May 7, 2008 4:51PM
Making Sense of Fannie and Freddie
By Alexis Glick
Sometimes, I think I’m schizophrenic! On the one hand, I’ve been pretty bullish about this market… and on the other hand, I look at the UBS news, rumors that Bank of America is trying to back away from the $7 a share bid for Countrywide (feeling that they overpaid — you got that right — and would now like to pay $2 a share), and Fannie Mae’s (FNM) third quarterly loss… And I can’t help but wonder is there another shoe to drop.
Everyone I talk to at the big banks, many of whom sit in the executive suite, feel the credit markets have turned the corner. They’re raising money pretty easily, particularly given the climate three months ago. They’re shedding assets and the credit markets have tightened. Just look at the spreads in the credit swaps market. They’re also the first to admit that Wall Street one year from now will look a lot different than it does today, and that at least 20%, if not 30% of the jobs will get cut. How the brokers make money when they’re forced to deliver is a whole other issue all together. I could dedicate five other blogs to that story.
But the reason I’m writing this blog is to discuss the elephants in the room: Fannie Mae (FNM) and Freddie Mac (FRE). After FNM reported its third quarterly loss yesterday, the stock had a very nice rally into the bell. The company added to its string of writedowns and talked about plans to raise $6 billion dollars. Friends tell me that agency paper historically, even at times like this, has a strong underlying bid from foreign investors — particularly given the spreads on agency versus treasury debt. Plus, let’s face it: we’re cheap at the moment and everyone on the planet knows that if we let FNM fail, the entire housing market and financial system collapses. Supporters of FNM say yesterday’s number wasn’t that bad, noting that the company lost $2.3 billion on mortgage defaults compared to $2.2 billion last quarter and that . Call me crazy, but that doesn’t sound very compelling! The company cut its dividend by 29% to 25 cents per share, which Wall Street tends to like — a sign it’s doing what it takes to shore up the balance sheet. That will free up $390 million dollars of capital. Fannie did improve market share, book of business and revenue from their guarantee and investment activities.
So is FNM in trouble? Was raising the cap the right decision or a reckless decision? What do you think about OFHEO’s decision to cut Fannie Mae’s capital surplus to 5%? The decision made by OFHEO, the Office of Federal Housing Enterprise Oversight, to lower its capital requirements and increase the size of the loans it is willing to lend was made in the hopes that FNM and FRE could fund a combined $200 billion in mortgage purchases. The problem, one which Barney Frank is addressing today on Capitol Hill and will address directly with FNM and FRE on May 21st, is why jumbo mortgages are still next to impossible to get and why rates have not improved given the increase in loan limits at FNM and FRE. Wasn’t that initiative supposed to help revitalize the mortgage and home buying market?
To date roughly $330 billion in mortgage securities have been written off and roughly $200 billion has been raised to shore up balance sheets, but predictions for mortgage related debt/risk are as high as $1 trillion. Is the worst behind us in the housing market? Not according to the most recent statement by FNM, who predicted yesterday that home prices in the U.S. could decline another 7 to 9%. Foreclosure filings as we’ve discussed in the past are up 23% in the first quarter and were more than double a year ago and — let’s face facts — we haven’t even hit the peak period of April and May where record amounts of adjustable rate mortgage mortgages are due to reset.
My friend Richard Suttmeier, Chief Market Strategist of Rightside.com makes some very valid and aggressive points on this issue. He notes several key issues:
1. Builders and developers are having problems re-paying $629 billion in construction and development loans to the community and regional banks. Four hundred and sixty-seven publicly traded banks have risk exposure to C & D loans that exceed regulatory guidelines.
2. The Federal Reserve should be the regulator of the primary dealers.
3. The FDIC (Federal Deposit Corporation) should be the regulator for all banks.
He also notes when discussing the TSLF (Term Securities Lending Facility) and PDCF (Primary Dealer Credit Facility):
“I think that the US Treasury and Federal Reserve have gone beyond the letter of the law with these lending facilities, and they put all Americans at risk by taking on securities that no one in the world wants to own. Since announcing these programs yields on US Treasuries have risen dramatically and the sizes of the two-year and five-year auctions have reached record amounts.
As the Federal Reserve takes on more toxic securities the primary dealers are able to buy more from clients around the world. How long will this process take given $165 trillion in notional amount of derivative contracts negotiated mainly by JP Morgan, Bank of America, Citigroup and Wachovia, etc. Don’t forget it’s a global issue with an estimated $500 trillion spread around the globe.
The FDIC Quarterly Banking Profile for Q1 2008 won’t be released until May 29, after Memorial Day. The data filed to the FDIC for this most important economic data includes details not required in reporting banks quarterly earnings report. I comb the data to find where the additional bad loans will come from. Sources tell be that some banks have not yet filed their data for Q1, and Bank of America is on the list of “Not Yet Filed” - HMMM!”
This morning, I invited Richard to state his case for the nationalization of FNM once again. A gutsy call! He thinks all GSEs should be nationalized and regulated by the U.S. Treasury. He doesn’t believe that if losses get worse, the loans will default. At the end of the day, he says they’ll get bailed out regardless of their status as a public company. After all they do have a not so quietly hidden line of credit with the U.S. government.
Get to the point Glick! Take a look at Richard go toe-to-toe with Chuck Lieberman, the Chief Investment Officer of Advisors Capital Management, who thinks Richard is taking it too far.
Believe me, the halls of Congress are panicking about reforming the GSEs and if you don’t think the increased risk on their books to help revitalize this economy isn’t dangerous, you’re kidding yourself. Stay tuned. This is a story that isn’t going away!
Watch the video:
