Monday, March 10, 2008

Barron's Cover Story: Is Fannie Mae (FNM) the Next Government Bailout?

Trying to sort through all the bad financials news today... from Countrywide Financial (CFC) FBI Investigation (as I've stated, they will find someone to put into jail for all this), to Bear Stearns (BSC) having liquidity concerns, to apparently the fears about Fannie Mae (FNM) raised from this Barron's cover story. Yep, letting the financial institutions self regulate is working fantastic! This Fannie/Freddie issue is a line item I've been raising for a long while (get your wallets out folks), but once again unless the Wall Street Journal or Barron's says something the herding sheep of Wall Street refuse to acknowledge it. So today's news apparently was a "shocker", and the stock was rewarded with a 13% loss. As I've been writing, to see such a steep drop in what is essentially a government backed institution is truly troubling...

...what I find most amusing is these 2 companies (along with Freddie Mac) are hobbling but our politicos think its wise to "stimulate" by raising the amount of loans they can take in, raise the type of loans up to $714K, and now recent proposals to allow them to offer mortgages with only 1.5% down. You'd think they politicians want to kill these 2 companies. Sort of the same foresight as the ethanol boondoggle. Well thankfully, they show great vision in all other parts of running our country (ahem)
  • IT'S PERHAPS THE CRUELEST OF ironies that in the U.S. housing market's greatest hour of need, the major entity created during the Depression to bring liquidity to housing, Fannie Mae, may itself soon be in need of bailout.
  • Fannie, of course, occupies a curious middle ground between the public and private sector as a result of its privatization in 1968 as a Government Sponsored Enterprise, or GSE. While owned by its shareholders, Fannie is regulated by a government agency and is able to borrow money cheaply, thanks to an implicit guarantee by Uncle Sam. It uses those funds to buy and securitize home loans -- lots of them. At year end, the company owned in its portfolio or had packaged and guaranteed some $2.8 trillion of mortgages or 23% of all U.S. residential mortgage debt outstanding.
  • Of late, however, Fannie's prospects have darkened notably. The company (ticker: FNM) lost $2.6 billion last year as a surge of red ink in the final two quarters more than wiped out a nicely profitable first half. And by late last week, credit-market jitters had penetrated the once-unassailable hushed precincts of the market in Fannie debt.
  • In the wake of margin calls on collateral at the investment concern Carlyle Capital, yields on guaranteed mortgage securities issued by Fannie and its GSE sibling Freddie Mac (FRE) rose to their highest level over U.S. Treasuries in 22 years. Likewise credit default swaps, measuring market concerns over the safety of Fannie corporate debt, have ballooned out to 2% of the insured amount from 0.5% just four months ago.
  • But, if the truth be known, a considerable portion of Fannie's losses also came from speculative forays into higher-yielding but riskier mortgage products like subprime, Alt-A (a category between subprime and prime in credit quality) and dicey mortgages requiring monthly payments of interest only or less. For example, Fannie's $314 billion of Alt-A -- often called liar loans because borrowers provide little documentation -- accounted for 31.4% of the company's credit losses while making up just 11.9% of its $2.5 trillion single-family-home credit book. Fannie was clearly looking for love -- and market share -- in some of the wrong places.
  • Likewise, Barron's has found other areas that may bode ill for Fannie's prospects. Its balance sheet is larded with soft assets and understated liabilities that would leave the company ill-equipped to weather a serious financial crisis. And spiraling mortgage defaults and falling home prices could bring a tsunami of credit losses over the next two years that will severely test Fannie's solvency.
  • Should Fannie or the similarly hobbled Freddie Mac buckle, the government would no doubt bail them out and honor their debt and mortgage guarantee obligations. Fannie common and preferred shareholders would likely suffer grievously in such a scenario.
  • POOLE HAS LONG BEEN skeptical -- correctly it turns out -- of Fannie and Freddie's ability to serve both God (their social mission of promoting liquidity and affordability) and Mammon (the shareholder and lush management compensation). At Fannie, a generation of Democratic Party insiders, such as James Johnson, Jamie Gorelik and Franklin Raines, made substantial fortunes in Fannie's executive suite. As Fannie Mae's top regulator, James Lockhart, pointed out in recent congressional testimony, the absence of debt-market discipline (the government guarantee makes Fannie and Freddie all but impervious to credit downgrades) makes pell-mell growth irresistible to shareholders and managers. Have a hunch, bet a bunch. (another case of heads I win, tails I still win! Seems to be rampant in our financial system)
If you want to read the specific balance sheet minutia feel free to click on the link to the article... for those of you who just care about the big picture, please prepare to send back that $600 to $1200 you are getting back from the government... they are going to need it back sooner or later ;)

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