The inevitable happens

The inevitable happens... The villain of Fannie Mae... Another Harvard man... What to buy now... The most respected company in America... Vulture investors gather... Why we mislead our subscribers...

It's probably the most famous thing I've ever written:

Fannie Mae and Freddie Mac, the two largest and most leveraged owners of U.S. mortgages are sure to go bankrupt in the next 12 months. Congress may decide to assume their liabilities, to prevent an unprecedented global financial calamity, but Congress won't bail out the firms' shareholders... I have so much confidence in this trade, unlike most short sell positions that I recommend you buy to cover after you're up 50%, I recommend you hold these positions until the shares literally no longer trade. Fannie Mae (NYSE: FNM, $27.59) and Freddie Mac (NYSE: FRE, $25.29) are going to zero. – PSIA, June 2008

Days after this appeared in my newsletter, Alan Abelson, the legendary financial editor of Barron's, endorsed my work and re-published parts of it on the front page of his magazine. Thank God I was right. Fannie and Freddie will be de-listed shortly, as the government bailout makes it impossible for the two companies to raise additional

capital. Both the common stock and most of the preferred shares will be wiped out.

Guess who won't be wiped out? The CEOs. Fannie's Daniel Mudd will get $9.3 million and Freddie's Richard Syron will take home $14.1 million. While I don't think these guys deserve anything, the real villain of this story is Franklin Delano Raines, a key leader of Fannie Mae in the 1990s – and "the first black man to head a Fortune 500 company." Raines made a fortune ($20 million in 2003 alone) by leveraging Fannie Mae to the hilt, a move that ensured its destruction if home prices ever fell. He also orchestrated an accounting fraud for which he was later fired. While Fannie was forced to pay a record $400 million fine for the scandal, Raines walked away with an SEC settlement that cost him nothing.

You'll never guess where Franklin Raines went to college... Harvard and Harvard Law School. He was also a Rhodes Scholar. As long-time readers know, we believe the worst thing that can happen to a public company is to have a Harvard man at the helm.

Last Wednesday, Sjuggerud told DailyWealth readers the one stock to buy when the government bails out Fannie and Freddie. This company exclusively owns bonds guaranteed by government-sponsored entities (like Fannie and Freddie). It pays out the majority of its earnings in dividends, and it's raised its dividend every quarter in the midst of the financial crisis. To read Steve's DailyWealth essay, click here...

"America's more communist than China." While he didn't give any stock picks, the always entertaining Jim Rogers did chime in on the government's bailout of Fannie and Freddie on European television this morning. Rogers said the government's actions are "welfare for the rich, socialism for the rich." It's "bailing out the financiers, the banks, the Wall Streeters. It's not bailing out the homeowners that are in trouble."

Rogers is right. The top 10 institutional owners control more than half the stock in each company.

We wrote it, did you buy it?

The company's brands dominate every pharmacy in the world: Tylenol, Motrin, Pepcid, Band-Aid, Neutrogena, and Johnson's Baby Powder... Branding, marketing, and distributing medicines, medical devices, and health-care products is one of the best businesses in the world – and J&J is the best at it. That's why its operating margins are consistently above 25%. And its return on equity is close to 30%... The investment case for J&J is easy to make. You're buying one of the world's best companies for peanuts. – PSIA, July 2006

PSIA pick Johnson & Johnson (JNJ) was voted the most respected company in America in a recent Barron's survey. The company won for its excellent management, a culture that focuses on long-term objectives, and generating shareholder value. One respondent in the survey said the company is "one of the best-run companies anywhere." And the stellar management is paying off. Shares of Johnson & Johnson are up 12% this year, beating the S&P 500 by 20 points. Readers are up more than 25% on the pick.

Johnson & Johnson is a perfect example of a Berkshire Hathaway stock (and Berkshire is a major holder). It's a world-dominating business you can buy at a fair price that mints cash. As Charlie Munger, Buffett's partner at Berkshire, said in a recent interview, "[I]f you buy a few great companies, then you can sit on your ass. That's a good thing."

Institutional investors have amassed hundreds of billions of dollars earmarked to buy the wreckage from the credit crisis. And when the institutions start buying, we'll see a huge run-up in share prices. Texas-based private equity firm TPG raised $30 billion in new funds this year to buy everything from Asian assets to distressed banks. And hedge-fund wunderkind John Paulson told investors he is ready to consider buying distressed financial assets. Paulson is launching his new Recovery fund on October 1 – investors in Paulson's two existing funds made 590% and 352%, respectively, last year. Paulson is still bearish on the economy. He expects losses to total $1.3 trillion. Widespread buying in the distressed sector is some time off, but there will be one-off opportunities.

Paulson's not buying yet, but insiders are. Bank insiders spent more money buying shares of their own companies this May, June, and July than in any previous three months in at least 20 years. They're clearly calling the bottom in financials. Insiders, including directors and executives, bought $296.2 million in the period.

Inside Strategist editor Brian Heyliger has already picked his favorite bank and will make a formal recommendation later this week. These shares have been hammered, and they're set for a huge rally. Subscribers will receive the issue on Wednesday. If you're not currently signed up for Inside Strategist, today is the last day to receive a huge discount. The deadline is midnight. To learn more, click here...

New highs: none.

Why do we mislead our readers? Why are we such ignorant dupes? We tackle your questions below and pass along the fitness tips we received over the weekend. Send your e-mail to: feedback@stansberryresearch.com.

"As you very well know, Sequoia Fund's Ruane has been dead for a while. And SEQUX has never been the same. Why do you mislead your readers. Or is it ignorance?" – Paid-up subscriber A.

Porter comment: Sorry to disappoint you, but we've commented on Ruane's death several times, most recently when we first advised our readers that his fund was re-opening for the first time since 1982.

As for why we "mislead" our readers, we keep hoping that all of our readers will realize we're complete frauds, ask for a refund, and refuse to do business with us anymore. Our business could implode like Enron or Fannie Mae. I could sure use a $14 million severance package. Too bad my partners would only laugh at me and send me to the unemployment office, along with the rest of the staff. More sincerely, we simply disagree with your opinion of the fund.

"Is it reasonable to ride a bike to/from the Stansberry office for you? It's a several-mile trip for me, & my company has a moderate-size workout room in its basement w/ locker rooms. I've ridden ~ 180mi since April, (not every day – couple times / wk), & I love it... less caffeine 'to wake up' in the morning but far better sleep @ night. My 1993 Intrepid is about to die, & we just might be a 1-car family after that... no license plate to renew every year & less trips to the DMV, no insurance, no gas, no oil changes, no other maintenance, ('you need to replace the head gasket...'), ride 1-way/wrong-way on streets going home, run stop signs, no speeding tickets... it's a fat list of '+' w/ nearly no '-' for me. And there's always the constant challenge to do it faster & w/ noticably less exertion. In April I avg'd 12.2mph, I'm closing on 14 now. And just for fun... no, I don't wear a helmet. Why? 'People don't want to be free, they want to be safe. By reversing that essential priority, life actually gets much more dangerous for all of us. - Dan Ferris.' Screw the helmets. Plastic & foam is going to stop 4,000 lbs of clueless soccer-mom-cell-phone-McDonald's-breakfast-SUV from rolling over me?" – Paid-up subscriber Jared Johnson

"Gentlemen – As a former Jap POW, I could have you guys down to 100 pounds in less time than it takes to pen one of your letters. However, since you'd probably resist my choice of menu and dislike the wait-people's fancy flashing of their bayonets while you eat, I fear it wouldn't work." - Paid-up subscriber JD Merritt

"Last year I came up with the idea of biking across Japan. After talking with my wife and friends, four of us decided to give it a try. None of us had ever done anything like this and had no idea what to expect. We had to carry everything we needed for our bikes, for camping as well as clothes. We left for Japan in March and started biking on March 12. We began on the southern island of Kyushu and biked up to the North tip of Hokkaido, a distance of more than 2100 miles. See our web site if your interested. Now the weight loss tip. As we progressed the amount of food I ate was incredible. I ate as much as I wanted, tables full of food and I pounded beer, sake and whiskey to wash it all down. I ended up losing 10 lbs at the end of 7 weeks of bike riding. It may not sound like much but, speaking in stock market terms, it was a loss of 7% (of my body weight). I'm not advocating riding a bike across Japan for nearly two months, but I bet if you could ride a bike to work, the weight would come off." – Paid-up subscriber Bob Greene

Regards,

Porter Stansberry

Baltimore, Maryland

September 8, 2008

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