Monday, January 4, 2010

Fed economist calls for US government Mortgage Backed Securities guarantees (FNM; FRE)

For Fannie and Freddie shareholders: Always remember, the survival of the corporate entities does not imply the survival of equity investments in the common. The only reason the Federales forbear on a wipeout is the hassle of taking the current conservatorship to the endgame, receivership.**
As we promised in our Dec. 30 post "The Price for Fannie and Freddie Keeps Going Up (FNM; FRE)":
This is a bookmark as much as anything else. Next month we'll get into some serious questions:

1) If the Treasury backstop is now "explicit", why the heck are the agencies paying higher yields than comparable treasuries.

2) With rising interest rates (thus falling prices) all but baked in, who is going to take the other side of the interest rate swaps that Fannie and Freddie need to manage their portfolio risk? AIG? Lehman?

3) Is Chairman Bernanke taking a page from Greenspan's book (using the agencies as liquidity providers during the Russian default/LTCM meltdown of 1998)?

All these fascinating queries and more, coming up!
Here's one part of the equation, question one, from Reuters:

* Fed economist wants asset-backed securities guaranteed

* Would avert Fannie Mae, Freddie Mac collapse, he argues

* Suggests guarantees similar to FDIC's structure

* Comments come as fate of Fannie Mae/Freddie Mac debated

By Joe Rauch

ATLANTA, Jan 3 (Reuters) - A U.S. Federal Reserve economist called on Sunday for the creation of a new federal institution to backstop losses on asset-backed securities to prevent any future collapse of mortgage finance giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N).

The government had to take over the mortgage finance companies in 2008 as a devastating financial crisis worsened. The two had been shareholder owned, but their congressional charters and Treasury lines of credit lent their debt securities a status just short of U.S. Treasuries in the eyes of investors.

"There ought to be government-backed ABS," said Fed economist Wayne Passmore in a presentation to the American Economic Association.

Atlanta Federal Reserve Bank President Dennis Lockhart participated in the session but did not make comments.

Fannie Mae and Freddie Mac, even under government control, play a major role in U.S. mortgage finance, and President Barack Obama has promised to propose early in 2010 how the companies should be structured in the future....MORE

Here's a bit on question three, from the Dec. 31 New York Times' article "Doubts on Regulation and Renewal Hang Over Wall St.":

...Right now, low rates are fattening banks’ profit margins, since many lenders are not passing on their own low costs to borrowers.[*] Lending rates will also spike as the government withdraws its trillion-dollar support of the mortgage market in the spring.

“Are they going to kill the housing market?” said Laurence D. Fink, chief executive of BlackRock, a big money management firm. “That is an issue.”

Most banks are hunkering down in anticipation of another big wave of real estate and consumer loan losses. Small and midsize banks are expected to be hit especially hard: They must absorb nearly $900 billion of commercial real estate losses over the next few years, causing several hundred banks to fail....

Both links were in the ZeroHedge post "In The Year 3000: Predicting The Liability Side Of The Fed's Balance Sheet"

*We first raised the "reliquify the balance sheets" question in our December '08 post "Mom, Ben Bernanke Likes Bankers Better than He Likes You"":

Savers are getting screwed as banks reliquify their balance sheets.
The ostensible reason short rates are now officially at 0.2% is to encourage banks to lend.
It's not going to happen. The banks are not taking on individual's or commercial's risk. Auto loans for a FICO score of less than 720 aren't being written.
So what are they doing? Carry-trade (say it like "Toga party").
For months, the borrow U.S. short, lend U.S. long has been used to rebuild banks balance sheets, destroyed by their former business practices.

Now with the Fed explicitly committed to lowering long rates (the 30-year trading at 2.63%, the 10-year at 2.144%), even borrowing at 0.2% doesn't give enough spread to run cash flow through the income statement and onto the bank's balance sheets.
What will the banks do? My guess is they will start buying sovereign debt for the yield, maybe even selling it to the Fed so they can take the money and do it all over again.
Right now Australian 15-years are priced at 4.20%.

Today, the American saver gets a pittance in a money market. It's really nothing but a wealth transfer racket.
Mom, we're going to Sydney.
Similar thoughts at "Investment Postcards from Cape Town":


...Hat tip: Mish, Global Economic Analysis

I joke around a lot but decided to get serious in our Oct. '09 post "Markets-Where Do We Go From Here?: Bank Earnings (BAC; C; GS; JPM)" [then he started cracking wise again -ed]:

...In September we pointed out the change in leadership the markets were experiencing, the bank sector which had led from the March 9 low were weakening. This has reversed in the last week and more particularly on Friday (KBW Bank Index [BKX] vs S&P):

Chart for KBW Bank Index (^BKX)

There is much handwringing about the bank's failure to lend.
Chairman Bernanke and the bankers are crying crocodile tears.

This is a deliberate policy. The banks get to play the U.S.'s do-it-yourself carry trade, borrow at an average .30% and lend at 4.00% (U.S. treasuries) 5.00% (mortgages) 10% (commercial loans), 12-28% (credit cards). They are literally printing money.

The Fed benefits by the banks buying treasuries because it allows them to perform their Quantitive Easing (monetizing the debt, i.e. printing money) in the mortgage market, cleaning up Fannie and Freddie's balance sheets. If the Fed didn't have the banks in the treasury markets interest rates would be considerably higher right now.
Everyone wins. If you forget about mom and pop savers.

Another wrinkle is the change the Financial Accounting Standards Board made last spring regarding how banks get to write down/write up their junk assets.
The new rules basically allow them to use whatever valuation they need to meet regulatory capital requirement. Cool huh?

Back when the FASB was considering the change we thought it was a big enough deal to put up multiple posts:

March 25
Banks to Write-UP Assets?
Following my mission critical (coffee a.m., lights p.m.) duties in importance is attempting to ascertain (sometimes feebly) regulatory impacts and how to make a buck off them. Here's one worth looking at, from the National Center for Policy Analysis:...
March 30
Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes
April 2
FASB Eases Fair-Value Rules Amid Lawmaker Pressure
April 2
Markets: Why the FASB Decision Matters

On Monday March 30 we posted "Getting Ready for the Wednesday/Thursday Market Pop":
As I said in the post immediately below, reality has attempted to intrude on the blogging.
I won't get all Fibonacci or 50-day on you, this decline has an odd feel to it. We might be setting up a nice mid-week run. The DJIA is currently down 307 at 7468 and the S & P is down 53.81 at 1491....
One of our rationales was the FASB move we'd been reporting was coming.
On Wednesday April 1 we posted "U.S. stock futures slip to start second quarter":

Great. Here I am calling for a midweek pop in the market and Dow futures indicate down 52.
Will this thwart my plans for world domination? In the words of Jimmy James (News Radio):

Mr. James:
"The original title of this book was 'Jimmy James, Capitalist Lion Tamer' but I see now that it's... 'Jimmy James, Macho Business Donkey Wrestler'... you know what it is... I had the book translated into Japanese then back in again into English. Macho Business Donkey Wrestler... well there you go... it's got kind of a ring to it don't it?

Anyway, I wanted to read from chapter three... which is the story of my first rise to financial prominence... I had a small house of brokerage on Wall Street... many days no business come to my hut... my hut... but Jimmy has fear? A thousand times no. I never doubted myself for a minute for I knew that my monkey strong bowels were girded with strength like the loins of a dragon ribboned with fat and the opulence of buffalo... dung. ...Glorious sunset of my heart was fading. Soon the super karate monkey death car would park in my space. But Jimmy has fancy plans... and pants to match. The monkey clown horrible karate round and yummy like cute small baby chick would beat the donkey."
-Episode #57 "Super Karate Monkey Death Car"
By way of
Well there you go. Pretty much says it all....
...By the bye, tomorrow the FASB will meet to decide whether to rescind mark-to-market accounting for the banks, see "Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes".
We gave you the rest of the story on May 30:
Thoughts on Markets, Investing and Life
The Dow Jones Industrial Average closed up 152.68 that day and a further 216.48. the next.
The run actually started a day earlier than I thought it would, with an 86 point advance on Tuesday.

Mom used to say, "It's great fun to fool around, just get your homework done first."
And there you go. One of the reasons we posted "Do not sell equities, Credit Suisse says" a week ago.
Update- one more thing to factor in, From Bloomberg:

Writedowns on Mortgage Servicing Make Even JPMorgan Vulnerable
The four biggest U.S. banks by assets may have to take writedowns on $55 billion of mortgage- collection contracts after marking them up by $11 billion in the second quarter, casting a shadow over earnings....

Well there you go.

**See also:

Walker F. Todd, “Bank Conservatorship and Receivership,” Economic Commentary, October 1, 1994, Federal Reserve Bank of Cleveland. It can be accessed at
And our recent posts on the GSE's:
U.S. to Lose $400 Billion on Fannie, Freddie, Wallison Says (FRE; FNM)
After TARP: Hidden bank subsidies-12/30/2009 (BAC; C; FNM; FRE)

Lawmakers Want Probe Into Treasury Aid for Fannie, Freddie (FRE; FNM)

The Price for Fannie and Freddie Keeps Going Up (FNM; FRE)

Fannie Mae, Freddie Mac exec pay suggests stock worth nothing (FNM; FRE)

Credit Suisse: Fannie, Freddie Action Means Large Scale Buyouts of Loans in Their Securities (FNM; FRE)

Fannie, Freddie Soar 20% on Treasury’s “Blank Cheque” (FNM; FRE)

Big Decision Looms on Fannie, Freddie (FNM; FRE)