Wall Street’s Dump of Freddie Mac and Fannie Mae Preferred Stocks Cost Investors Billions


The sale of billion of dollars of Fannie Mae and Freddie Mac preferred stock in 2007 and 2008 was accomplished by fraud on unsuspecting public investors and the complicity of mortgage originators that bought the shares knowing they were poison, according to attorney and professor Seth E. Lipner in his July 7th Forbes article entitled “How Fannie And Freddie Unloaded Their Trash.”

Fannie Mae and Freddie Mac were in desperate trouble in late 2007. They were central players in the mortgage securitization business that bundled subprime, Alt-A, adjustable-rate and other doomed residential mortgages into the toxic structured products that imploded and led to the financial crisis.

In the Fall of 2007, the mortgage bubble was bursting into massive foreclosures and bankruptcies of subprime lenders. Two Bear Stearns hedge funds had suddenly and dramatically collapsed under the weight of their structured subprime holdings. Fannie and Freddie were hemorrhaging losses from loan guarantees, derivatives trading, and were fast running out of the capital they needed to avoid being placed into conservatorship by the weak and ineffective government agency that was supposed to oversee them.

In short, Fannie’s and Freddie’s condition was very grave. To hang on, they needed an immediate and very large capital infusion. To accomplish that, they issued almost $18 billion of “noncumulative preferred stock.” (Non-cumulative means that the issuer does not have to make up for unpaid dividends; they do not accrue).

“These firms were being re-capitalized, bailed-out in effect, by the investors who bought these preferred securities,” writes Professor Lipner, who added: “Why would anyone buy the securities of these entities? Why would anyone even sell them?”

The answer to the first question, according the Professor, is a two-part one: (1) Retail investors, many of whom were allowed to remain under a misimpression that Fannie and Freddie were government agencies whose securities were guaranteed by the federal government and therefore safe, were duped by the Wall Street banks that sold the preferred stock without disclosing material facts and risks, and (2) the small and medium-sized banks, which bought the lion’s share of the preferred stock, were mortgage originators that depended on Fannie and Freddie to buy the subprime mortgages they originated, and with some additional pressure from politicians, were incentivized to prop up those entities despite their grave financial condition.

The answer to the second question ? why would Wall Street sell Fannie and Freddie preferred stock under these circumstances ? is much simpler, says Professor Lipner ? it’s the big underwriting fees ? one-third of a billion dollars between November 2007 and June 2008. Lehman and Merrill were lead underwriters of the Fannie offering, with Goldman, Merrill, Bank of America, Bear Stearns, Citi, Deutsche Bank, Morgan Stanley and Wachovia under them. Goldman and Lehman were lead on the Freddie offering, with all of the above-mentioned (except Merrill) under them.

To cash in on the fat underwriting fees, Professor Lipner writes, the Wall Street banks agreed to underwrite the preferred stock as “firm commitments.” In other words, the stock was part of the underwriting firms’ inventories, giving them an incentive to push it on the investing public.

Many ordinary investors who were sold Fannie and Freddie preferred stock have filed arbitration claims to recover their losses.

Attorney J. Boyd Page, senior partner of Page Perry, commented: “While complicit mortgage originators purchased some of the nearly $18 billion of preferred stock of the entities, a lot of it was peddled to individuals and small businesses who believed they were making a solid, conservative income-producing investment. The fact that the Wall Street banks would sell the securities knowing they were time-bombs about to explode is shameful, and should be dealt with harshly.”

Page Perry and Deutsch & Lipner have represented investors in unsuitability and misrepresentation/omission cases against brokerage firms for many years. The firms are actively involved in representing investors with complaints involving Freddie Mac and Fannie Mae investments. For further information, please contact us.