Buffett’s Lesson of Fannie Mae & Freddie Mac

Billionaire investor Warren Buffett had some very pointed words for shareholders of Freddie Mac and Fannie Mae at the annual Berkshire Hathaway shareholder meeting that took place earlier this month.

This is not Buffett’s typical style. He often refrains from naming any names, but on the topic of preferred stock, he did not have any filter whatsoever: “Noncumulative has certain defects, and preferred holders of Freddie Mac and Fannie Mae are finding that out. They are a terribly weak form of security.”

What Is the Terrible Weakness?

The preferred shareholders will ordinarily receive preferential treatment, which is the reason for the name. Preferred shareholders of the stock are typically supposed to get their dividends first, before the common shareholders have the ability to stake their claim.

Cumulative preferred shareholders should even have a better advantage over noncumulative preferred shareholders. If in any given year dividends are skipped, they are supposed to be preferred at a later date once the company is capable of paying a dividend. Freddie and Fannie preferred shares are noncumulative, although, and every one of the dividends that should have been paid since September 7, 2008 are lost forever.

In 2009, dividends started soaring when all preferred dividends were then redirected to the United States treasury.

If Freddie Mac and Fannie Mae are eventually returned to public owners, then once again, preferred shareholders could then collect a dividend. But they won’t collect any of the dividends that were skipped previously.

Why Does This Matter?

As the battle continues to brew over who should legally own Freddie and Fannie, normal preferred dividend days for distribution continue to pass. The amounts are significantly growing each day. In a few months time, the preferred shareholders will have spent the last six years waiting for any dividend at all.

There’s no question that Freddie Mac and Fannie Mae shareholders would ultimately make huge returns if the government were to release them into private hands, and shares ultimately trade back to where they were, but there’s no doubt of the fact that dividends in arrears are not ever going to come about.

If there’s one thing to learn from Freddie Mac and Fannie Mae, it’s that cumulative preferred shares and noncumulative preferred shares do have their commonalities, but the differences truly count when it really matters.

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