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FNM/FRE Guarantees; Lehman 'Buy' Rating?!

Regarding Fannie Mae and Freddie Mac:

The most important issue is not the value of the equity holders' stake -- it is essentially zero -- but to ensure that Fannie and Freddie keep operating. Even slight glitches can have ripple effects.

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CNBC Special Report:

- Will Stocks Hit Bottom after Fannie, Freddie?

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That's why the Street had a tough time on Tuesday, when Freddie auctioned $3 billion in new debt on Tuesday, at yields 1.13 percentage points above comparable Treasuries, the highest spread ever for Freddie debt. This implies higher mortgage rates; even modest increases (a half point or so) could cause the U.S. housing market to slip into a further leg down.

Ladenburg Thalmann analyst Richard Bove believes the government must provide an explicit guarantee to provide more funds into the two companies; if not, the markets will not provide the requisite funds.

Another option is a restructuring, with the U.S. having to guarantee the debt of the two companies, but only until a longer term plan is put into place.

Elsewhere:

1) Citigroup joined several other firms in lowering third-quarter estimates for the major brokerages, including Lehman Bros. , Morgan Stanley and Goldman Sachs . "We're lowering our 3Q08 estimates to reflect the difficult operating environment, characterized by lower client-related trading volumes and losses on hard-to-sell assets (primarily mortgage securities)," said a Citigroup note.

But wait, read on -- Citi has a BUY on Lehman and Morgan Stanley:

"MS is extremely well-positioned to benefit when the environment improves and LEH is discounting more erosion in book value than we anticipate. While measures such as selling Neuberger and raising equity may be on the table, we view them as lower probability actions over the next couple of months."

2) While equity holders in Fannie and Freddie may have little left, even bondholders of the two companies are under a little pressure, according to Sandler O'Neill.

Several insurance companies own a significant amount of the two companies' bonds, including Ace and Travelers. Sandler notes that "their stocks have been under pressure as a result of their FNM and FRE bond ownership. As long it appears that the Fannie Mae and Freddie Mac bond holders will be made whole, we would use weakness in these BUY rated stocks as a buying opportunity."


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