Hank Paulson likely has too much self-respect to repeat his assertion that the Treasury won't need to bail out Fannie (FNM) and Freddie (FRE). So it will be interesting to see what he does say when he finally speaks publicly about them again.

The farther FNM and FRE stocks fall, the sooner Paulson will have to act. The companies have now all but forfeited any opportunity they had to raise equity from third parties, and as yesterday's Freddie debt sale showed, even debt buyers are getting nervous. This, in turn, is helping to push up mortgage rates, which is what the Treasury fears most.

Some still speculate that a third-party equity buyer will ride to the rescue, but this is a pipe dream. No private-market buyer would likely invest without an explicit guarantee from the government. And because this guarantee would likely preserve some (not much) value for current shareholders, Paulson is unlikely to provide it. Paulson spent weeks answering the charge that he bailed out Bear Stearns while leaving Mom and Pop to go bankrupt, and the criticism of a similar move at Fannie and Freddie would be intense.

Most analysts speculate that the bailout will take one of two forms:

Investment in preferred equity, which would wipe out current shareholders.



Purchase of debt, with some of Fannie and Freddie's mortage portfolios pledged as collateral.

Those who are still buying FNM and FRE's stocks at this level are presumably banking on the second scenario. They shouldn't: It will likely just delay the inevitable. Buying debt would provide liquidity, but it wouldn't solve the credit problem. And, eventually, unless the economy and housing markets suddenly recover, future losses would likely force the companies to raise equity. Which returns us to bailout option No. 1.

Barring a miracle, FNM and FRE are going to zero. It will be interesting to see how long it takes the market to reflect that.

See Also: Another Nail in the Fannie-Freddie Coffin