Markets

The Fannie Mae Trap

Two smart and savvy investment icons fell hard for Fannie and Freddie. What were they thinking?

What causes otherwise smart, even super-intelligent, people to take leave of their senses and do really dumb things?

I wish I knew. I'm blaming the presidential election cycle. It has people worked up into such a partisan frenzy that they are behaving irrationally, and it's spilling over into the investing world. I'll give you two examples of gifted people, whom I respect, burning up their shareholders' money in ways that leave me almost speechless.

Cockroaches

Fund manager Don Yacktman, having emerged triumphant from a terrible investing slump several years ago, remarked to me that "the difference between being stubborn and being principled is being right." So count the legendary Bill Miller as being among the stubborn.

Last summer, it was apparent even to me that any financial institution affiliated with home mortgages was in deep trouble -- and none more so than Fannie Mae and Freddie Mac, the two government-sponsored companies that together own or guarantee $4.5 trillion in mortgages. Every week brought more bad news. They were among the many mortgage-owning financial companies infested with cockroaches this year.

The Cockroach Theory holds that one bit of bad news will be followed by many more bits of bad news, just as one cockroach in your kitchen heralds many others you haven't yet seen. So as mortgage foreclosures consumed the capital of these two institutions like an out-of-control bonfire, Miller's group at Legg Mason revealed on August 15 that the fund had bought 26 million more shares of Freddie Mac, which, at the price Freddie traded at then, were worth some $150 million. In all, Legg Mason owned 79 million shares of the company -- 12% of the total -- worth almost half a billion dollars. In less than a month, after the government threw both Fannie and Freddie into conservatorship, all but $70 million of that investment had been fed to the flames.

Now to the guys and gals at the Dodge & Cox funds, who fell in love with Fannie Mae. Their team-driven approach attracts them to companies that are down but (they hope) not out. Dodge & Cox kept buying Fannie for its funds until they owned, at last word, 120 million shares. Presumably all were thrown onto the bonfire, too, as Fannie's share price plunged from $12 a share on August 1 to a buck recently, thanks to the government takeover.

What is D&C's story? An e-mail to shareholders lamely reported that D&C team members had "met over the last several months with the company's management and industry professionals" and presumably concluded that Fannie Mae was sitting pretty. But like Miller's people at Legg Mason, they did the worst due diligence and risk analysis I've seen in ages. The Dodge & Cox team is both smart and cautious. What were they thinking? Not about cockroaches!

Speculation

The epidemic of mortgage foreclosures and the resulting deterioration of the financial strength of Fannie and Freddie should have made these once-venerable companies suitable only for speculators. Instead, the two stocks ended up stuffing the portfolios of two famously conservative (Dodge & Cox) and savvy (Bill Miller) investment icons, making them look both foolish and feckless.

The one question I would ask now of both is, What have you learned? The answer to that question (presuming it ever comes) could determine whether Legg Mason Opportunity and Dodge & Cox Stock funds remain on the Kiplinger 25 honor roll.

Most Popular

12 Costs of Owning a Cat
how to save money

12 Costs of Owning a Cat

Housecats may be known for their aloofness and low-maintenance attitude, but they're not cheap. Here's what you can expect to spend if you plan on ado…
October 16, 2020
How to Pick the Right Medicare Plans for You
Healthy Living on a Budget

How to Pick the Right Medicare Plans for You

As you're signing up for Medicare, you must learn the basics of Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and even doug…
September 30, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
October 15, 2020

Recommended

Stock Market Today 10/19/20: Investors Lose Their Nerve as Relief Deadline Nears
stocks

Stock Market Today 10/19/20: Investors Lose Their Nerve as Relief Deadline Nears

Retail sales in September improved by more than expected and a consumer sentiment reading improved, providing the market with a tiny lift Friday.
October 19, 2020
Stock Market Today 10/16/20: Cheerful Consumer Data Gives Stocks a Small Bump
stocks

Stock Market Today 10/16/20: Cheerful Consumer Data Gives Stocks a Small Bump

Retail sales in September improved by more than expected and a consumer sentiment reading improved, providing the market with a tiny lift Friday.
October 16, 2020
Stock Market Today 10/15/20: Stocks Slip Again on Dour Jobs Data
stocks

Stock Market Today 10/15/20: Stocks Slip Again on Dour Jobs Data

Worse-than-expected weekly unemployment claims, as well as continued gridlock on COVID stimulus, stymied stocks Thursday.
October 15, 2020
5 Investing Tips to Get Your Wealth Plan on Track
investing

5 Investing Tips to Get Your Wealth Plan on Track

A number of pitfalls have conspired to make this one of the most difficult investing environments in years. Take the reins with these investing tips.
October 15, 2020