Fannie Mae and Freddie Mac have provided a painful lesson for investors in all financial stocks: During a crisis, take everything a firm says with a shaker-full of salt.It shouldn't be surprising that executives will try to accentuate the positive, or at least play down the negative, given that financial firms live or die by retaining market confidence. How many times, after all, have financial firms said they have enough capital, only to turn around and raise more? Or said that the dividend is safe, just before cutting it.
Fannie and Freddie showed how high the stakes can be. And confidence is again center stage, with shares in firms like Lehman and Washington Mutual plunging Tuesday.
To defend themselves, investors should focus on the financial results a firm files with regulators according to generally accepted accounting principles, while giving far less credence to the non-GAAP measures firms often highlight.
The same caution should be applied to regulatory measures of financial strength. Those were, after all, what Fannie and Freddie pointed to for months in a bid to reassure investors that they were adequately capitalized.
Investors also should be on guard when it comes to measures of banking strength, such as Tier 1 capital, given that these involve a degree of management judgment. And, most important, investors should stick with management that acts, rather than talks.
By: David Reilly
Wall Street Journal; September 10, 2008
