shares of the GSEs could very well wind up worthless, or they could yield more than 20-bagger returns. The potential for massive gains or complete losses? Sounds just like a lottery ticket.

The article Powerball Investing: Fannie and Freddie originally appeared on Fool.com is written by Alexander MacLennan.

Alexander MacLennan owns common shares of Freddie Mac. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: long January 2014 $25 calls on American International Group.

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