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CNBC Anchor Stunned
Thursday, July 10, 2008
Freddie
Posted by Harriet at 12:52 PM
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33 comments:
Pretty scary.
Contrarian - see the link. Its now 2 items suggesting doom, 1 item (paulson article) suggesting not. Average is shifting towards you my friend!!!
Ace said...
Pretty scary.
You bet it is. Anon you better make it 3 to 1 because as bullish as I am, even I am spooked by this.
If Fannie & Freddie go down I think our BEST CASE scenario is that we are back at September 2007 again. Meaning all the housing market gains (not in prices but in fundamentals), of the last 10 months are wiped out. I will not even state my worst case scenario here publicly, but lets just say this, even if you want to buy, you really really shouldnt root for them to fail.
As free market as I am, here I would support a govt prop up (not like it matters because it would happen anyway). Right now, their pricing is driven by fear, and rightly so. It will subside only if there is some real soundness in them - the next 10 days will be critical.
Wow.
Sorta like Enron, Nortel, Worldcom.
crt, maybe all of us ought to
--sell if we can or finish paying on our lease, then
--pitch in and buy one of those empty McMansions,
--hide in it until this has completely blown over.
Contrarian said...
But I already knew that. I have been telling people this was going to happen since 2002. :-)"
Hold on there big fella. It aint in the bag yet. Besides, something tells me youve had some predicitons in the past that havent worked out as gloomily as you suggest. As have I countless times...
The other issue is timing. Ive said to friends that I do think humanity will get wiped out by an asteroid impact. Like so many predictions like this is not a matter of "if" but "when".
Same thing goes for predictions of the downfall of the UK as a global superpower. The writing was on the wall for them back in the 1860s and at that point many were coming out and saying their downfall was imminent. It kicked up again in the 1890's 1910's WWI and FINALLY happended in WWII.
So in hindsight, we now look back at those 1860's predicters as real oracles. That said, they died before their predictions came true and were called nutjobs til the day of their death. Did they really "know" it, or were they just predicting something that would happen eventually anyway?
If Fannie and Freddie go under, or are even forced to stop lending all bets are off.
What we would see then would be a true crisis.
I hope the taxpayer is able to escape without picking up the bill again, I doubt it...
"Sorta like Enron, Nortel, Worldcom."
In more ways than one...
Bad accounting, too big to fail...
This is a perfect example of why the government never should have let Fannie and Freddie grow into what they have become in the first place.
Now that they have all but eliminated their competition they are almost impossible to let fail, but that is exactly what they should do.
Does the stock price actually effect capitalization for Freddie and Fannie? Unless they were selling more stocks to raise money... I mean, their dividends will be dropping because they are not going to be making money in the near term, so their stock price should be going down between that and general uncertainty, but the stock price itself reflects their percieved value, right? Not effects their actual balance sheets, right?
From WSJ:
The time lapse between Freddie's announcement of its intention to raise the fresh funds and the actual offering of common stock will dearly cost the company's shareholders.
If Freddie had issued $2.75 billion of common stock at its May 14 stock price, it would have needed to issue some 100 million new common shares. An issue of that size would have been about 16% dilutive to existing shareholders.
Since that time, Freddie's stock price has plunged more than 70%, so if it were to raise those funds at prices as low as those Thursday - the stock sold at times at around $8 - Freddie would have to issue more than 340 million shares.
Freddie had 646.72 million shares outstanding as of March 31. Issuing 340 million new shares would dilute the value of holdings of existing stock holders by more than 50%.
Given the steep decline in share price, the common stock offering "will be substantially more dilutive than management likely initially estimated," said UBS analysts led by Eric Wasserstrom in a research note Thursday. Wasserstrom is cautious on the shares, citing "challenges of raising capital" among the reasons behind his outlook.
So yes, it will effect the capitalization in that they have to offer far more existing shares thus seriously diluting ownership.
Thanks Joel and Silvia,
I was under the mistaken impression that that stock sale capitalization had already come and gone. The time lapse is a killer. Is there any chance they will thus choose a different path for capitalization, since this one now looks so, mmm, foolish?
"Freddie had 646.72 million shares outstanding as of March 31. Issuing 340 million new shares would dilute the value of holdings of existing stock holders by more than 50%."
Not only that... but you can't just increase supply by 50% and expect the stock price to hold steady.
You would expect them to have to sell at a significant discount to the current market price.
Barry Ritholtz calls them "Fraudie and Phonie."
They are undercapitalized and have been living on the edge for years. This much we know. But we also know that the powers that be in the US and abroad absolutely cannot permit them to go down the tubes. That would jeopardize the world economy. Both the Fed and the Treasury know that the US economy is seriously overleveraged, and they're trying to unwind this mess in as orderly a fashion as possible, thus preventing the panic, malaise, and debt deflation that caused the Great Depression.
Which brings us back to Fraudie and Phonie. Our net creditor trading partners will provide the GSEs with sufficient capital to remain solvent while we deleverage for the next 2 years. China would be up the creek if we stopped buying their goods. Once FNM and FRE shaft their existing shareholders by issuing diluted stock, it may actually be a good time to buy shares on the cheap.
Fannie, Freddie `Insolvent' After Losses, Poole Says
Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae's assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.
``Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,'' Poole, 71, who left the Fed in March, said in the interview yesterday.
http://tinyurl.com/5qylgd
So Contrarian, how do you think this will play out and what do you suggest that someone do with their down payment?
Watching pre-market trading, Fannie Mae broke Google. The graph literally went off the charts like you would think of in a cartoon. I got a screencap:
fannie free fall
I see two likely options:
First, there will be no White Knight. No one is going to want to touch this with a 100-foot cattle prod, so basically versions of government intervention.
1 ) Government extends 5 or 10-year loans to both companies (think the Chrysler bailout in the 80s). I view this as the most likely option.
2 ) Government takeover. Shares go to zero, but bonds will be redeemed at face value.
Either way, it's a bad scenario.
I think you're all over reacting. Afterall, all of these banks and companies are using new "intraweb" techniques to verify the true risk model of their customers. They would not have lent money that wouldn't be repaid. Besides, the higher subprime interest rates account for the defaults. Risk is well balanced over our pan-global economy.
My $0.02
PS - sorry, had to channel a little bit of Lance there...
Speaking of channeling lance... I really should go dig up his famous "subprime lemonaid" post where he "explained" to all of us how the new risk models had allowed lenders to compensate for default risks among subprime borrowers.
Contrarian: As I said the mortgage tax deductions did not exist before the 1970s, and they were a gimmick to prop up the U.S. economy.
I'm fairly certain that it existed prior to the 1970's.
Found it. Here.
By the time the G.I.'s returned from World War II, bursting with dreams of homeownership, the mortgage industry was ready for them. It wasn't until after 1950 that the majority of homeowners had mortgages. And thanks to this ready financing, renters suddenly became owners. After hovering around 45 percent for the first half of the 20th century, the proportion of owner-occupied homes soared. By 1960, 62 percent of Americans owned their homes. (Today, the figure is only slightly higher: 69 percent.)
Of course, it was in those postwar years, when people were getting their first mortgages and also their first homes, that Americans discovered the joy of the interest deduction.
Lots of gloom 'n doom at WaPo and other sites. The stock price cratering of FNM and FRE combined with the IndyMac failure sure is interesting reading.
I mowed my lawn yesterday. Last night, I organized some books to give away. I'll head over to Home Depot this morning, we're working on the basement. Might swing by a pal's restaurant for lunch.
What I'm saying is that life goes on.
"KH Said...
I'm fairly certain that it existed prior to the 1970's. "
Thats essentially correct, basically all interest was deductible and has been since day 1 of the tax code. IRS has tried to make certain types of interest non-deductible, especially after Commissioner v. Glenshaw Glass (I think) when it finally got a big win from the supreme court.
It was in the 70's when the IRS was looking to trim down certain types of home mortgage interest that Congress stepped in and codified what had essentially been part of the common law for the last 70 years. At that point the IRS backed off, and the rest is history.
Thats the amazing thing about the Code. Its so complex, yet silent on so many issues. If you read it, and make a sound argument based on it (and tax court precedent) on why you dont need to pay this tax or that theres a good chance you will win, because even the IRS doesnt "know" if you are right or not (again, because the code is silent or unclear on the issue).
As a kid I always thought (mostly from TV & the likes) that an audit was the most dreaded thing in the world. However, when you know a bit about the law itself, its amazing how quickly an auditor will give up and move on to an easier "target" who it can push around. Sad but true...
Incidentally, Contrarian, the word "scheme" is not always bad. It is a legal "term of art" which has negative connotations with the general public (i.e. some court cases still use the term "bastard" for instance).
As long as others are discussing tax law. I'll put on my tax lawyer hat and chime in:
-- For an outstanding article concerning the history of the mortgage interest deduction, I refer all of you to this 2006 NY Times piece:
http://tinyurl.com/ru285
-- Personal interest expenses were generally deductible from the beginning of the tax code through 1986. Some here may recall being able to deduct credit card interest. It was not a matter of common law, but rather, it was a code section that allowed a deduction for interest paid with little limitation. I'll leave it to CRT to explain what Glenshaw Glass, an opinion concerning the definition of income, had to do with personal interest deductions.
-- As consumer indebtedness grew after WWII, the component of the interest deduction attributable to personal expenditures grew with it. In 1986, Congress limited deductions for personal interest to certain mortgage interest. Although the 1986 Act limited the deduction for personal interest, it also lowered the top marginal rate from 50% to 28%.
-- President Bush's Tax Reform panel proposed several years ago to eliminate the mortgage interest deduction and replace it with a limited tax credit. Converting the item from a deduction to a credit means that a dollar of interest paid would have the same tax benefit for all taxpayers, regardless of their marginal rate ( a deduction for a taxpayer in the 28% bracket is worth 28 cents whereas a deduction for a taxpayer in the 15% bracket is worth 15 cents).
"a deduction for a taxpayer in the 28% bracket is worth 28 cents whereas a deduction for a taxpayer in the 15% bracket is worth 15 cents"
I should clarify that a dollar deduction is worth 28 cents in tax savings to someone in the 28% bracket, and so on for someone in the 15% bracket.
OK, I can rest easy.
"Terminator X said...
I'll leave it to CRT to explain what Glenshaw Glass, an opinion concerning the definition of income, had to do with personal interest deductions."
Was Glenshaw Glass the "gross income wherever derived" case? If so, I must be confusing this case with another. Tax law 101 was many years ago for me. Either way, I will defer to you on the subject...
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