Alan Jones is the product manager of Locklizard Limited, a digital rights management (DRM) company specializing in document security and copy protection. It operates in the U.S. and overseas and counts Honda, Nike, the NBA, Shell, Cisco and Harvard Law School among its more than 5 million users.
About 15 years ago, Jones suffered a tragic family loss, but the silver lining was a $350,000 inheritance that he hoped to build into wealth for the next generation.
“I was always interested in the stock market, but I never had the courage or the money to invest in it,” he said.
After some deliberation, he took a friend’s advice and put his newfound money in play — but he wasn’t taking wild risks or chasing fast gains. “I did some research online and found stocks that seemed promising,” said Jones. “Fannie Mae and Freddie Mac.”
Read on for the rest of his cautionary tale.
The Federal National Mortgage Association (FNMA), known as Fannie Mae, and the Federal Home Loan Mortgage Corporation (FMCC) or Freddie Mac, were never glamorous stocks. Created by Congress during the Great Depression to provide the mortgage market with liquidity, stability, and affordability, they’ve both been publicly traded for decades.
Jones saw in Fannie Mae and Freddie Mac the stability and permanence he sought in a long-term investment.
“They were two government-sponsored enterprises that provided mortgages to millions of Americans,” he said. “They were considered safe and stable investments with high dividends and low risks. They were also backed by the federal government, which meant they would never fail or default.”
Jones was hardly alone. Many other investors were lulled into a false sense of security by what Forbes called the “implicit guarantee” of government backing that the companies enjoyed.
“Given their importance, most investors in Fannie and Freddie assumed that they were too big to fail,” the publication wrote. “If the companies ever ran into trouble, they assumed the government would bail Freddie and Fannie out. This wasn’t something stated explicitly in any laws or regulations. Nevertheless, this made FNMA and FMCC seem to be less risky investments than many other similar companies.”
But these were not Treasury bonds. These were publicly traded stocks issued by companies chasing shareholder profits.
Fannie and Freddie leveraged the implicit guarantee — which investors like Jones took for granted — to borrow trillions of dollars for less than their competitors and position their bonds as being safer than those issued by similar companies. Their actions inflated the housing bubble of 2005-2007 with unsustainable mortgages that Freddie and Fannie backed — and Jones’s family legacy was along for the ride.
When the housing bubble burst in 2008, Fannie and Freddie were at the center of the storm and the house of cards collapsed too quickly for investors like Jones to sidestep.
In the end, the implicit guarantee was no guarantee at all.
“It turned out that Fannie Mae and Freddie Mac were not as safe and stable as they seemed,” said Jones. “They were actually deeply involved in the subprime mortgage crisis, which was triggered by the collapse of the housing market in 2007. They had bought or guaranteed billions of dollars worth of risky loans that were defaulting at an alarming rate. They were losing money faster than they could make it, and they were on the verge of bankruptcy.”
In the public imagination, the Great Recession began with the collapse of Lehman Brothers on Sept. 15, 2008 — but Jones was already wiped out by then.
On Aug. 10, 2007, Fannie Mae was trading at $66.46 per share. By the end of the year, it had fallen under $35. But the damage was hardly done.
“The stock price of Fannie Mae and Freddie Mac started to plummet and plunge,” said Jones. “They went from $20 and $15 per share to $10 and $5 per share, then to $5 and $2 per share, then to $1 and $0.50 per share. They lost more than 90% of their value in a matter of weeks. I watched in horror as my investment turned into dust.”
On Sept. 12, 2008 — three days before the Lehman Brothers collapse — Fannie Mae was trading at $0.74 per share.
Jones succumbed to classic investor paralysis — no one wants to sell at a loss just before an anticipated recovery. But there would be no recovery for Jones.
“I panicked and sold all my shares at the lowest possible price, hoping to salvage whatever I could,” he said. “I sold 10,000 shares of Fannie Mae at $0.50 per share and 10,000 shares of Freddie Mac at $0.30 per share, for a total return of $8,000. I lost $342,000, which was almost all of my inheritance. I felt devastated and betrayed. I felt like I had been cheated and robbed by the stock market. I felt like I had dishonored my uncle’s memory and wasted his legacy.”
In the wake of the crash, the government absorbed Freddie and Fannie into a conservatorship and pulled its shares from public exchanges. They now trade as penny stocks on the OTC market.
None of that helped Jones, who watched helplessly as a fortune dissolved into a modest emergency fund.
“I learned a hard lesson,” he said. “I learned that the stock market is not a sure thing or a magic bullet. It is a risky and volatile business that requires knowledge, research, skill, and discipline. I learned that there is no such thing as a safe or stable investment.”
He concluded, “There is always a chance of losing money or even going broke. I learned that I should never invest more than I can afford to lose or put all my eggs in one basket. I learned that I should diversify my portfolio, do my due diligence, set my goals and limits, be realistic and rational and follow my instincts. My advice for other investors who want to avoid the same outcome is don’t be greedy or naive, don’t be impulsive or emotional, don’t be influenced by hype or rumors, don’t be afraid to ask for help or advice and don’t give up on your dreams.”
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