Mr Mortgage: Fannie/Freddie Massively Underestimated Risks
Posted on July 12th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research
I already did a Fannie/Freddie post a couple of days ago. After some thought and listening to the media underestimate the actual risk the agencies present with respect to the quality of the loans they guaranty, I decided to make a video on the subject.
YouTube video link: http://www.youtube.com/watch?v=WzUjccc9eHQ
It is amazing how most still think the agencies are mostly ‘prime’. Nouriel Roubini, who I greatly admire, recently published his spot-on thoughts about this situation and in it, I believe even he overestimates the quality of agency paper and underestimates risk.
Things are changing for the worse daily and it is now clearer than ever that subprime is subprime, Alt-A is closer to subprime than ‘Prime’ and ‘Prime’ is closer to Alt-A than anyone ever thought possible. Making it worse, the ‘negative equity effect’ is reeking havoc across all paper grades. -Best, Mr Mortgage
SUNDAY PM UPDATE… News is Breaking that Paulson is throwing the bathroom sink at this. Not quite the ‘kitchen sink’ yet. Bloomberg summarizes. Read below…what a mess! In the video above I explain why this is so disastrous. Whalen has no idea of the risks involved with something like this.
Making `Explicit’
“It is time to recognize that the GSEs were always dependent upon government support and now we must make the implicit explicit,” said Christopher Whalen, co-founder of independent research firm Institutional Risk Analytics in Torrance, California.
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July 13th, 2008 4:28 am
I just listened to your video on this . . . it’s just getting scary out there. I have to admit, the Fannie Mae and Freddie Mac situation has made me a lot more nervous. There is just one thing I want to know right now – where can the average Jane go to find an honest opinion on whether her finances are in shape to weather the coming storm? My husband and I went to a financial adviser six years ago and decided that his head was lost in the posterior region of his anatomy and did not follow his advice. If we had, I’d know the answer – we’d be screwed. Reading patrick.net, Mish and Mr. Mortgage and has helped me avoid a bunch of land mines, but I’d like a more personal look by an expert. Any hints on finding honest advice, anyone?
July 13th, 2008 9:55 am
The situation was recently described as “falling off a cliff in slow motion”.
All of these catastrophes, and there have been many, have varying lag times in terms of how long it takes for the results to move from Wall Street to Main Street.
For me personally I am planning for the intermediate term, that is until July 10, 2010 two years from now. By that time it will be much more clear how to proceed.
Fortunately we seem to have a bit of time to prepare for the dire outcomes.
Tony
July 13th, 2008 10:12 am
Although the spreads are indeedc widening as Mr. Mortgage points out in his excellent video, we need to characterize this correctly.
The spread which widened Friday was the spread between Freddie and Fannie paper and US Treasuries. I assume that is what Mr. Mortgage is referring to.
However, the CAUSE of the widening spread was huge amounts of money moved OUT of Treasuries and smaller amounts moved into Freddie and Fannie debt. Let me explain
Interest rates and yields on Treasuries went UP 20 basis points on Friday, i.e. the bonds went down 20 basis points. This is because people SOLD Treasuries. One reason they sold Treasuries is because the credit rating of the USA will be jeopardized by putting Fannie and Freddie into conservatorship. So they dumped Treasury bonds.
By contrast, Freddie and Fannie paper was more popular. SOME of those proceeds from the sale of Treasuries went into purchasing Fannie and Freddie bonds.
So the SPREADS widened, but this is because Treasuries took a huge hit.
WHY did all this happen?
Because SOME OF THE people ditching the Treasury paper are snatching up the Freddie and Fannie bonds because they are convinced that it will be guaranteed by the government.
The fresh sale of several billions of dollars of Freddie paper for Monday already looks very well subscribed, and most likely it will go quite well for this very reason.
The forecast for Freddie and Fannie STOCK, by stark contrast, looks much bleaker over time and it looks set to go the path of Lehman.
REMEMBER, in bankruptcy, bondholders have first call on the assets and stock equity holders are DEAD LAST.
Tony
July 13th, 2008 10:25 am
Hi Tony- anomalous activity. lately the trade has been buy UST for safety and sell agency MBS…spreads widening. We had action at some points last week as you point out where speculators are jumping into said distressed agency paper and selling UST. This has not been the typical trade however. Good points.
July 13th, 2008 11:59 am
Tony, if what you described happened, the market would actually see a spread tightening. If UST are sold, UST yields would go up. IF those dollars then went into FNMA you see yields fall on FNMA paper. The result, spreads tightening. TO have the spread widen,(given UST yields went up 20bps) FNMA would have to have had even more flows out, with the proceeds from both sales going into some other investment.
C&C – To determine what you should be doing with your money, you first need to determine the time frame involved with the different accounts($’s) you have to deal with. What sort of volatility are you willing to experience? If you feel you need to prepare for a depression,(which I don’t subscribe), you will need to then determine how bad the depression gets. Do money markets “break the buck”, does the FDIC stay solvent, is paper money worth anything since we are no longer on the gold standard? If you think we are going to experience deflation similar to Japan, you would want to look at the longest duration bonds of the strongest governments. If you do not feel as if you need to prepare for Armageddon, then probably having 1 years earnings in savings/cash/cds is probably sufficient, and then determining your allocation between all remaining assets classes after than depending upon your risk tolerance. I wish there was one right answer, but there is no silver bullet.
July 13th, 2008 12:32 pm
Housing Realist-
There is a bit of subtlety here.
I emphasized in my post that SOME of the UST sales went into agency paper. Some of the OTHER proceeds from Treasury sales clearly went into other currencies and out of the dollar.
Additionally OTHER large capital flows went into GSE bonds, especially after the rumour of the Fed discount window being available to Fannie and Freddie. This helped to lower their yields.
On Friday, Treasuries were net losers (a bad day, on average 20bp), compared to GSE paper. That is why the spreads widened.
The point I was trying to make is that one of the smarter proxy arbitrage trades on Friday was made by players selling Treasury paper and buying GSE paper. This trade, and the justification for it that I just described, was reported either in the WSJ, NYT or FT over the weekend, I just don’t recall which one.
Tony
July 13th, 2008 12:33 pm
But of course the STOCK is a COMPLETELY different analysis, for the reasons previously described…. in bankruptcies the stockholders are last in line and the bondholders are first in line.
Tony
July 13th, 2008 12:37 pm
There were buyers in size of agency MBS paper on Friday, which did push pirces up, yields down. But, again this was not how the trade has been going. This is the ‘the Govt is going to expicitly back $5 trillion’ trade, which I do not think will happen.
I think those that rushed into agency bonds on Friday will get their head handed to them just like everyone who rushed into anything housing or mortgage related thinking they were smart over the past year and a half.
I bet Bill Miller was at the front of the line! Haha.
July 13th, 2008 2:53 pm
Hey–
LOVE what you do, and am a big fan of your site and blogs, but I did want to comment that the little plug you gave for your advertisers at the end was a little much.
I think it is enough that the advertisers are out there for people, but they don’t need to be hawked during your otherwise, very informative clips. Could be a real turn off for many…for what it’s worth.
July 13th, 2008 3:14 pm
So 20bps on $5.3 trillion… with a few more bps to come in the coming days. What are agency MBS rates at now, and what were they say a year ago? It would be interesting to sit down with a calculator to try and figure out the $ swing on the Fannie Freddie $5T…
anyone?
Great stuff here Mr. M.. as always.. way to go.
July 13th, 2008 3:57 pm
I think you are way overstating the actual losses for the gse’s . They’re not going to lose ALL 5 Tril in mortgages. The vast bulk are current with heavy equity behind them. And the ones who do default, theres a home and real estate existing to recover much of the mortgage.
No, what will happen is the stockholders of both gse’s ( preferred included) will lose their equity, about 80 bil. Then the gov will step in and support the bonds. The gse’s will lose maybe 100 bil but so what? The U.S. Gov runs a deficit that large every 3 months so its not going to sink the country.
Afterwards the Gov will reissue new equity on the gse’s to start over again with the strictest of requirements.
The gov has to step in. The loss of confidence if they hung mortgage bond holders out to dry would be nothing short of catatrophic. It’s the equivalent of a default on U.S. treasuries.
July 13th, 2008 6:00 pm
You can call it “slow motion monerization of the debt”. Come to think of it, I think I will hold on to my physical barbaric relic.
July 13th, 2008 6:18 pm
Paulson just came out with a plan to “backup” Fnma and friends!!!
By the way Bill Gross was one of those moving into FNMA towards the end of the week, per the WSJ.
July 13th, 2008 7:19 pm
Futures melting up!!!!!
Could there be a two or three day MAJOR short squeeze? Hmmm…….
July 13th, 2008 7:57 pm
remember CONGRESS has to approve this mess and this will still cut the shares of the stocks in half. I don’t understand what $15 bil will do to make securities holders feel secure that their $5.3 trillion will receive timely payments. I bet anything IF the gap lasts until the morning they will hammer it red within a half an hour.
You know what else this does??? It leaves the investment banks to fend for themselves. Did you see how the borrowing from the IB’s at the TAF is down to zero last week. The market cheered it. I say its because they have NO investment greade collateral left.
July 13th, 2008 7:58 pm
Also, NY Times says “As part of the plan, the administration will also call on Congress to raise the national debt limit, people briefed on the plan said
What will this do to the bucko.
they just say the word ‘bailout’ and futures rally. I think bailouts are because something bad has happened. The market may have finally figured this out.
July 13th, 2008 8:23 pm
Admin. Where did you find that they are only backing with 15bil? Because that is nothing if 5tril default rates inches up by 30bps.
July 13th, 2008 8:27 pm
There could be a rally this week, maybe a good one, but we go lower after yet another last chance to get out.
July 13th, 2008 8:39 pm
What does the bottoming process look like? How much lower do we go? 10%,20%,50%. What is the all clear sign? Stock market is a forward looking discounting mechanism.
July 13th, 2008 9:12 pm
SPX 1050 has a bullseye on it.
July 13th, 2008 9:22 pm
what do operating earnings in the aggregate decline to? I believe 2007 operating earnings came in, in the low 80s. Op earnings contracted a bit over 20% from peak 2000 to 2002.
July 13th, 2008 10:29 pm
15 Billion will cover about a week’s worth of losses!!
It’s a bandaid on a severed jugular!!
July 14th, 2008 12:18 am
Where does this 15bil figure keep coming from? I’ve have not seen that in any of the press releases.
July 14th, 2008 12:22 am
One of the dozen bloomberg articles mentioned it.
July 14th, 2008 12:26 am
As Paulson, Helicopter Ben and our bought and paid for Congressmen get into the act of “saving” the financial system – remember these are the very same folks who made billions of dollars during the speculative bubble. Now the fox get even more powers to guard the taxpayer henhouse which has already been raided.
The bottom line to keep everyone in check is what has worked for every fascist regime since time immemorial – fear!
Folks, your wages are going to be garnished for the rest of your lifetime as well as kids lifetime to insure that these billionaires investments is kept whole. They’ve already made off with the loot. Just note that hedge fund managers made billion dollar bonuses during those bubble years. Just look at the how much Paulson, Bob Rubin and other Wall Street executives made in bonuses during the go-go years. No one is even talking about seizing their assets.
They have scared you so much that you will happily pay to bailout their bad investments for decades to come.
July 14th, 2008 1:18 am
Tony B and Housing Realist – thanks for the guidance! I’ll be making some adjustments over the next few months. After reading all of the insights from you very intelligent people, I’ll be taking some advice from my great grandma too . . . I’m going to stuff my mattress with cash!
July 14th, 2008 4:49 am
Thanks Curiouser and Curiouser-
We are falling off a cliff in slow motion.
The 15 billion dollar figure came from an unsourced article in the Sunday Times of London that was picked up and propagated by Bloomberg and Reuters.
It had some elements of truth to it.
Tony
July 14th, 2008 7:41 am
It reminds me of what my dad always said in the 70′s:
“I’m from the Government, I’m here to help you”
Wheeeeeeeeeeee……
July 14th, 2008 8:38 am
Jim Rogers had a great idea this morning on Bloomberg. Not a lot of risk to it. Short US treasury bonds.Paulson is a national-socialist like all the bums in Washington.
Bailout my eye. Allo inflation ! “Inflate or die.”
July 14th, 2008 11:18 am
Really bugs me to see all of the “shares rally on Fed plan” news.. meanwhile not a lot about the fact that Indymac quietly went titters over the weekend.. Funny timing.. I get the sense that there is a TON of spin out there..
July 14th, 2008 11:22 am
I think the implications of the Federal moves with respect to the GSEs are becoming clear.
The Treasury and Fed have each said that EITHER use of the discount window by the GSEs OR the purchase of stock by the Federal Government to support the share price would cause independence in the decisionmaking of Fannie and Freddie, i.e. more direct Federal involvement in their decisionmaking. In other words, there will be a price to pay if either of these death spiral options becomes necessary.
Fannie and Freddie are each leveraged more than 50 to 1. What is clear throughout all the discussions is that this insane leverage ratio needs to decrease.
What that means is that Fannie and Freddie are going to have to disgorge substantial amounts of the paper they currently hold.
And that means more mortgage paper flooding the market, depressing bond prices and raising both yields and mortgage rates.
Tony
July 14th, 2008 11:23 am
CORRECTION: The Second paragraph above should read:
The Treasury and Fed have each said that EITHER use of the discount window by the GSEs OR the purchase of stock by the Federal Government to support the share price would cause DIMINISHED independence in the decisionmaking of Fannie and Freddie, i.e. more direct Federal involvement in their decisionmaking. In other words, there will be a price to pay if either of these death spiral options becomes necessary.
July 14th, 2008 12:02 pm
[...] Mr Mortgage: Fannie/Freddie Massively Underestimated Risks [...]
July 14th, 2008 12:29 pm
Fannie and Freddie raised 3 Billion this morning and WE the TAX PAYER will fund them with another 15 Billion or whatever… USB writes down more than that every other week for crying out loud. That is absolutely nothing compared to their TRUE losses. Heck, they will have lost that by dinner tonight…
I find it amazing that folks still think that the GSEs are somehow different than the rest. Like their mortgages are much sounder and their leaders were that much more brilliant than other companies. They probably had 100 Billion or so in bad paper before this all came to light. A 15-20 Billion cash infusion will not do much and the street is not going to be impressed with this little game Paulson is playing. They strong armed some folks over the weekend to get what they got done this morning. Try doing that again on Friday and see what happens.
Rates will go higher and mortgages will be that much harder to get. The stricter lending standards and fresh losses will only make it even harder. If this keeps up at some point you will be going to another country to get your loan because we won’t have many lenders left with any money to lend. They will all just be empty shells…
July 14th, 2008 12:54 pm
Gold and silver are saying today. “MONETIZATION OF THE DEBT”. Loud and clear.
July 14th, 2008 1:08 pm
Not everyone is happy as a pig in a pile of slop. In a Bloomberg article today on this mess Jim Rodgers really speaks out and he is none too happy…
The U.S. Treasury Department’s plan to shore up Fannie Mae and Freddie Mac is an “unmitigated disaster” and the largest U.S. mortgage lenders are “basically insolvent,” according to investor Jim Rogers.
Taxpayers will be saddled with debt if Congress approves U.S. Treasury Secretary Henry Paulson’s request for the authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, Rogers said in a Bloomberg Television interview. Rogers is betting that Fannie Mae shares will keep tumbling.
“I don’t know where these guys get the audacity to take our money, taxpayer money, and buy stock in Fannie Mae,” Rogers, 65, said in an interview from Singapore. “So we’re going to bail out everybody else in the world. And it ruins the Federal Reserve’s balance sheet and it makes the dollar more vulnerable and it increases inflation.”
Fannie Mae’s market value is now about $10 billion, down from $38.9 billion at the end of 2007. Freddie Mac’s market value has shrunk to about $5 billion from $22 billion at the end of last year.
“These companies were going to go bankrupt if they hadn’t stepped in to do something, and they should’ve gone bankrupt with all of the mistakes they’ve made,” Rogers said. “What’s going to happen when you Band-Aid and put some Band-Aids on it for another year or two or three? What’s going to happen three years from now when the situation’s much, much, much worse?”
Rogers said he had not covered his so-called short positions in Fannie Mae and would increase his bet if it were to rally. Short sellers borrow stock and then sell it in an effort to profit by repurchasing the securities later at a lower price and returning them to the holder.
The U.S. economy is in a recession, possibly the worst since World War II, Rogers said.
“They’re ruining what has been one of the greatest economies in the world,” Rogers said. Bernanke and Paulson “are bailing out their friends on Wall Street but there are 300 million Americans that are going to have to pay for this.”
July 14th, 2008 1:47 pm
I agree with Jim Rogers. Looking forward to hyperinflation when the US debt doubles in the next year and Helicopter Ben puts the printing press into overdrive just to pay the interest!
Or we can default. Take your pick!
July 14th, 2008 1:53 pm
[...] Mr Mortgage: Fannie/Freddie Massively Underestimated Risks [...]
July 14th, 2008 2:25 pm
Who wants to bet WAMU will not make it through this month? They may not even make it through this week…
Batter up!!!
July 14th, 2008 2:44 pm
ALL LOANS ARE SUBPRIME WHEN THE COLLATERAL IS FALLING 50%
July 14th, 2008 3:22 pm
Let’s see now 5.2 Trillion – 50% haircut = 2.6 Trillion… How much is that per every man, woman and child in this country?
We can probably pay for it by the time they get ramped back up and do it all over again…
July 14th, 2008 7:44 pm
The cost of the bailout(s) is borne more so by currency holders than taxpayers directly. It hurts mostly those without the capital and knowledge to invest in the correct hedges, as cost of living will rise faster than wages.
July 15th, 2008 2:15 pm
[...] Mr Mortgage: Fannie/Freddie Massively Underestimated Risks [...]
July 16th, 2008 2:46 am
I am sure Jim Rogers is hopping mad on this.
What a bunch of morons !
Short selling banned for brokerage stocks, not mining stocks
Submitted by cpowell on 02:47PM ET Tuesday, July 15, 2008. Section: Daily Dispatches
SEC Curbs Shorting of GSE Stocks,
Considers Limits for Wider Market
By Kara Scannell
The Wall Street Journal
Tuesday, July 15, 2008
WASHINGTON — The Securities and Exchange Commission announced an emergency action aimed at reducing short-selling that targets Wall Street brokerage firms as well as Fannie Mae and Freddie Mac, and will immediately begin considering new rules to extend new requirements to the rest of the market.
SEC Chairman Christopher Cox said the SEC would institute an emergency order requiring any traders to pre-borrow stock before shorting Fannie Mae and Freddie Mac, the embattled government-sponsored entities that own or back more than half the nation’s mortgages. It would also apply to the stocks of Lehman Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley. The order is a near-term fix and will expire in 30 days.
Mr. Cox said the SEC “will undertake a rulemaking to address the same issues” across the market.
The move will likely limit short-selling for the two mortgage entities, which have seen their stock prices fall sharply in recent weeks. Wall Street has been calling for the SEC to address short-selling, which some believe is contributing to market volatility and could be used to manipulate shares of financial stocks.
It comes as short interest, or the amount of outstanding short positions, is at an all-time high for NYSE Euronext-listed stocks.
Short-selling, a legitimate trading strategy geared to profit from falling stock prices, has long been a lightning-rod issue, so changes that cover the entire market will likely be hotly debated. Companies have complained that short-sellers target their stocks with the purpose of driving them down, while short-sellers have been credited with identifying a company’s true market value.
Under current rules, a short-seller must locate shares to borrow, which are later replaced with stock bought at a lower price. Some market watchers have been concerned that traders were borrowing the same shares from the same lender over and over, and driving down stock prices.
Under the emergency order, traders will be required to borrow the stock and the lender would then take it out of the market and not allow other traders to use it to satisfy requirements that they’ve located stock.
July 17th, 2008 2:30 am
By Kara Scannell
The Wall Street Journal
Tuesday, July 15, 2008
WASHINGTON — The Securities and Exchange Commission announced an emergency action aimed at reducing short-selling that targets Wall Street brokerage firms as well as Fannie Mae and Freddie Mac, and will immediately begin considering new rules to extend new requirements to the rest of the market.
Marc,
Kara from the WSJ omitted an important word in her article. This statement is incorrect and that is proven by her next comment,…”SEC Chairman Christopher Cox said the SEC would institute an emergency order requiring any traders to pre-borrow stock before shorting Fannie Mae and Freddie Mac”.
What Cox stated the SEC was attempting to limit NAKED short selling. Naked short selling is basically counterfeiting shares and selling them in the market. There is a huge difference between the two. This game has been played though out wall street to the tune of hundreds and hundreds of billions of dollars.
This should be the next great scandal to hit the street. Once you know the facts surrounding this practice it becomes tough to buy stock, it seems much safer to short. Here is a link to an interview with an old wall street hand named Bud Burrell, I would advise anyone who is long stocks to listen to this even if you are familiar with naked short selling as Bud claims this reaches to the highest levels of our government where even the regulators are bought off. here is the link…
http://www.financialsense.com/fsn/main.html
Listen to Special interview:
The Greatest Crime in History
July 17th, 2008 6:26 am
At it was done by the preferred clients of the banks, their buddies the hedge fund managers.
Naked short selling. Yes they do it in the mining sector with complete contempt. These hypocrits and these bums from the SEC are ONLY intervening in the banking sector.
What’s this ? I know it was naked shorting. But it’s strange, this was the case for years in the gold mining sector and small share, and the SEC found it perfectly OK. What Bushie shit runs this organization.Good work Brownie. Bush is a incompetent shit. I am hopping mad.
Now the SEC will be investigating the rumour spreaders on the US banking system. Will they do the same thing for the other sectors ?
July 22nd, 2008 8:05 pm
[...] Mr Mortgage on Fannie/Freddie Massively Underestimated Risks [...]
July 22nd, 2008 9:42 pm
[...] Mr Mortgage on Fannie/Freddie Massively Underestimated Risks [...]
July 22nd, 2008 10:31 pm
[...] Mr Mortgage on Fannie/Freddie Massively Underestimated Risks [...]
July 27th, 2008 8:21 pm
[...] Mr Mortgage on Fannie/Freddie Massively Underestimated Risks [...]
July 30th, 2008 4:04 pm
[...] Fannie/Freddie: Massively Underestimated Risks [...]
August 4th, 2008 8:22 pm
[...] Fannie/Freddie: Massively Underestimated Risks [...]
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August 28th, 2008 12:14 am
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September 1st, 2008 10:43 am
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