First we have the oil spikes above 140. Then we nearly have Lehman committing sepukku. Then we have a surge in profit taking on all commodities, in particular oil prices, which should move stocks higher. Then we have Iran testing some missile, but largely found to be unfounded. The US markets is finding it difficult to get some traction to pull itself to 12,000. Every time it tries, some news comes along to knock it off its feet. The latest to drag the US markets off a couple of hundred points was a report on Fannie and Freddie. Investors took that as another reason to sell but the selling was pretty aimless and unconvincing. Not that Fannie and Freddie needing probably anothe US$75bn to stay relevant is not bad news. It is the final thud on the coffin which investors needed to hear on "solving" the property problems. The fact that the news is out should not signal a SELL but rather a BUY. Below was the CNNMoney article, followed by my posting on Fannie & Freddie back in May:
By Paul R. La Monica, CNNMoney.com editor at large Last Updated: July 8, 2008: 11:09 AM EDT NEW YORK (CNNMoney.com) -- Wall Street needs a glass of milk, some cookies and a hug. Monday's activity on Wall Street was a classic case of what happens when fear takes over and otherwise rational people panic. Just look at the chart of the Dow to the right. In the early part of yesterday's trading, stocks were up because investors were finally starting to see some encouraging news on the inflation front. The dollar had gained ground against the euro and the price of crude oil dipped below $140 a barrel. The weak dollar has been cited as a key reason why the price of oil, food and other commodities have surged lately. But then Lehman Brothers shook the market. Ironically, Monday's financial follies had nothing to do with fears about an imminent collapse of the troubled investment bank. Instead, a widely respected analyst at the firm, Bruce Harting, issued a report about mortgage financing giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), suggesting that there was a chance the two would have to raise an additional $75 billion in capital in the event of an accounting rule change. As news of this report circulated around trading desks, it caused an abrupt end to Monday's rally. The Dow, up as much as 110 points in the morning, plunged in the mid-afternoon. At one point, the Dow was down nearly 168 points before going on to recover some of its losses and finish the day about 57 points in the red. "It's hard to read the mind of investors on a day-to-day basis,"said Jack Ablin, chief investment officer with Harris Private Bank in Chicago. "So whether the market selloff was justified or not, clearly the $75 billion number got the headlines and investors really honed in on it." But the strangest thing about yesterday's sudden change of heart on Wall Street is that as scary as some of the Fannie and Freddie headlines were, if anyone bothered to read the Lehman report in its entirety, they would have noticed that Harting went out of his way to point out that the doomsday scenario he described would probably not come to fruition. He wrote that the ramifications of the pending rule change would be "so contrary to all other current capital ratios and policy initiatives that we cannot imagine such an outcome occurring," and added later on his note that an "onerous increase in capital requirements is unlikely" for Fannie and Freddie. Simply put, this report didn't seem to have enough meat in it to justify the broad market selloff that took place. It's just another example of how bearish market sentiment is these days. Some investors are looking for any excuse to sell - and they found it with the Lehman note. "The reaction to the report shows you how vulnerable the market is. In the note, he didn't list it as an absolute that Fannie and Freddie would have to raise $75 billion. He actually said it was a small possibility," said Quincy Krosby, chief investment strategist with The Hartford.."This is an indication of investors selling now and asking questions later."
Thursday, May 08, 2008Following the scare at Bear Stearns, Paulson and Bernanke are now furiously looking at the troubled Fannie Mae and Freddie Mac. These two were created by the US government and now hold more than 80% of all mortgages bought by investors in 1Q2008. This was doubled the same period last year.
They are the mortgage financiers of choice nowadays because lending has frozen somewhat in other avenues. Both companies have a combined capital of just US$83bn, but holds US$5 trillion in debt and other commitments. Fannie just announced a US$2.19bn loss for 1Q2008 and Freddie will announce next week.
Estimates range from US$17bn-US$22bn, the additional losses they are now sitting on. Weak and weaker housing prices are gnawing at the value of the debt they are holding. Even if both fail, they should not hurt the equity markets badly (but will drag sentiment down) because they will definitely be bailed out. However, such a move will put further downward pressure on the USD.
The potential of just any one of them failing will cause housing prices to dip even further. The longer they are operating on a respirator, it is unlikely housing prices will find a bottom anytime soon. Both companies will need to raise a lot of capital from the market, but will there be investors willing to pony up? The SWFs may be willing to look at them but both are sensitive companies and will not be allowed to have any SWFs on board. Both companies do not lend directly to home buyers but they buy from banks and other lenders. The reason why they account for 80% of all mortgages written in 1Q2008 indicates that banks are quick to sell the mortgages and lighten up as much as they could. Not exactly promising. To alleviate the sub prime issue, these two companies may have been "asked" to buy mortgages from the banks so that credit does not freeze up. But their balance sheet cannot withstand much further if housing prices fall further, which is highly likely. Something's gotta give soon. Another bailout so near election time will be prime fodder for the Democrats to nail the Republicans.
What is exceptionally worrying was that Congress temporarily raised the cap on the size of mortgages these two companies can buy from US$417,000 to US$730,000. This can only mean that credit is also freezing up in the higher range of properties, not just the lower end.
Paulson: Fannie and Freddie are adequately capitalized
photos: Linda Chung Kar Yan