I am fascinated by the Civil Rights Movement of the 1960's. One of Dr Kings closest aides was a young man called John Lewis. John Lewis was a freedom rider and helped organise the historic marches from Selma to Montgomery.
Despite being bruised and bloodied he continued and continues to believe in the power of non-violent demonstration.
Always an ardent Clinton supporter, he switched his allegiance to Barack Obama. In this interview on MSNBC he explains why.
Thursday 28 August 2008
Wednesday 20 August 2008
Markets: Fannie Mae but will Uncle Sam?
One of the 'landmark' moments in this financial crisis along with the failure of Bear Stearns Bank has been the near collapse of Fannie Mae and Freddie Mac. Despite warnings as far back as 2004, these two behemoths continued to guarantee bad loans, effectively exacerbating the crisis to the point where they now threaten to spark a meltdown in the credit markets should they fail to meet their obligations.
Obviously, this cannot be allowed to happen. However, a government bail out, whilst temporarily offering respite could lead to a further lack of confidence should they not be there with a blank cheque the next time that they or another beleaguered institution faces a crisis of confidence.
This brings us to the issue of 'corporate socialism' in a capitalist society. Should failing companies be allowed to die natural deaths or should they be given billions of dollars worth of taxpayers oxygen? Unfortunately, it is not simply a matter of a badly run corporation going bankrupt but of the tsunami effect that that corporations collapse will have on those who inhabit it's ocean.
Can we afford an illiquid America where lending becomes the exception and no longer the rule? Could a country like the US with its negative saving rate, survive without credit or could it's entire financial infrastructure collapse under a credit crunch if there were to be no handouts for the banks?
The primary obligation of government is to protect the people from adversaries within and without. If our economies merely reflect who we are as people, then have we not become our own worst enemies?
Unfortunately, the probable consequence of this crisis is that we will find it much more difficult to take out personal loans in the future. Mortgage lending will initially be ultra conservative, relaxing only when profitability returns to the structured lending market.
So like children suitably admonished, the mortgage lending industry will revert back to lending money to qualified people who can afford to service loans. The effect of this will be to cool inflation as less properties will be built because demand will drop.
The upshot of this is that with almost a moritorium on lending, the savings rate will increase. The downside is that it won't last. The banks, seeing increases in certified deposits will begin to re-offer loans to those who previously they ignored and rejected, ease their lending criteria and begin a new cycle.
The past truly is prologue.
Below is a particularly adroit article from Jonathan Laing of Barrons:=
The Endgame Nears For Fannie and Freddie By Jonathan R. Laing
The almost inevitable government recapitalization of Fannie Mae and Freddie Mac will likely wipe out investors—and management.
It may be curtains soon for the managements and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac . It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"
Many of Fannie's and Freddie's credit losses come from
risky mortgages that the agencies bought or
guaranteed in recent years to boost their market share.
Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.
Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.
What's more, the fair-value figures reported by the companies may overstate the value of their assets significantly. By some calculations each company is around $50 billion in the hole. But more on that later.
Bringing Fannie and Freddie to heel will be difficult for the Bush administration, despite the GSEs' (Government-Sponsored Enterprises') parlous financial condition. Consider their history. In the early 1980s Fannie was effectively insolvent, but the government allowed it to continue operating. Eventually long-term interest rates dropped, bolstering the value of the company's mortgages and bringing it back from the brink. Earlier in the current decade Fannie and Freddie successfully fought a full-scale attempt by the White House and some brave Republican legislators to clamp down on their operations, after they were caught perpetrating accounting frauds.
Note, too, that Fannie and Freddie have nonpareil lobbying operations and formidable political strength, owing to their hefty donations and penchant for hiring former political operatives. Besides, the agencies claim they've landed in their current predicament through no fault of their own. As Freddie Mac Chairman and CEO Richard Syron recently put it, the GSEs have been hit by a "100-year storm" in the housing market, accentuated by some higher-risk mortgages that they were forced to buy to meet government affordable-housing targets.
The latter contention is more than disingenuous. A substantial portion of Fannie's and Freddie's credit losses comes from $337 billion and $237 billion, respectively, of Alt-A mortgages that the agencies imprudently bought or guaranteed in recent years to boost their market share. These are mortgages for which little or no attempt was made to verify the borrowers' income or net worth. The principal balances were much higher than those of mortgages typically made to low-income borrowers. In short, Alt-A mortgages were a hallmark of real-estate speculation in the ex-urbs of Las Vegas or Los Angeles, not predatory lending to low-income folks in the inner cities.
In the current bailout the Bush administration is playing from strength. Not only have the GSEs' stocks been decimated, but trading in their debt -- whether the $1.6 trillion of corporate obligations or $3.6 trillion of mortgage-backed securities the two have guaranteed -- would have been in disarray had the recent housing bill not made explicit the U.S. government's backing of that debt. Even so, GSE debt spreads are starting to widen, relative to Treasury yields.
An insider in the Bush administration tells Barron's Fannie and Freddie are being jawboned by the Treasury Department and their new regulator, the Federal Housing Finance Agency (FHFA), to raise more equity. But government officials don't expect the agencies to succeed. For one thing, only a "capital raise" of $10 billion or more apiece would have any credibility. Yet, what common-stock investors would advance that kind of money to entities that have market capitalizations of $8.5 billion (Fannie) and $4 billion (Freddie), especially as the FHFA will use its new powers to boost dramatically the regulatory capital the GSEs must have in coming years?
Just as disconcerting for prospective shareholders, all but $300 million of the $7.2 billion in equity Fannie raised in the second quarter was lost in the very same quarter, according to its fair-value balance sheet. With credit losses surging at both agencies, $20 billion in new common equity wouldn't last long.
The cost of selling new preferred stock, meanwhile, would seem to be prohibitive for Fannie and Freddie. The dividend yields on their preferreds have soared to around 14%, in part because of a recent rating downgrade by Standard & Poor's. Yields that high would blight the future earnings prospects of both concerns.
Should the agencies fail to raise fresh capital, the administration is likely to mount its own recapitalization, with Treasury infusing taxpayer money into the enterprises, according to our source. The infusion would take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends. Then again, the administration might show minimal kindness to preferred shareholders; local and regional bankers have been lobbying the Bushies not to wipe out the preferred since the bankers own a lot of that paper and rely on the bank preferred-stock market for much of their own equity capital.
An equity injection by the government would be tantamount to a quasi-nationalization, without having to put the agencies' liabilities on the nation's balance sheet, and thus doubling the U.S. debt. Treasury would install new management and directors at both, curb the GSEs' sometimes reckless investment and guarantee operations, and liquidate in an orderly fashion the GSEs' troubled $1.6 billion in on-balance-sheet investments. Then the companies could be resold to the public without their explicit government debt guarantees, or folded into government agencies like Ginnie Mae or the FHA.
Should the Bush administration lose its nerve and kick the GSE bailout forward to the next administration, a similar scenario still might unfold. In a column last month in the Financial Times, Lawrence Summers, Treasury Secretary in the Clinton administration and an important economic adviser to Democratic presidential candidate Barack Obama, opined that in view of the sad financial condition of Fannie and Freddie, both should be thrown into government receivership to protect the U.S. taxpayer. Republican presidential contender John McCain, for his part, fulminated in a recent op-ed in the Tampa Bay Times that if a dime of taxpayer money is used to bail out the companies, "the managements and the boards should immediately be replaced, multimillion-dollar salaries should be cut, and bonuses and other compensation should be eliminated."
THE WHITE HOUSE BEGAN to worry about Fannie's and Freddie's solvency in February, when both agencies reported capital-shredding losses for the fourth quarter of 2007. Adding to the official concern was the deepening turmoil in the residential- mortgage market, and the need for the agencies to keep mortgage money flowing.
The White House dispatched Treasury's then-Undersecretary for Finance Bob Steel to cut a deal with both Fannie and Freddie. In return for the pair doing its best to raise $10 billion each in new equity, the administration would eliminate the cap on mortgage paper the agencies could put on their balance sheets, and lower the increased minimum regulatory capital requirements imposed on the GSEs after their previous accounting scandal.
According to our source, both agency managements seemed amenable to the March deal, though they demurred on raising new capital immediately. They thought, and Treasury agreed, that any share flotation would have to wait until May, when first-quarter earnings were scheduled to be announced, providing investors with material information. Come May, Fannie kept its side of the bargain by raising $7.2 billion in mostly common equity. But Bush officials were shocked when Freddie failed to follow suit on an announced $5.5 billion equity raise.
According to our source, Freddie's Syron offered a variety of excuses. He said neither he nor several senior board members wanted to dilute current shareholders since the stock had fallen from 67 in the summer of 2007 to around 25 in May. He also insisted Freddie could do nothing on the core capital front until it had completed its formal corporate registration with the SEC under the 1934 Act. That argument seemed fishy, since Freddie had raised $6 billion in preferred capital the previous November, and like Fannie has an exemption from registering stock issues with the SEC. A Freddie Mac spokesperson says the company was acting according to legal advice.
Freddie succeeded in exploiting the Prague Spring of regulatory forbearance. Monthly statements show it bought even more mortgages, gunning the growth in its retained, on-balance-sheet portfolio by 11% in the second quarter. By reducing its hedging costs, it also doubled its vulnerability to loss from interest-rate moves. It appears Freddie was hoping a Hail Mary Pass with the portfolio would somehow reduce its spiraling operating losses.
In retrospect, the agency meltdown seemed inevitable as the housing crisis deepened and credit losses mounted. On July 7 an analyst report claimed both agencies might have to raise substantially more capital because of a change in accounting regulations. Both stocks went into free fall, tumbling nearly 50% on the week.
The Bush administration feared the stock collapse would signal that the companies were heading for insolvency, and thus call into question the safety of their $5.2 trillion debt and guarantee obligations, despite the government's implicit guarantee of that paper. The impact of a failed GSE debt auction would be global and catastrophic, since foreigners, including many Asian central banks, owned $1.5 trillion in Fannie and Freddie paper.
After a frantic weekend meeting, Treasury Secretary Paulson announced on July 13 a rescue plan under which the Fed, and ultimately the Treasury, would backstop all Fannie and Freddie debt, and buy equity in the companies should that be necessary to bolster them. The omnibus housing bill passed and signed into law several weeks later codified all this in addition to establishing a new regulator for the GSEs with strong receivership powers.
In the weeks since, Freddie has continued to put off raising capital, even though it finally completed its registration as a corporation with the SEC. Syron said when second-quarter earnings were released Aug. 6 that the company was waiting for a more "propitious" time. One might argue it came in May, when the stock was 25, not 6.
BOTH GSES CONTINUE TO NOTE their so-called core or regulatory capital levels remain comfortably above the minimum required by federal regulation. This ignores what would happen, however, if their balance sheets were marked to fair value -- or if their fair-value estimates were hugely inflated, as indeed may be the case. Both balance sheets, for one, contain an entry called deferred tax assets that bulks up Fannie's fair-value net worth by $36 billion and Freddie's by $28 billion. These assets don't represent real cash but tax credits the agencies have built up over the years that can be used to offset future profits. But, since the tax assets can't be sold to a third party, or disappear in a receivership or sale of the company, they are disallowed in the capital computations of most financial institutions. Ironically, the worse a company does, the more capital cushion this asset creates.
The Bottom Line
A quasi-nationalization of Fannie Mae and Freddie Mac could involve the issuance of new preferred stock. The companies' assets may be worth negative $50 billion each.
The companies also appear to have boosted their capital ratios by sharply curtailing their repurchase of soured mortgages out of the securitizations they've guaranteed. In the fourth quarter of last year, for instance, Freddie Mac took a loss of $736 million on loans repurchased. In this year's first quarter that figure dropped to $51 million -- a stunning decline in view of the continued deterioration of the housing and mortgage markets. Instead, the company made the interest payments to bring the mortgages current -- a much smaller outlay, but a tactic that only pushes an inevitable loss forward into future quarters. In Fannie's case, by postponing the buyback of bad loans the company avoided more than $1 billion in second-quarter charge-offs and a hit to its net worth.
Other numbers also give pause. Less generous marks to Freddie's $132 billion investment holdings in private-label subprime and Alt-A securities would lop another $20 billion off its net worth. And, more than likely, Fannie's credit reserves of $8.9 billion won't fully protect it from future losses on $36 billion of seriously delinquent mortgages on its $2.8 trillion book.
After accounting for deferred tax assets and generous asset marks, Fannie and Freddie each may have a negative $50 billion in asset value, and little prospect of digging themselves out of the hole. Whether Fannie and Freddie are liquidated or nationalized as a prelude to privatization, in their current form they won't be missed.
Obviously, this cannot be allowed to happen. However, a government bail out, whilst temporarily offering respite could lead to a further lack of confidence should they not be there with a blank cheque the next time that they or another beleaguered institution faces a crisis of confidence.
This brings us to the issue of 'corporate socialism' in a capitalist society. Should failing companies be allowed to die natural deaths or should they be given billions of dollars worth of taxpayers oxygen? Unfortunately, it is not simply a matter of a badly run corporation going bankrupt but of the tsunami effect that that corporations collapse will have on those who inhabit it's ocean.
Can we afford an illiquid America where lending becomes the exception and no longer the rule? Could a country like the US with its negative saving rate, survive without credit or could it's entire financial infrastructure collapse under a credit crunch if there were to be no handouts for the banks?
The primary obligation of government is to protect the people from adversaries within and without. If our economies merely reflect who we are as people, then have we not become our own worst enemies?
Unfortunately, the probable consequence of this crisis is that we will find it much more difficult to take out personal loans in the future. Mortgage lending will initially be ultra conservative, relaxing only when profitability returns to the structured lending market.
So like children suitably admonished, the mortgage lending industry will revert back to lending money to qualified people who can afford to service loans. The effect of this will be to cool inflation as less properties will be built because demand will drop.
The upshot of this is that with almost a moritorium on lending, the savings rate will increase. The downside is that it won't last. The banks, seeing increases in certified deposits will begin to re-offer loans to those who previously they ignored and rejected, ease their lending criteria and begin a new cycle.
The past truly is prologue.
Below is a particularly adroit article from Jonathan Laing of Barrons:=
The Endgame Nears For Fannie and Freddie By Jonathan R. Laing
The almost inevitable government recapitalization of Fannie Mae and Freddie Mac will likely wipe out investors—and management.
It may be curtains soon for the managements and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac . It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"
Many of Fannie's and Freddie's credit losses come from
risky mortgages that the agencies bought or
guaranteed in recent years to boost their market share.
Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.
Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.
What's more, the fair-value figures reported by the companies may overstate the value of their assets significantly. By some calculations each company is around $50 billion in the hole. But more on that later.
Bringing Fannie and Freddie to heel will be difficult for the Bush administration, despite the GSEs' (Government-Sponsored Enterprises') parlous financial condition. Consider their history. In the early 1980s Fannie was effectively insolvent, but the government allowed it to continue operating. Eventually long-term interest rates dropped, bolstering the value of the company's mortgages and bringing it back from the brink. Earlier in the current decade Fannie and Freddie successfully fought a full-scale attempt by the White House and some brave Republican legislators to clamp down on their operations, after they were caught perpetrating accounting frauds.
Note, too, that Fannie and Freddie have nonpareil lobbying operations and formidable political strength, owing to their hefty donations and penchant for hiring former political operatives. Besides, the agencies claim they've landed in their current predicament through no fault of their own. As Freddie Mac Chairman and CEO Richard Syron recently put it, the GSEs have been hit by a "100-year storm" in the housing market, accentuated by some higher-risk mortgages that they were forced to buy to meet government affordable-housing targets.
The latter contention is more than disingenuous. A substantial portion of Fannie's and Freddie's credit losses comes from $337 billion and $237 billion, respectively, of Alt-A mortgages that the agencies imprudently bought or guaranteed in recent years to boost their market share. These are mortgages for which little or no attempt was made to verify the borrowers' income or net worth. The principal balances were much higher than those of mortgages typically made to low-income borrowers. In short, Alt-A mortgages were a hallmark of real-estate speculation in the ex-urbs of Las Vegas or Los Angeles, not predatory lending to low-income folks in the inner cities.
In the current bailout the Bush administration is playing from strength. Not only have the GSEs' stocks been decimated, but trading in their debt -- whether the $1.6 trillion of corporate obligations or $3.6 trillion of mortgage-backed securities the two have guaranteed -- would have been in disarray had the recent housing bill not made explicit the U.S. government's backing of that debt. Even so, GSE debt spreads are starting to widen, relative to Treasury yields.
An insider in the Bush administration tells Barron's Fannie and Freddie are being jawboned by the Treasury Department and their new regulator, the Federal Housing Finance Agency (FHFA), to raise more equity. But government officials don't expect the agencies to succeed. For one thing, only a "capital raise" of $10 billion or more apiece would have any credibility. Yet, what common-stock investors would advance that kind of money to entities that have market capitalizations of $8.5 billion (Fannie) and $4 billion (Freddie), especially as the FHFA will use its new powers to boost dramatically the regulatory capital the GSEs must have in coming years?
Just as disconcerting for prospective shareholders, all but $300 million of the $7.2 billion in equity Fannie raised in the second quarter was lost in the very same quarter, according to its fair-value balance sheet. With credit losses surging at both agencies, $20 billion in new common equity wouldn't last long.
The cost of selling new preferred stock, meanwhile, would seem to be prohibitive for Fannie and Freddie. The dividend yields on their preferreds have soared to around 14%, in part because of a recent rating downgrade by Standard & Poor's. Yields that high would blight the future earnings prospects of both concerns.
Should the agencies fail to raise fresh capital, the administration is likely to mount its own recapitalization, with Treasury infusing taxpayer money into the enterprises, according to our source. The infusion would take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends. Then again, the administration might show minimal kindness to preferred shareholders; local and regional bankers have been lobbying the Bushies not to wipe out the preferred since the bankers own a lot of that paper and rely on the bank preferred-stock market for much of their own equity capital.
An equity injection by the government would be tantamount to a quasi-nationalization, without having to put the agencies' liabilities on the nation's balance sheet, and thus doubling the U.S. debt. Treasury would install new management and directors at both, curb the GSEs' sometimes reckless investment and guarantee operations, and liquidate in an orderly fashion the GSEs' troubled $1.6 billion in on-balance-sheet investments. Then the companies could be resold to the public without their explicit government debt guarantees, or folded into government agencies like Ginnie Mae or the FHA.
Should the Bush administration lose its nerve and kick the GSE bailout forward to the next administration, a similar scenario still might unfold. In a column last month in the Financial Times, Lawrence Summers, Treasury Secretary in the Clinton administration and an important economic adviser to Democratic presidential candidate Barack Obama, opined that in view of the sad financial condition of Fannie and Freddie, both should be thrown into government receivership to protect the U.S. taxpayer. Republican presidential contender John McCain, for his part, fulminated in a recent op-ed in the Tampa Bay Times that if a dime of taxpayer money is used to bail out the companies, "the managements and the boards should immediately be replaced, multimillion-dollar salaries should be cut, and bonuses and other compensation should be eliminated."
THE WHITE HOUSE BEGAN to worry about Fannie's and Freddie's solvency in February, when both agencies reported capital-shredding losses for the fourth quarter of 2007. Adding to the official concern was the deepening turmoil in the residential- mortgage market, and the need for the agencies to keep mortgage money flowing.
The White House dispatched Treasury's then-Undersecretary for Finance Bob Steel to cut a deal with both Fannie and Freddie. In return for the pair doing its best to raise $10 billion each in new equity, the administration would eliminate the cap on mortgage paper the agencies could put on their balance sheets, and lower the increased minimum regulatory capital requirements imposed on the GSEs after their previous accounting scandal.
According to our source, both agency managements seemed amenable to the March deal, though they demurred on raising new capital immediately. They thought, and Treasury agreed, that any share flotation would have to wait until May, when first-quarter earnings were scheduled to be announced, providing investors with material information. Come May, Fannie kept its side of the bargain by raising $7.2 billion in mostly common equity. But Bush officials were shocked when Freddie failed to follow suit on an announced $5.5 billion equity raise.
According to our source, Freddie's Syron offered a variety of excuses. He said neither he nor several senior board members wanted to dilute current shareholders since the stock had fallen from 67 in the summer of 2007 to around 25 in May. He also insisted Freddie could do nothing on the core capital front until it had completed its formal corporate registration with the SEC under the 1934 Act. That argument seemed fishy, since Freddie had raised $6 billion in preferred capital the previous November, and like Fannie has an exemption from registering stock issues with the SEC. A Freddie Mac spokesperson says the company was acting according to legal advice.
Freddie succeeded in exploiting the Prague Spring of regulatory forbearance. Monthly statements show it bought even more mortgages, gunning the growth in its retained, on-balance-sheet portfolio by 11% in the second quarter. By reducing its hedging costs, it also doubled its vulnerability to loss from interest-rate moves. It appears Freddie was hoping a Hail Mary Pass with the portfolio would somehow reduce its spiraling operating losses.
In retrospect, the agency meltdown seemed inevitable as the housing crisis deepened and credit losses mounted. On July 7 an analyst report claimed both agencies might have to raise substantially more capital because of a change in accounting regulations. Both stocks went into free fall, tumbling nearly 50% on the week.
The Bush administration feared the stock collapse would signal that the companies were heading for insolvency, and thus call into question the safety of their $5.2 trillion debt and guarantee obligations, despite the government's implicit guarantee of that paper. The impact of a failed GSE debt auction would be global and catastrophic, since foreigners, including many Asian central banks, owned $1.5 trillion in Fannie and Freddie paper.
After a frantic weekend meeting, Treasury Secretary Paulson announced on July 13 a rescue plan under which the Fed, and ultimately the Treasury, would backstop all Fannie and Freddie debt, and buy equity in the companies should that be necessary to bolster them. The omnibus housing bill passed and signed into law several weeks later codified all this in addition to establishing a new regulator for the GSEs with strong receivership powers.
In the weeks since, Freddie has continued to put off raising capital, even though it finally completed its registration as a corporation with the SEC. Syron said when second-quarter earnings were released Aug. 6 that the company was waiting for a more "propitious" time. One might argue it came in May, when the stock was 25, not 6.
BOTH GSES CONTINUE TO NOTE their so-called core or regulatory capital levels remain comfortably above the minimum required by federal regulation. This ignores what would happen, however, if their balance sheets were marked to fair value -- or if their fair-value estimates were hugely inflated, as indeed may be the case. Both balance sheets, for one, contain an entry called deferred tax assets that bulks up Fannie's fair-value net worth by $36 billion and Freddie's by $28 billion. These assets don't represent real cash but tax credits the agencies have built up over the years that can be used to offset future profits. But, since the tax assets can't be sold to a third party, or disappear in a receivership or sale of the company, they are disallowed in the capital computations of most financial institutions. Ironically, the worse a company does, the more capital cushion this asset creates.
The Bottom Line
A quasi-nationalization of Fannie Mae and Freddie Mac could involve the issuance of new preferred stock. The companies' assets may be worth negative $50 billion each.
The companies also appear to have boosted their capital ratios by sharply curtailing their repurchase of soured mortgages out of the securitizations they've guaranteed. In the fourth quarter of last year, for instance, Freddie Mac took a loss of $736 million on loans repurchased. In this year's first quarter that figure dropped to $51 million -- a stunning decline in view of the continued deterioration of the housing and mortgage markets. Instead, the company made the interest payments to bring the mortgages current -- a much smaller outlay, but a tactic that only pushes an inevitable loss forward into future quarters. In Fannie's case, by postponing the buyback of bad loans the company avoided more than $1 billion in second-quarter charge-offs and a hit to its net worth.
Other numbers also give pause. Less generous marks to Freddie's $132 billion investment holdings in private-label subprime and Alt-A securities would lop another $20 billion off its net worth. And, more than likely, Fannie's credit reserves of $8.9 billion won't fully protect it from future losses on $36 billion of seriously delinquent mortgages on its $2.8 trillion book.
After accounting for deferred tax assets and generous asset marks, Fannie and Freddie each may have a negative $50 billion in asset value, and little prospect of digging themselves out of the hole. Whether Fannie and Freddie are liquidated or nationalized as a prelude to privatization, in their current form they won't be missed.
Thursday 7 August 2008
Humour: New Bubbles Required-Read Here
The Onion is that rare and delicate thing, an American satirical publication with a particularly dry wit.
Often its comments are more germane and incisive than those of the New York Times or Washington Post, but in the tradition of Britains, Private Eye.
But this is classic:
Recession-Plagued Nation Demands New Bubble To Invest In
WASHINGTON—A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.
"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."
The current economic woes, brought on by the collapse of the so-called "housing bubble," are considered the worst to hit investors since the equally untenable dot-com bubble burst in 2001. According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.
"Perhaps the new bubble could have something to do with watching movies on cell phones," said investment banker Greg Carlisle of the New York firm Carlisle, Shaloe & Graves. "Or, say, medicine, or shipping. Or clouds. The manner of bubble isn't important—just as long as it creates a hugely overvalued market based on nothing more than whimsical fantasy and saddled with the potential for a long-term accrual of debts that will never be paid back, thereby unleashing a ripple effect that will take nearly a decade to correct."
Enlarge Image The Next Bubble?
"The U.S. economy cannot survive on sound investments alone," Carlisle added.
Congress is currently considering an emergency economic-stimulus measure, tentatively called the Bubble Act, which would order the Federal Reserve to† begin encouraging massive private investment in some fantastical financial scheme in order to get the nation's false economy back on track.
Current bubbles being considered include the handheld electronics bubble, the undersea-mining-rights bubble, and the decorative office-plant bubble. Additional options include speculative trading in fairy dust—which lobbyists point out has the advantage of being an entirely imaginary commodity to begin with—and a bubble based around a hypothetical, to-be-determined product called "widgets."
The most support thus far has gone toward the so-called paper bubble. In this appealing scenario, various privately issued pieces of paper, backed by government tax incentives but entirely worthless, would temporarily be given grossly inflated artificial values and sold to unsuspecting stockholders by greedy and unscrupulous entrepreneurs.
"Little pieces of paper are the next big thing," speculator Joanna Nadir, of Falls Church, VA said. "Just keep telling yourself that. If enough people can be talked into thinking it's legitimate, it will become temporarily true."
Demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income. But as more and more time has passed with no substitute bubble forthcoming, investors have begun to fear that the worst-case scenario—an outcome known among economists as "real-world repercussions"—may be inevitable.
"Every American family deserves a false sense of security," said Chris Reppto, a risk analyst for Citigroup in New York. "Once we have a bubble to provide a fragile foundation, we can begin building pyramid scheme on top of pyramid scheme, and before we know it, the financial situation will return to normal."
Despite the overwhelming support for a new bubble among investors, some in Washington are critical of the idea, calling continued reliance on bubble-based economics a mistake. Regardless of the outcome of this week's congressional hearings, however, one thing will remain certain: The calls for a new bubble are only going to get louder.
"America needs another bubble," said Chicago investor Bob Taiken. "At this point, bubbles are the only thing keeping us afloat."
Often its comments are more germane and incisive than those of the New York Times or Washington Post, but in the tradition of Britains, Private Eye.
But this is classic:
Recession-Plagued Nation Demands New Bubble To Invest In
WASHINGTON—A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.
"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."
The current economic woes, brought on by the collapse of the so-called "housing bubble," are considered the worst to hit investors since the equally untenable dot-com bubble burst in 2001. According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.
"Perhaps the new bubble could have something to do with watching movies on cell phones," said investment banker Greg Carlisle of the New York firm Carlisle, Shaloe & Graves. "Or, say, medicine, or shipping. Or clouds. The manner of bubble isn't important—just as long as it creates a hugely overvalued market based on nothing more than whimsical fantasy and saddled with the potential for a long-term accrual of debts that will never be paid back, thereby unleashing a ripple effect that will take nearly a decade to correct."
Enlarge Image The Next Bubble?
"The U.S. economy cannot survive on sound investments alone," Carlisle added.
Congress is currently considering an emergency economic-stimulus measure, tentatively called the Bubble Act, which would order the Federal Reserve to† begin encouraging massive private investment in some fantastical financial scheme in order to get the nation's false economy back on track.
Current bubbles being considered include the handheld electronics bubble, the undersea-mining-rights bubble, and the decorative office-plant bubble. Additional options include speculative trading in fairy dust—which lobbyists point out has the advantage of being an entirely imaginary commodity to begin with—and a bubble based around a hypothetical, to-be-determined product called "widgets."
The most support thus far has gone toward the so-called paper bubble. In this appealing scenario, various privately issued pieces of paper, backed by government tax incentives but entirely worthless, would temporarily be given grossly inflated artificial values and sold to unsuspecting stockholders by greedy and unscrupulous entrepreneurs.
"Little pieces of paper are the next big thing," speculator Joanna Nadir, of Falls Church, VA said. "Just keep telling yourself that. If enough people can be talked into thinking it's legitimate, it will become temporarily true."
Demand for a new investment bubble began months ago, when the subprime mortgage bubble burst and left the business world without a suitable source of pretend income. But as more and more time has passed with no substitute bubble forthcoming, investors have begun to fear that the worst-case scenario—an outcome known among economists as "real-world repercussions"—may be inevitable.
"Every American family deserves a false sense of security," said Chris Reppto, a risk analyst for Citigroup in New York. "Once we have a bubble to provide a fragile foundation, we can begin building pyramid scheme on top of pyramid scheme, and before we know it, the financial situation will return to normal."
Despite the overwhelming support for a new bubble among investors, some in Washington are critical of the idea, calling continued reliance on bubble-based economics a mistake. Regardless of the outcome of this week's congressional hearings, however, one thing will remain certain: The calls for a new bubble are only going to get louder.
"America needs another bubble," said Chicago investor Bob Taiken. "At this point, bubbles are the only thing keeping us afloat."
Sunday 3 August 2008
Investment: Recommendations
As we all know, we live in turbulent times. This global depression, which is a combination of structural weakness within the western financial system and massive demand for materials and soft commodities in China and India is truly changing the world we live in.
In a previous blog, I quoted Thomas Malthus's theory that agriculture grows arithmatically (1,2,3,4 etc) and population geometrically (2,4,8,16). He believed that to control population in order to feed the people, we needed pestilence and war. Malthus could not have foreseen the advances in medical science and the influence of the UN on the world.
Please click on the Casey Chart above right for an illustration of this.
In 1979, China introduced it's "one child" law to curb rampant population growth. Whilst draconian and invariably cruel, this policy (albeit unknowingly)has probably done more to stabilise worldwide food prices than any single piece of legislation from any government anywhere, ever.
Despite this, we still have a major food crisis to deal with. The combination of high oil prices and massive hikes in food inflation will have a major toll on our everyday lives.
Below is a short video from Fox News with Bud Conrad which goes straight to the heart of this matter.
Click here for the video
So where to invest? As Bud Conrad mentions, the major US food corporations such as Sarah Lee, Kellogg and General Mills are looking to increase prices by up to 20% by years end. This indicates that the Futures Markets will continue to be strong.
The Powershares DB Agriculture ETF (DBA) is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities – corn, wheat, soy beans and sugar. The index is intended to reflect the performance of the agricultural sector. The fund is nondiversified.
The Market Vectors Agribusiness ETF (MOO) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal Agribusiness index. The fund normally invests at least 80% of total assets in equity securities of U.S. and foreign companies primarily engaged in the business of agriculture, which derive at least 50% of their total revenues from agribusiness. Such companies may include small- and medium-capitalization companies.
I think that this combination of futures and straight equity is very powerful. However, I would advise waiting for a month, as August is looking uncertain for equities generally. Additionally agricultural futures have tended to soften during the summer.
Click here for the Chart
It is not often that I recommend a particular individual stock but Cash America International looks like a no brainer. Along with Ezcorp, Cash America is a leading provider of credit services to individuals who do not have cash resources or access to credit to meet their short-term cash needs. Where do low income people go, now that sub prime loans are no longer available?
Cash America and Ezcorp provide a real alternative but with a much more structured loan criteria and security. If the western economies stay illiquid, people will need short term cash. These two corporations have the means to capture this empty corporate real estate.
Below is an article about Cash America from SeekingAlpha.com,accompanied by a chart of both companies.
Cash America: Up 16% on Higher Guidance
by: Brian Bober posted on: July 08, 2008
Yesterday, Cash America (CSH), the leading pawn retailer and one of the leading cash advance merchants, dramatically raised its Q2 2008 guidance sending the stock up 16%.
Cash America expects second quarter 2008 earnings per share to be between 51 cents and 54 cents. The Company’s updated expectation for the second quarter of 2008 is now between 62 cents and 64 cents per share, up over 44% from 43 cents per share earned in the second quarter of 2007. Cash America will release complete second quarter results on July 24, 2008 before the market opens.
This is the second quarter in a row that during the quarter CSH has increased its guidance. On March 24, 2008 CSH raised its EPS guidance to $.80 - 82 from $.70 – 75 then exceeded that updated guidance on April 24 with actual EPS of $.86. Cash America’s business is really running on almost all cylinders.
Revenue from pawn loans and increased gross profit dollars on the sale of merchandise exceeded expectations… [while the] online cash advance product offering experienced strong revenue growth and lower than expected loan losses.
Regulatory Risk
The only cylinder potentially misfiring is due to regulation risks of its cash advance business. This caused the company to reduce full year 2008 EPS guidance by 15 cents and consider closing 139 stores. The regulatory risks warrant caution however several prominent 3rd parties, including the New York Fed and Yale, have released major studies demonstrating the positive effects of CSH’s type of short term lending.
Online Short-Term Financing Platform
Cash America has a strong, growing online cash advance platform. This platform offers short-term cash advances over the Internet to customers in 32 states and in the UK. The online platform, which was acquired in September 2006, has spent years getting various regulatory approvals and tweaking its proprietary lending models. Recently the president of the Internet Services division purchased 57,400 shares of CSH.
Crossover of Retail Customers
The current consumer lead recession has driven many sub-prime lenders from the market. This has caused many new marginal borrowers to seek financing from Cash America. In addition, many traditional retail customers are crossing over from traditional retail to pre-owned merchandise. Cash America offers a smooth transition for many customers with its strongly branded safe, clean stores easing the migration of new customers. The pre-owned merchandise offered by CSH allows consumers to stretch their limited dollars. For example, it is common for jewelry to be priced 35-40% below traditional retail outlets.
Solid Management & Growth
CSH’s seasoned management has a history of being conservative and open with shareholders. The company’s growth is high quality coming from its brick and mortar stores’ organic growth (not by opening new stores) and through the company’s online platform. Even after yesterday’s run-up Cash America has a P/E around 12 based on its current 2008 full year guidance which now appears extremely conservative.
Click here for the Chart
Again, I believe that if August is as weak for equities as predicted by analysts at RBOS and Morgan Stanley, then it is worth keeping our powder dry for September.
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