Trading the Fannie-Freddie Bailout

We won’t spend a lot of time gloating about how, yet again, Cramer was right. But for months he’s been calling for Treasury Secretary Henry Paulson to takeover Fannie Mae and Freddie Mac. And that’s just what happened this weekend.

Some key parts of the deal: Washington put the two mortgage companies into a government conservatorship and replaced Fannie CEO Daniel Mudd and Freddie CEO David Moffett. Washington will also purchase the agencies’ mortgage-backed securities, injecting new cash in the mortgage market. But probably most importantly, all of the bad loans hurting Fannie and Freddie now have government backing.

Cramer sees the deal as crucial for three reasons: There will be more money for mortgages at cheaper prices. The rate of foreclosures should slow. And Cramer’s “more certain than ever” that his call on the housing bottom – for the third quarter of 2009 – will be right.

Finally, the house-price depreciation that’s been plaguing the market should come to a halt. Since 2005, double-digit declines in home values have led to mortgages that were worth more than the house to which they were attached. So it made sense for owners to just walk away. Those foreclosures in turn lead to lower home values and still more foreclosures. But with the government now backing up our mortgages, virtually anything – reduced payments, extended terms – can be done to keep people in their homes. Now foreclosures should come down and owners will owe less on their homes.

Mortgage rates on the whole will come down, too. Fannie and Freddie had been keeping rates artificially high, Cramer said, because they were having trouble selling their mortgage-backed paper. Potential buyers didn’t trust it – until the government stepped in. With interest rates down, homes cheaper now than before the boom, the recent housing legislation and 60% decline in homebuilding from two years ago, there’s now incentive for buyers to work their way back into the market.

Now that the bad loans are being taken care of, banks like Wachovia, Bank of America, Wells Fargo and Washington Mutual can find their footing. They’ll finally start to enjoy the profit spread between what they pay you for interest on your savings account and what they charge you for other loans.

Cramer said these developments, in addition to a decline in energy prices, could lead us out of this bear market.

So how do you play it? Cramer recommended his Fortress Four banks: Wells Fargo, Bank of America, US Bancorp and JPMorgan Chase. Plus, he added Wachovia, on the strength of CEO Bob Steel, to make it a Fortress Five. All these banks are in position to go higher now that the Fannie-Freddie problem has been solved.

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