Fannie, Freddie and Facebook

The administration has unveiled its proposal to wind down the mortgage market, I mean Fannie and Freddie, over the course of some very long and ambiguous time frame. I haven't read the white paper myself, but having read the WSJ's summary, it's abundantly clear that a few pesky details have not been addressed. Such as, who's going to buy the trillions of dollars worth of mortgages that will need to be originated in order to keep the housing market from collapsing? Or, how will the average American be able to afford to buy a house at current prices, when interest rates sky-rocket on mortgages because there is no federal subsidy anymore? Stuff like that. All minor.

Moving on to way more interesting and exciting news. According to Reuters, Facebook is mulling a $1 billion employee share sale that would value the company at $60 billion. This is not to be confused with the $1.5 billion share sale it did a month ago that valued the company at $50 billion. I'm not blaming the folks at Facebook for wanting to cash out a bit. Most 25 year old geeky programmers could really use a porsche and a 10,000 sq ft bachelor pad to get chicks at 25. But if the company is really going to tack on $10 billion in market cap per month, you might as well wait for the IPO, which is only a year away. Otherwise, you're gonna make it look like you really think your company's stock is overvalued and you've got to get out RIGHT NOW before it craters.

Good News For Housing, For Real

The WSJ reports today that home affordability has returned to pre-bubble levels in many US markets in the past year. Having prices return to a point where the average person can actually buy one is far better for the economy than any bailout, tax break or zero interest rate. It didn't stop our politicians and friends at the Fed from attempting to artificially inflate prices to keep this dreaded reality from occurring, by offering free money mostly to those who didn't need or deserve it. For there are many folks out there who were prudent, bought what they could afford, had bad timing, are underwater now, can't refi, and have had to watch the parade of hand-outs pass them by. It'd be like the government refunding everybody who bought pets.com stock on margin in 2000 at the highs, without giving a penny to those who bought Enron in their retirement accounts, even though Enron was a fraud and pets.com was just a really dumb business idea. Both of them pumped by Wall Street, of course. But back to housing...

The ratio of home prices to annual income had fallen to 1.6 by last September, below the historical average of 1.9 from 1989-2003 and down from the peak of 2.3 in late 2005. Great news for those who: a.) have a job b.) need a house and don't already own one and c.) can get a mortgage. In the bad news department, there are still: a.) lots of unemployed folks out there b.) people who bought at the highs who are underwater and might walk away if prices continue to decline, and c.) mortgage rates are marching higher.

Fannie and Freddie have been the mortgage market since all of our friendly neighborhood non-conforming specialists, ahem, got out of that market rather quickly in 2007-2008. The White House is planning to release its plans for the two mortgage behemoths on Friday. Although somebody leaked to the WSJ that the administration wants to phase out the housing-finance giants, it seems impossible to imagine. They are 90% of the market. We're talking trillions of dollars. Are banks really going to originate and hold on to all those mortgages? Cause nobody is going to buy them without government guarantees. Especially not after the CDO fiasco of 2007. We'll see what the government has to say, and then the market is just going to do what it wants to do.

Banks and Loan Buybacks

The WSJ reports today on the battle banks are facing over potential loan buybacks. Banks face the prospect of a new round of losses from loans they originated right before the credit markets collapsed. While originating and securitizing loans as fast as they could to fuel the bubble machine, some banks forgot to do a few basic things, like make sure the borrowers had income, for example. So they just filled out loan docs and made up the info that didn't fit normal underwriting standards. While it was easy to just shovel the loan off and forget about it, Fannie and Freddie, at the behest of their regulator the FHFA, are stepping up efforts to recoup losses on delinquent loans if they find any violations of "reps and warranties" (i.e. lies lies and more lies on loan docs.)

Last month, the effort to claw back loan losses was stepped up when FHFA broadened its probe to include private label, or non-agency, MBS. The FHFA sent out subpoenas to 64 issuers of MBS and other parties to probe for potential loan repurchases. Even the Fed has stated it may make repurchase claims after reviewing some of the dogsh-, I mean "collateral", it inherited from Bear and AIG.

What does this mean? More losses for banks and more pummeling of MBS securities. Who is this going to affect the most? The analyst quoted in the WSJ article, Chris Gamaitoni of Compass Point Research & Trading, believes losses at Bank of America might hit $21.8 billion for the bank. Losses at Wells and JP Morgan are estimated to be a mere $6 billion or so. The article does not mention how much he believes non-agency losses might be. In any event, the banks are not going down without a fight, as it pays to spread the losses out for as many years as they can. The irony is if they would've spent as much time and effort underwriting the mortgages to begin with, they wouldn't be in this pickle.

Housing Starts, More on Fannie and Freddie

Housing starts fell 10.6% in October to a seasonally adjusted 529,000 annual rate. Building permits also declined. Those ever-accurate economists were forecasting a 1.7% increase in starts so this number was disappointing to say the least. It seems as if builders are reluctant to break ground on new projects with inventories and vacancies on existing properties sitting at record highs. With both the expiration of the housing tax credits and the end of Fed's aggressive purchases of MBS looming on the horizon, it's not surprising that builders are hesitant. It seems like their time and money is better spent coming up with new programs to lobby the government for, rather than building houses.

Good article in the WSJ about Fannie and Freddie's involvement in the apartment market. If you thought that Fannie and Freddie were just doing their civic duty to prop up the residential mortgage market, you're wrong. The housing behemoths are also huge lenders to multifamily projects. How huge? They did 84% of all multifamily lending in 2008. The 2008 numbers don't scare me quite so much since at least underwriting was tightened up a bit by then and nobody else was lending. What does scare me is the 43% of market share the combined companies had in 2007 and 34% in 2006, back when banks like Lehman brothers were still around doing moronic deals. For example, Fannie and Freddie helped finance the massive and overpriced Archstone Smith apartment LBO by lending $9 billion to the deal. Or my vote for the dumbest real estate transaction of the bubble, Tishman's $5.4 billion purchase of Stuyvesant Town, where Fannie and Freddie purchased $1.5 billion in CMBS from that deal. I'm not sure I understand exactly how financing bloated leveraged buyouts became part of their mission statement, but it was a bubble and fortunately taxpayers are here to clean up the mess. The good news is that Fannie and Freddie's apartment building loans only add up to around $300 billion, which is a mere drop in the bucket compared to the $5 trillion of single-family loans that they back. It always helps to put these things in perspective, doesn't it?

Treasury Nixes Sale of Fannie Tax Credits to Goldman

Apparently, there is only so much humiliation the Treasury can take from the profiteers of Goldman Sachs. While the Treasury's investment in Fannie continues to bleed cash out of its eyeballs, Goldman Sachs has money coming out of its ears. The folks at Goldman have daily meetings trying to figure out what on earth they are going to do with all the money they keep making, and then during those meetings, they just keep coming up with more ideas on how to make more money! Like buying tax credits from Fannie. After all, there is no way in hell Fannie is ever going to make another penny and everyone hates to waste a good tax credit. Really this is all in the interest of tax efficiency.

Not so fast, says the Treasury. According to a letter Treasury sent Fannie, selling the $2.6 billion in tax credits would cost taxpayers more than the company would gain from the sale. So the Treasury has nixed the sale. Fannie claims to be reviewing the decisions, whatever that means. When the Treasury owns you, I'm not sure how much of a say you get in these matters. Poor Goldman is stuck writing a big check to the government. Although, I'm sure their tax guys already have a few more tricks up their sleeves.

Fannie and AIG: The Dogs of the TARP

All of those optimists who think the US government is going to make a killing on its TARP investment have yet to take a look at Fannie's latest earnings report, released yesterday after the close. The good news is that Fannie actually reported a narrower loss than in last year's third quarter. The bad news is that the loss was still $18.87 billion. Really, how excited can an investor get over the phrase "losses narrowed to a mere $19 billion?" The loss was primarily due to a $22 billion increase in credit-loss provisions and foreclosed-property costs due to spiking delinquency rates. The mortgage giant put in its quarterly request for more money from the government, this time a puny $15 billion.

So really, why should anyone care about Fannie anymore? It's barely a public company since the government seized the mortgage giant and put it into conservatorship last September. Fannie Mae is the mortgage market. In fact, Fannie, Freddie and FHA loans account for approximately 95% of mortgage issuance this year. Earnings reports from Fannie and Freddie aren't merely company earnings for investors in those firms, but they are important barometers of the economy. Spiking delinquencies and foreclosures for Fannie's properties paint a rather bleak picture of the state of the housing market, one that counteracts all the bullish carping of those who believe that a few months of slightly higher medians for housing prices means it's back to the boom years of 2005. The government is keeping the housing market alive. And it's costing us a pretty penny.

In other Fannie news, the WSJ reports that Fannie has introduced the "Deed for Lease" program, a new program that allows delinquent borrowers to transfer their property to Fannie Mae in exchange for a lease. Borrowers-turned-tenants will pay market rents, which in many cases are much lower than their mortgages and might be offered extensions when their lease expires. The hope is that allowing delinquent borrowers to stay in their homes will keep another wave of foreclosures from hitting the market and depressing prices further, causing yet more homeowners to go upside down on their mortgages thus continuing the endless downward spiral in housing prices. The program is only offered to those who are seriously delinquent, which seems to create an enormous incentive for those who are upside-down but current on their mortgages to stop paying so they too can remain in their house for much lower monthly payments. Furthermore, it doesn't really solve the problem of the massive losses that Fannie needs to take when owners who paid too much for their homes hand the properties over to Fannie. It just delays the loss recognition for a few years (depending on how Fannie chooses to account for it, and everyone knows Fannie is famous for its scrupulous accounting.) Unless, of course, housing prices miraculously rebound and Fannie can just sell its mounting inventory for a huge profit in a few years. Yeah, right. Other than those minor pesky issues, I think it's a great idea.

Finally, we get to AIG. The formerly highly regarded insurance conglomerate that everybody loves to hate on. AIG posted a highly anticipated profit of a whopping $455 million. Of course, compared to the year-earlier loss of $24.47 billion, these results were spectacular. New CEO Robert Benmosche did not miss the opportunity to pat himself on the back, remarking that AIG's results "reflect continued stabilization in performance and market trends." Yeah, AIG will be out of the $120 billion hole in no time. Mr. Benmosche's strategy is to become more patient in selling off all of those valuable businesses AIG owns. You know, like the airline leasing business, AIG's "crown jewel," which is looking for a new buyer along with just about every other airline leasing operation in existence that is currently up for sale. That crown jewel that just had to borrow money from AIG (i.e. the government) because it couldn't refinance its debt. On the horizon is another $5 billion charge the company plans to take as it closes an SPV connected to its foreign life-insurance business to pay off $25 billion of its New York Fed credit line. Then there's the investment company Primus Financial Holdings that AIG sold last quarter for $2.15 billion, its biggest sale globally so far. The company will book a $1.4 billion fourth-quarter loss on that sale. Seems like the CDS book wasn't the only thing on AIG's books being mismarked.

Goldman Shopping For Fannie Tax Credits

Ever the savvy financial engineer, Goldman Sachs is seeking to purchase unused tax credits from Fannie Mae. It's a simple idea really. Fannie, the former mortgage giant now 80% owned and controlled by the US government, has punted close to $38 billion in the first half of the year. Meanwhile, the folks at Goldman are swimming in dough thanks to ridiculous amounts of easy money tossed their way courtesy of the Fed, FDIC and the Treasury. Goldman is merely being tax efficient and trying to cut its bill a bit with some fancy accounting footwork. Besides, there's no way Fannie is ever crawling out of the hole and has no use for the mounting tax credits sitting on its books.

The only small problem with the plan is that it doesn't look or sound quite right to all of those angry plebians carrying pitchforks that are out for Goldman's hide. Why should Goldman be allowed to skip out on paying its tax bill after it's already received so much help from Uncle Sam? So the government is scrutinizing the deal and trying to determine whether it is worth the political furor that is sure to follow if it swaps some of the tax credits with Goldman for cold hard cash to help boost Fannie's bottom line. I personally don't care one way or the other. What difference does it make if Goldman gives money directly to the IRS or to Fannie? It all winds up in the same bucket. If Treasury is smart, it will just price the tax credits so that there is no financial benefit to doing the deal and Goldman will just pay its taxes directly. Problem solved. Given what an incredibly poor job Treasury has done so far negotiating its deals with Wall Street Banks (i.e. handing out 100 cents on the dollar to terminate the AIG swaps and doling out TARP funds without any restrictions, just to name two) it's hard to imagine it will negotiate a savvy deal this time around. After all, if there were no financial benefit, Goldman wouldn't be itching to do a deal. My advice to Goldman? Just pay your damn taxes and try to stay out of the papers.

Unemployment, AIG, FNMA

• Nonfarm payrolls fell by 247,000 and the jobless rate dropped to 9.4% from 9.5%. This report was slightly better than expected, yet the economy is still shedding jobs. This month's jobs losses bring the total number of jobs lost since the recession began to 6.7 million.
• Egads! AIG reported a profit, the first one in seven quarters as investment losses narrowed. The insurance company, now 80% owned by the US government, posted net income of $1.82 billion, or $2.30 a share. So if you were looking for an explanation as to why the stock ripped this week, here it is: Somebody leaked the crop report.
• To help offset AIG's tidy profit, Fannie Mae, also 80% owned by the government, reported a $15 billion loss and put in its request for another $10.6 billion from Uncle Sam to cover the resulting net worth deficit. The mortgage giant had a few sobering comments in its press release: "We are experiencing increases in delinquency and default rates for our entire guaranty book of business, including on loans with fewer risk layers...Total nonperforming loans in our guaranty book of business were $171.0 billion on June 30,2009 compared with $144.9 billion on March 31.2009."

Fannie Says "No Condo Financing For You!"

Perhaps all of the builders frantically breaking ground on multi-family units in the Northeast should've checked in with Fannie Mae.  The Wall Street Journal reports that Fannie is adding restrictions to its condo financing programs.  Fannie used to guarantee mortgages where 51% of the units in a building had been sold but is raising the level to 70%.  Furthermore, Fannie will no longer back loans for sales in buildings where 15% of current owners are delinquent on home owners association fees or where more than 10% of the units are owned by a single-entity.  Fannie says that the new rules protect borrowers (i.e. from their own stupidity) from buying units in buildings that have a high risk of failure and also protect the taxpayer from throwing good money into troubled developments (i.e. we've already punted enough on other crappy investments.)  Additionally, both Fannie and Freddie are raising fees on condo buyers (i.e. we'll make it all back on fees!)

The timing of Fannie's announcement is not particularly favorable for developers hoping that low interest rates will make a dent in the current glut of new condos for sale.  The US finished 2008 with a supply of condos large enough to absorb 14 months of demand.  Furthermore, the supply is set to increase by about 28% this year as 93,000 units are completed nationwide.  A bankruptcy lawyer representing a developer in Chapter 11 says "It's not that there's not demand; you just can't get the financing."  I find this statement to be very amusing.  I'm quite certain that everyone in America would love to have a shiny new condo, probably several shiny new condos, and would gladly finance them with no money-down interest-only loans, thereby creating unlimited demand for condos.  In fact, this is where all of that demand for condos a few years back actually came from, a bunch of people who couldn't afford them without exotic financing.  Developers now have to adjust to more normal demand levels.  The growing disparity between the price of renting and the price of owning over the past few years should've been a warning to developers that actual demand for housing didn't support the runaway prices of condos.  But it was far too convenient to ignore the signs and continue building as long as the party lasted.  Well, the party's over.  Unfortunately, we all have to pay the tab now.    

Fed Throws $800 Billion More At Credit Markets

The Fed initiated yet another lending facility called the Term Asset-Backed Securities lending Facility (TALF.)  The TALF will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.  The Treasury will provide $20 billion of credit protection to the Federal Reserve Bank of New York in connection with the TALF.  This new facility is aimed at freeing up lending in the consumer and small business loan arena, and should help companies like American Express who were begging for TARP funds because the ABS market had essentially shut down.  

Additionally, the Federal Reserve announced this morning that it would purchase as much as $600 billion in debt issued or backed by GSE's.  The $600 billion will be broken down into $100 billion in direct debt of Fannie, Freddie and the Federal Home Loan Banks and $500 billion in MBS.  The direct debt will be purchased through auctions from primary dealers, while the MBS will be purchased from asset managers to be selected via a competitive process (i.e. PIMCO)

These programs are aimed at alleviating the continued pressure in the credit markets that have forced spreads to widen to unprecedented levels.  Consequently, despite the Fed's easing to a 1% fed funds target, borrowing rates for consumers on mortgages and other types of debt remains stubbornly high.  Will this work?  Who knows?  Bringing down the cost of mortgages was the initial goal of putting Fannie and Freddie into conservatorship, and that didn't seem to go too well.  Furthermore, I'm not sure if it's just my twisted sense of humor, but I find it hilarious that the Fed is buying GSE debt.  The government already owns the GSEs.  So, the government is basically buying debt from...itself.  Why this should tighten spreads further is a mystery to me, but it will probably work in the short term.  Much like yesterday's announcement of the Citigroup bailout, a detailed outline of how losses would be allocated to each government entity had me in hysterics.  In the end, does it really matter if the FDIC or the FED takes the hit?  It's ultimately all going to come out of our pockets.       

Freddie Mac Posts $25 Billion Loss, Requests $14 Billion From Treasury

Freddie Mac posted a $25 billion third-quarter loss.  The losses were tied to the writedown of $14.3 billion in deferred tax assets, $9.1 billion in security impairments on its available-for-sale securities and $6 billion in credit-related expenses arising from the "dramatic deterioration in market conditions."  These losses officially take Freddie's book value into the negative by $13.8 billion, requiring a capital infusion from the US Treasury.  As a refresher for any readers who have successfully blocked all the horribly depressing financial news from their memories, both Fannie and Freddie were placed into conservatorship of the Federal Housing Finance Agency of September 6th.  The Treasury has pledged to inject capital in the form of preferred shares into the mortgage lenders when the value of their assets declines below the value of their liabilities up to a maximum amount of $100 billion for each company.  Fannie's $29 billion loss reported on Monday did not require a capital infusion yet, but most analysts expect that the company will need one after the fourth quarter unless the mortgage market improves dramatically.

Fannie Loses $29 Billion, Can't Afford New Pants

Fannie Mae posted a net loss of $29 billion for the third-quarter.  The loss is not quite as bad as it seems, as $21.4 billion is related to a write-down of deferred tax assets.  The company is merely admitting early that those assets will expire before it can generate profits again.  The balance of the loss came from increased loan loss reserves and other investment losses.  The losses cut Fannie's book value in half but because book value is still positive, an equity injection from the government is not necessary yet.  The good news is that net revenue jumped 53% to $4.06 billion as net interest income more than doubled and guaranty-fee income rose 20%.   The bad news is that the serious delinquency rate was 1.72% up from .64% a year ago and is estimated to head higher next year as the housing market continues to deteriorate.        

Bailouts, CDS Defaults, and DeJa Vu

The historic bailout of Fannie and Freddie by the US Treasury turned out to be only one story in a very interesting and volatile trading day yesterday.  The repercussions of the Treasury's action will be weighed for some time, however, the tightening of mortgage bond spreads seems to be the most positive immediate benefit of the plan.  Spreads on agency MBS came in around 40 basis points, giving the entire banking sector a nice mark-to-market gain.  Interestingly, this was a huge boost to Paulson's equity investment in Fannie and Freddie, as the two firms hold enormous mortgage portfolios.  It appears as if Mr. Paulson learned a thing or two about front-running a trade from his time at Goldman.  The tightening of mortgage spreads, however, did not filter out into the rest of the bond market, indicating that the credit markets are still nervous.

Falling in the category of significant unintended consequences of the bailout was the event of default triggered in the CDS market by the conservatorship.  The ISDA will settle the CDS through cash auctions that will likely take 30 days.  It should prove to be nothing more than a back-office nightmare, unless, of course, somebody finds a huge out-trade.  Apparently the CDS market has grown exponentially, despite the fact that the settlement process is performed through the use of fax machines rather than electronic confirms.  I predict at least a few cases of "No no no!  We definitely sold these.  We were not buyers!  I don't care what your stupid confirm says.  Look it doesn't matter that I can't actually find and produce my confirm, my trader says it was a sell and there is no way I'm going to tell him that I can't find the confirm!"

In bizarre and completely unrelated news, UAL declared bankruptcy in 2002.  Unfortunately, the story was so compelling that it was posted as a new headline yesterday and picked up by Bloomberg.  I suppose it seemed so probable that UAL could file for bankruptcy again, that investors didn't even bother to actually read the story before dumping the stock.  UAL adamantly denied the filing and the error was eventually discovered.  For savvy traders who were paying attention, there was a small window of opportunity to buy UAL at $3 before trading was halted.  

The Lehman saga continues unabated.  Reports this morning about KDB officially ending talks about taking a significant stake in the firm are crushing the stock.  Lehman's options for a private sector rescue continue to narrow, which means its days are numbered.  Something tells me that by the end of the week the enthusiasm surrounding the bailout of Fannie and Freddie will be a distant memory.

  

     

Overseas Markets Rejoice in US Government Bailout of GSEs

Hank Paulson's plan to seize Fannie and Freddie is being greeted by cheers from overseas markets, with stocks soaring and financials performing particularly well.  It is no surprise that overseas markets like this plan.  For one thing, central bankers around the world are breathing a big sigh of relief.  After all, foreign central banks were big buyers of agency debt and were probably sweating bullets at the recent significant widening of spreads on agency debt on the panic over Fannie and Freddie's solvency.  Now that Mr. Paulson has laid out his plan which protects holders of Fannie and Freddie's debt by injecting capital if and when equity ever turns negative, central bankers don't have to worry about any embarrassing phone conversations with bosses where they have to explain how they lost the country's reserves on "speculative" investing.

Meanwhile, futures on the Dow and S&P are pointing to a sharply higher open in the US as well.  Treasuries are selling off as the "flight to quality" trade is no longer as compelling.  Given that the government will now be buying MBS outright in the market as part of Mr. Paulson's plan, it is logical that MBS spreads should narrow significantly in anticipation of the government's purchases.  However, this is one part of the plan that was somewhat ambiguous.  The plan did not specify how much MBS the government planned to buy, only that it wanted to lower mortgage rates for borrowers seeking new mortgages.  If the government is serious about affecting the spread then it will more than likely need to buy large quantities of mortgages.  A few weeks ago, I jokingly suggested that the Fed should buy agency debt to take advantage of the juicy spread between agency debt and where the Treasury borrows money.  The Treasury will basically be doing this when it begins buying MBS, holding the securities to maturity and managing the portfolio.  Part three of Mr. Paulson's plan is to turn the US government's balance sheet into an MBS hedge fund.  But I have to admit, if I could borrow unlimited amounts of money at 3.80% for ten years, I'd be looking for all sorts of high yielding assets to purchase and "hold-to-maturity."

In any event, it looks like the market will rally, at least in the short term.  This will be the big capitulation event that everyone was looking for.  No matter that Bear Stearns was the "big capitulation" event a mere six months ago and a huge failure of that magnitude was sure to mark the end of the credit crisis.  Here we sit now with two much larger failures (and several smaller ones in between), involving government guarantees yet again.  This bailout doesn't really change the deteriorating fundamentals of the housing market, it merely helps restore a modicum of liquidity to the mortgage finance market.  Yet another emergency plan was cobbled together in a rush to avoid a market meltdown, along with the Bear bailout, and all of the Fed's fancy new liquidity facilities for Wall Street banks.  We'll see how long the euphoria lasts this time.    

Fannie and Freddie in Conservatorship

Hank Paulson outlined his plan to "rescue" financial markets and put Fannie and Freddie's shareholders' out of their misery. You can read the full text of his statement here. The Federal Housing Finance Agency (FHFA) has been appointed the Conservator of Fannie and Freddie. The companies will continue to function without interruption and will pay their obligations, although senior management will be ousted. The stocks will continue to trade but the powers of the stockholders will be terminated. The Treasury has entered into a Senior Preferred Stock Purchase Agreement with each GSE. Under the agreement, the Treasury will inject capital into the GSEs at any time that the FHFA determines that assets exceed liabilities according to GAAP and will inject capital in an amount equal to the difference between assets and liabilities. The agreements are indefinite in duration and have a capacity of $100 billion with each GSE and will be senior to both the common and preferred shareholders. In return for taxpayer's generosity, the Treasury will immediately receive $1 billion of senior preferred stock in the GSEs with warrants for the purchase of common stock representing 79.9% of the common stock. The new senior preferred will accrue dividends at 10% and come with a host of covenants. The covenants of most interest to current common and preferred shareholders probably pertain to the elimination of BOTH common and preferred dividends and a limit on an increase in the GSEs' debt to 110% of their debt as of June 30th 2008. This will no doubt hurt many banks that invested in the preferred stock under the assumption that the dividends were secure. Regulators are encouraging banks to contact the FDIC if their regulatory capital levels are greatly diminished due to this action. Apparently, the Fed, FDIC and OTS are going to "work" with the institutions to restore capital adequacy.
In addition to the preferred stock purchase agreement, the Treasury will also purchase MBS outright, as well as provide additional funding through collateralized loans. Interestingly, these loans will also be available to the Federal Home Loan Banks. I suppose Mr. Paulson wanted to nip any speculation about a liquidity crisis at the FHLB in the bud. So, in effect, he is killing three birds with one stone.
Mr. Paulson's plan appears comprehensive and intends to finally put an end to all of the speculation about the failures of Fannie and Freddie leading to an outright collapse of the financial markets. Will it work? That is the $5 Trillion question. More thoughts and comments to follow, but now I have to catch my flight home.

Yet Another Treasury Official Blabbers to the Press About Fannie and Freddie

Speculation continues to circulate about the future of Fannie and Freddie.  The general consensus seems to be that the government will inject equity into the GSE's in the form of some type of preferred shares.  According to a variety of "informed" sources the new equity would rank senior to the common, thus wiping out the existing equity holders and diluting the preferred shareholders.  If you read the Barron's article over the weekend, or the report in the Financial Times, you would be led to believe that "inside sources" confirmed this outcome.  However, Reuters has yet another "source familiar with Treasury thinking" who claims that "any effort by the Treasury Department to backstop Fannie Mae and Freddie Mac would seek to maintain the companies as shareholder-owned enterprises.  So, what's it gonna be?  I was gearing up for a big announcement from the Treasury over the weekend about its plans to deal with the GSE's.  But this new report makes me wonder if the Fed is just going to sit back and wait it out.  Concerns have been circulating about the $225 billion in debt that Fannie and Freddie has to roll over before September 30th.  Frankly, the Fed has already loaned Wall Street over $300 billion to help finance their mortgage and agency inventories, so what's another $225 billion?  The Fed owns over $479 billion in treasuries which it can sell and replace with agency paper and earn a much nicer spread.  Doing this would be completely insane, but frankly, it's no more crazy than the idea of fully nationalizing Fannie and Freddie.  What the Treasury actually decides to do is anyone's guess at this point.  One thing is for certain, if nothing happens over the weekend, investors should prepare themselves for yet another bumpy ride.   

Another Day, Another Plunge in Fannie and Freddie Shares

Shares of Fannie Mae and Freddie Mac are down on the day again, as investors continue to race for the exits.  Rampant speculation continues about the future of the mortgage giants, with many calling for a nationalization of the two firms.  Remarkably, the Treasury Department has been mum about the matter, claiming that it has no immediate plans to intervene in the two firms activities.  I am not terribly surprised by the plunge in Fannie and Freddie's stocks (or their preferred and sub debt.)  However, I find the widening of spreads on Fannie and Freddie's senior debt to be a real head scratcher.  Spreads on Fannie and Freddie's senior debt are wider than they were before Hank Paulson announced that the government would inject unlimited funds into the GSE's.  If the government is supporting  these two firms financially, then owning Fannie and Freddie's debt should be the same as owning US Treasuries.  If anything, Treasuries should get pummeled because the potential debt burden on the US government has increased by a couple of trillion dollars.  Yet somehow, Treasuries are still being viewed as a "safe haven" while Fannie and Freddie's debt is looking more like toxic waste.  Those with good insight about this situation are welcome to comment.  For interesting commentary on the precarious situation the Treasury faces with the GSE's, Naked Capitalism has a great summary that is worth reading.

A Crazy Plan for Hank Paulson on Saving Fannie, Freddie, and Lehman

When Hank Paulson took his post as US Treasury Secretary, he probably thought it would be a nice relaxing break from the high-stress job of running Goldman Sachs.  After all, what does a Treasury Secretary do, other than shake hands with figureheads and make emphatic statements claiming to support his administration's "strong dollar policy?"  Mr. Paulson, however, has found himself in the difficult position of attempting to bailout most of the US financial sector while avoiding the use of taxpayer funds.  The US market narrowly avoided a complete meltdown in March when Paulson forced JP Morgan to buy Bear Stearns.  It would've been the perfect plan were it not for the $29 billion in dicey mortgages that the Fed has guaranteed for JP Morgan.  No use of taxpayer funds, yet.  Expanding the type of collateral that the Fed will take in its loans to Wall Street to include triple AAA rated MBS and ABS was also inspired genius, assuming that none of these institutions fail and leaves the Fed holding undesirable collateral in a panicky market.  Opening the discount window to investment banks was a shrewd move to shore up confidence and keep Lehman from facing Bear's fate in March.  Investment banks have yet to tap the discount window.  So far, so good.  When Fannie and Freddie's stocks began to plummet on fears that they were insolvent, Paulson crammed through a landmark housing bill that had stalled in congress in order to make the implied government guarantee explicit.  Although I am not a mind reader, I believe that Paulson was hoping that the explicit guarantee would boost confidence so much that the government would never have to take an equity stake in the faltering mortgage entities.  The market, however has called his bluff.  Fannie and Freddie's shares have been reeling, dragging down the recently rebounded financial sector on a belief that the government will have to make an equity infusion that will wipe out the common and potentially the preferred shareholders.

Since desperate times call for desperate measures, I have a crazy plan for Mr. Paulson on how to save Fannie, Freddie and Lehman while making a few bucks in the stock market.  First, call Lehman Brothers and tell them that the government plans to buy one billion shares of Fannie and Freddie tomorrow, giving Lehman one trading day to front-run the order.  Then, Mr. Paulson can give the order to Lehman to buy one billion shares the following day at the market.  Since this is around ten times the average daily volume, both of the stocks should spike significantly.  A short squeeze will follow as the small-time shorts get squeezed out.  Mr. Paulson can then call Chris Cook at the SEC and tell him to put out an emergency short-sale ban.  The SEC must outlaw ALL shorting, not just the naked variety.  The stocks will surge higher as shorts are forced to cover.  Once both share prices have quadrupled, Fannie and Freddie can raise more capital from a few strategic foreign investors.  After all, this has got to look like a great investment compared to the Chinese or Indian stock markets of late.  Although the government's share will be diluted by the new capital raising, it should be more than offset by the appreciation in the stock.  Lehman, having front-run the buy side, can also front-run the equity issuance and post a gain that may help offset the $4 billion or so in losses that it is more than likely to have this quarter.

If all of this sounds crazy, then you haven't been keeping up with current events.  It only seems slightly more crazy than the reality confronting the market.  Fannie and Freddie on the verge of a direct equity infusion from the government?  Insanity!  Lehman's stock getting annihilated again because all of those "rumors" about untenable losses turned out to be true?  Shocking!  Is everyone at Lehman "comfortable" with those marks now that the investment bank is yet again desperately searching for new ways to raise capital?  Erin Callan can thank Dick Fuld for giving her the boot, as it was a better move for her career than Mr. Fuld's.  Mr. Fuld has nowhere else to point the finger.

Only time will tell how the turmoil in the financial markets will finally be resolved.  You can bet on more surprises along the way.  The only thing that seems certain is that the financial universe will continue to shrink as players get weeded out during the downturn.  Pundits attempting to call the bottom will eventually grow weary.  Only when completely crazy ideas begin to sound reasonable will a bottom begin to form.  When I get a call from Mr. Paulson asking for the outline of my plan, I'll let you know it's safe to buy financials again. 

  

Fannie Mae Posts More Losses, Cuts Dividend

Fannie Mae posted a net loss of $2.3 billion, excluding preferred dividend payments, and said it would slash its dividend by 85 percent.  The mortgage lender booked $5.35 billion in credit-costs as it increased loan loss provisions and charge-offs.  One would think that investors could no longer be surprised by the magnitude of Fannie's losses after the recent precipitous plunge in the mortgage lender's stock and the disappointing losses reported by Freddie Mac yesterday.  Yet the stock is down another 14% in pre-market trading, so apparently someone was surprised.  According to CNBC, 49% of the losses came from Fannie's Alt-A portfolio of mortgages.  I wrote about Fannie Mae's $344.6 billion in Alt-A exposure on May 7th, and wondered at the enthusiasm surrounding Fannie's last earnings report.  I felt that the company had enormous exposure to losses from Alt-A's given how poorly those assets are performing and considering the amount of leverage that Fannie employs.  The good news is that Fannie's debt is now officially guaranteed by the US taxpayer which protects the rest of the banking system from catastrophic losses due to a Fannie Mae default.  It is growing increasingly likely that Fannie will be sporting some fresh capital that is also guaranteed by the US taxpayer, which doesn't help Fannie's current shareholders, but will keep the housing market from complete and total collapse due to a lack of financing.  Nevertheless, if financials can rally in the face of this awful news, then maybe we really have found the bottom.

House Passes Legislation to Bailout Fannie, Freddie, Homeowners, Everyone

Landmark housing legislation sailed through the House today and is expected to pass through the Senate, bypass a Presidential veto and become law in a few days.  The bill amounts to a host of last minute measures cobbled together that throw money at several disparate housing problems.  The hope is that maybe one or two of them will actually solve a problem.  Most importantly, the bill gives Treasury Secretary Hank Paulson the power to inject capital into Fannie Mae and Freddie Mac and appoints a new regulator for the GSEs.  As I have noted before, I think it is appropriate for the Treasury to make their guarantee explicit given how the markets were in a complete panic a week ago.  A certain measure of confidence has been restored in the banking sector now that investors are less preoccupied with Fannie and Freddie's failure.  That confidence alone can ensure that the Treasury never has to inject capital.  Given their bloated balance sheets and huge amounts of leverage, Fannie and Freddie will need more capital if delinquencies and defaults rise (as they most certainly will given the absence of a bottom in housing).  But with a government guarantee in place, the firms will most likely be able to raise cash from the private sector.  Furthermore with a strict new regulator, theoretically we won't find ourselves in the same boat again.  I say "theoretically" because this is the Government we're talking about.  Lawmakers tried to appear as if they cared about limiting losses to taxpayers by tying any bailout of Fannie and Freddie to the federal debt limit.  Then they went and raised the debt ceiling by $800 billion.  

The portion of the bill that I am most skeptical of is the $300 billion Barney Frank brainchild that has been floating around for some time.  What Representative Frank proposes is that the FHA refinance up to $300 billion in mortgages of borrowers who cannot afford their current mortgage, into a more affordable mortgage.  Not only would the rate be lower but the principal would be reduced by a "significant amount," forcing the lenders to write down the value of the loan on their books, and extinguishing all second liens.  The borrower would then share in any appreciation in equity 50/50 with the government, assuming he lived in the house at least five years.  If he refinances or sells the property before five years, the government gets an even larger share of the equity (100% in the first year, 90% in the second, phasing by 10% until it hits 50%).  Presumably, if prices go lower, the homeowner will have all the incentive in the world to walk and leave the government with the bill.  There is no reason to believe that borrowers will default at a lower rate to the FHA than they would to a private mortgage lender.    

One major flaw in this bill is the idea that any American would give up his God given right to the equity in his home.  Owning a home in the US was touted for too long as the surest way to build wealth.  In parts of the country where home inventories are still very high and prices continue to drop, it seems unlikely that anyone would chose this option.  The logical choice would be to default, hand the keys back to the bank, go back to renting, wait 5 years or so for your credit to improve and buy another house where you get 100% of the equity.  While the bill claims that this will help 400,000 homeowners, my guess is that it will be far fewer than that.  You can read the rest of the 687 page document here if you're having trouble sleeping.  Trust me, it works.  I'm going to bed.