Warren Buffett on Fannie Mae and Freddie Mac

On my previous post, I'm wondering what is the chance of shareholders of common stocks of Fannie Mae and Freddie Mac would suffer permanent loss of capital. With tremendous amount of leverage, worsening economy, deteriorating housing market and diminishing liquidity in credit market, it takes huge courageous to go against the crowds, which Bill Miller, Richard Pzena and David Dreman have been doing.

It would be helpful to hear what Warren Buffett, the greatest investor of all time, has to say.

From CNBC Interview with Becky Quick, Buffett said Freddie and Fannie would have been gone a long time ago if the government hadn't been behind them. He thinks Freddie and Fannie will survive but shareholders could "lose a lot of money".

When asked is Fannie Mae going under? Buffett says in a sense they already have because they wouldn't survive without government backing. "They priced risk wrong."

Take home messages from Warren Buffett...

Rule No 1: Never Lose Money

Rule No 2: Never Forget Rule No 1

Freddie Mac: An Interesting Bet?

Bill Miller has increased his stake in FRE and now owns 12.2% of the company. Besides Bill Miller, other smart managers such as Richard Pzena, Charles Brandes, David Dreman and others are long on FRE.

On the other hand, there are smart people like Bill Ackman, Whitney Tilson and others that short FRE.

Being an amateur investor myself, it is scary to see very smart people on different side of the bet. My knowledge is too shallow to analyze the complex FRE and the severity of housing slump.

However, I have been thinking.....

If Miller, Pzena and Dreman were right, the earning power would be $3 - $5 per share 2 to 3 years out. Using PE of 10, FRE would worth $30 to $50. Let's say $30. At current price of $4, that is a 7.5-fold increase.

If Ackman and Whitney were right, FRE would worth 0.

Assuming 50% chance of 7.5-fold increase and 50% chance of going to 0, the expected value = $15 per share.

With such a high positive expected value of $15, this seems like a potential good bet.....?

What is your thought on the above? Shoot me an email.

P.S. Actually, I think the LONG CASE has higher probability than the SHORT CASE. Combined Miller's, Pzena's and Dreman's ages > combined Ackman's + Whitney's ages. :)

This is only a mental exercise...

DISCLOSURE: No position