Mortgage Giants Sink To New Lows

Mortgage giants Fannie Mae and Freddie Mac are sinking fast and investors are reeling from their losses. A few days ago I wrote that any rally should be used to short these stocks and even I am surprised at how fast things are unraveling.

An article from BusinessWeek, Fannie and Freddie Resume Their Freefall, explains what is happening with these GSEs:

Fannie and Freddie are trapped in a vicious cycle. The companies will have to raise capital through stock sales, and the multibillion-dollar amounts they have to raise could result in a massive dilution of shareholders' equity. In anticipation, investors have been dumping the shares, driving their prices sharply lower. And the devalued currency of Fannie and Freddie shares means they will have to sell even more shares.

"It appears that stock investors are realizing they will take a back seat to bond holders in the event of any major recapitalization or government injections in the GSEs," wrote Action Economics analysts in a Web site posting July 9."

Are Fannie and Freddie too big to fail? Should investors be buying their shares at these levels? Again, I like the way the article ends off:

With Fannie and Freddie backing an estimated 70% of all U.S. home mortgages, they may indeed be too big to fail—except for their shareholders.

My advice to investors remains the same: stay underweight financials (or avoid them altogether) and don't believe anyone that tells you this credit crisis is over. We are just in the early stages of the longest deflationary episode that we'll experience in our lifetime.