"The Big Short" Burry: Cracks appear in the US housing market, still betting on Fannie Mae (FNMA.US) and Freddie Mac (FMCC.US)

According to Zhitong Finance APP, despite the sharp declines in the stock prices of Fannie Mae (FNMA.US) and Freddie Mac (FMCC.US), "The Big Short" Michael Burry continues to hold shares of both companies. He stated that although cracks are starting to appear in the U.S. real estate market, a potential government announcement could trigger a revaluation of these two mortgage giants.

On Tuesday, Fannie Mae fell 9%, marking its worst single-day performance since June; Freddie Mac fell 8%, its biggest single-day drop since May.

PMI adjustment“Not Important”

Burry believes that the decision by the U.S. Federal Housing Finance Agency (FHFA) on Tuesday to align Fannie Mae's private mortgage insurance (PMI) policy with Freddie Mac’s may be a disappointing signal for shareholders.

This adjustment allows loan servicers to proactively contact eligible Fannie Mae borrowers and guide them to cancel PMI after a certain level of home equity has been reached; Freddie Mac had previously allowed this practice. FHFA Director Bill Pulte stated that borrowers can therefore “stop paying for unnecessary insurance and keep the money for themselves.”

However, Burry thinks this relatively mild policy change may signal that larger actions against the two mortgage giants are unlikely to happen in the short term. He said, “I think the announcement to bring Fannie Mae closer to Freddie Mac may send the signal that there won’t be any progress in this saga in the near future.”

Burry agrees that this change is “not important,” but added: “Perhaps there are other things happening that we don’t know about yet.” While he anticipates little progress in the near term and agrees that the next political catalyst may come after the midterm elections, he said he is not considering selling.

Burry warns: Cracks are appearing in the U.S. housing market

Burry issued his warning as the average top-tier 30-year fixed interest rate in the U.S. reached 7.22% on Tuesday. Existing home sales in August dropped 2%, hitting a 14-month low; however, median prices still rose 1.6% year-over-year. For the new housing market, the median price in July dropped 0.9% year-over-year to $393,800, the lowest since July 2021.

“I think we’re starting to see some issues in the housing market. Home prices may have already started to fall,” Burry said. “But I don’t believe the housing market will trigger a second global financial crisis.” He warned that further rate hikes could break the “mortgage rate lock-in effect,” which has kept many homeowners from moving.

“Rising rates may cause homeowners to act in all sorts of surprising ways, such as refinancing before rates go higher, or selling their homes before rates rise further,” he added. A Nashville real estate agent pointed out that in August, there were about 5,400 homes for sale, while about 820 homes were sold, and around 900 were under contract. Burry said he was “shocked” by the excess housing supply in Nashville, calling it possibly the highest on record for the city.

Airbnb (ABNB.US) CEO Brian Chesky on Tuesday night highlighted the broader issue of U.S. housing shortages, announcing a $250 million housing initiative and noting that the U.S. needs more than 5 million additional homes.

It’s worth noting that the Federal Reserve will announce its rate decision on Wednesday local time, and any signals regarding future rate paths could further affect mortgage affordability and housing activity. The current market expectation for a 25 basis-point rate hike is already above 94%.

Why isn’t Burry selling? Awaiting a government announcement that could change everything

Burry said he considered adding to his positions in Fannie Mae and Freddie Mac on Tuesday but ultimately decided to wait. “The current situation may be influenced by factors we don’t know about,” he said. “The charts look ugly, and I think momentum traders have to exit first before the stock can stabilize.”

But he does not plan to sell. Burry noted that trying to sell out and buy back carries the risk of missing out on a government decision that could transform the investment. “There is a powerful psychological bias that makes you not want to be too lightly positioned in these stocks, because an announcement that could change everything might come at any time,” he said. “I’ve been holding continuously, just increased my positions slightly this fall.”

Key risks looming over Fannie Mae and Freddie Mac

Since September 2008, Fannie Mae and Freddie Mac have been operating under U.S. government oversight. The U.S. Treasury holds senior preferred shares, which have priority claims over subordinate preferred and common shareholders, and also holds warrants to purchase 79.9% of each company’s stock at nominal prices.

These senior preferred shares’ liquidation claims (recently valued at $350 billion) are the main concern for shareholders. Unless those claims are reduced, canceled, or converted under favorable terms, the value for common shareholders could be significantly diluted. When asked if the stock could fall to all-time lows, Burry replied: “If senior preferred share liquidation claims aren’t reduced or canceled, then yes.”

In March this year, Burry estimated that if a compromise were reached allowing the U.S. Treasury to retain about 25% of the claims, Fannie Mae’s stock could be around $15 and Freddie Mac could be in the high teens to just over $20. In July, he said a more favorable resolution could initially boost common share prices by three to four times, and in the long term, by six to seven times, with the effects of dilution from the warrants already factored in.

On Stocktwits, retail investors are “bullish” on Fannie Mae but “neutral” on Freddie Mac. By contrast, Tipranks data shows that Wall Street analysts overall rate Fannie Mae a “Hold” with an average target price of $7.65 and Freddie Mac a “Moderate Buy” with an average target price of $9.17.

Year-to-date, Fannie Mae and Freddie Mac are down 53% and 55%, respectively.