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For Short Sellers, It Doesn’t Get Much Better

Blood is in the water, and short sellers, often viewed as the sharks of Wall Street, are circling.

As shareholders of Fannie Mae and Freddie Mac watched their investments plunge in value Thursday, short sellers, who bet against stocks, could count their winnings.

Considered smart money by some, short sellers have wagered against Fannie and Freddie in growing numbers as the mortgage crisis has worsened. Many of them have profited handsomely as the companies’ shares have tumbled roughly 70 percent this year.

On June 13, with Fannie Mae trading at $24, investors had a cumulative short position of 140 million of the company’s shares, representing an increase of more than threefold since last August. For Freddie Mac , at $23 a share, short interest was 77 million shares in June, up from 17 million shares the previous summer. On Thursday, Freddie’s stock closed at $8.11 a share, and Fannie at $13.36.

This extensive destruction of shareholder value and the profits made by those who saw it coming has again brought scrutiny to short sellers, who borrow shares and sell them, hoping to buy them back later at a lower price and profit from the difference.

Not surprisingly, most the big players are not talking.

No comment, wrote James Chanos, a widely known short seller, in an e-mail when asked if he was shorting Fannie and Freddie.

Ditto for David Einhorn. The normally talkative hedge fund executive who made headlines and money on his successful bet that Lehman Brothers stock would fall, also declined to comment, said a spokesman.

In a climate where members of Congress rail against short sellers, and chief executives like James Dimon of JPMorgan Chase say that those who start and pass on rumors should go to jail, it is not surprising that hedge fund executives are choosing to remain silent.

One prominent hedge fund executive, who declined to be identified for these reasons, said that he had shorted Fannie Mae and Freddie Mac in the past and might do so again. The reason, he said, was simple: Together, Fannie Mae and Freddie Mac own or guarantee about $5.2 trillion of mortgages and have but a sliver of equity to support their stretched balance sheets.

And as the Bear Stearns government intervention made clear, any public rescue, if one came at all, would come at a very low price for shareholders.

That a weakening housing market might hurt the two companies, which hold or back about half of the country’s mortgages, might seem obvious now. But as recently as last October, with the housing crisis in full swing, Fannie and Freddie were trading at $60, backed by respected mutual fund managers like William Miller of Legg Mason (Freddie) and Capital Research (Fannie and Freddie).

One longtime skeptic who has had a short position and is willing to talk about it is Douglas Noland, a portfolio manager at the Prudent Bear Funds, a company run by David Tice, a bear market investor.

Since the late 1990s, Mr. Noland has been publishing research and telling anyone who might listen that Freddie and Fannie would suffer greatly when the United States credit bubble eventually burst. It was a prescient call that might be cause for celebration, but Mr. Noland says he has felt no such joy.

“I am sickened by this,” he said by telephone from his Dallas office as he watched the stocks of Fannie and Freddie plunge 12.7 percent and 21 percent, respectively, on Thursday. “I had the same sick feeling after September 11. These companies are at the heart of the United States financial system of dollar based securities. Millions of people will suffer.”

Mr. Noland argues the standard refrain of the short seller. Fannie and Freddie, even more so than Bear Stearns, are dependent on the confidence of the marketplace and immediate access to short term credit markets in order to support its mountain of debt. “I just don’t see how they can grow if the market is losing confidence,” he said.

He describes the research he has written over the years as an effort to educate people, although it could be said that his bear market musings also served his fund’s purpose by spreading a view that would eventually benefit the Tice funds. “It’s a terrible thing,” he said. “I wish we could have stopped this from happening.”