Thursday, July 10, 2008 3 comments ++[ CLICK TO COMMENT ]++

Will the US Government Support Fannie Mae and Freddie Mac?

The question of whether Fannie Mae (FNM) and Freddie Mac (FRE) are backed by the US government has mostly been a theoretical question. Well, the theory is starting to enter the practical stage right now. I don't follow these companies closely and don't really know the full details, but my feeling is that these companies will be fine on their own. However, that is not good enough for the market these days. Just like how Lehman Brothers (LEH) is under a cloud of rumours (nearly all of it negative), speculation seems to influence Fannie and Freddie these days more than anything real on the ground.

One of the big problems faced by Fannie and Freddie is similar to what the bond insurers faced over the last year. Namely, mark-to-market valuations show huge losses and we end up with a weak-looking balance sheet. I'm on the side that is very skeptical of mark-to-market values during stressful times--like now. But the market only looks at itself: the market value. These institutions look fine from a fundamental point of view but all it takes is a loss of faith for them to collapse. Remember, Bear Stearns collapsed without defaulting on any payment (in fact, I don't think anyone really knows why Bear collapsed, other than for a run on the bank.) Fannie and Freddie won't collapse and will likely be helped by the government; but that doesn't mean that shareholders in those companies won't be beaten up pretty badly.

Speaking as a newbie, one of the lessons I'm learning is how vulnerable financial institutions, even those with strong history and seemingly decent balance sheets, are to rumours and the whims of the market. Industrial, technology, and various other companies, in contrast, are driven mostly by fundamentals. Sure, the stock price could rise or fall based on future expectations; but there was always a fundamental element. For instance, I invested in GM bonds a few years ago (this was after the ratings cut and rumours of almost-imminent demise) and most of the fluctuations, either in the bond or the stock, were largely due to some fundamental reason (such as sales decline, delayed product, strike/problems with Delphi, etc). I'm not saying rumours and stories don't move these stocks but the move is so minor compared to financials.

One of the things I've wondered is whether Lehman and Bear would have faced similar problems if they were private (as they had been for many decades.)

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3 Response to Will the US Government Support Fannie Mae and Freddie Mac?

July 11, 2008 at 3:18 AM

"one of the lessons I'm learning is how vulnerable financial institutions, even those with strong history and seemingly decent balance sheets, are to rumours and the whims of the market. I"

I disagree. Speculative houses of cards funding bad math with hot money are vulnerable to . . . the truth.

The sad truth is that anyone who purchased a home in the last, say, 36 months paid too much.

That part's no big deal-- values rise and fall, and usually that is dealt with peaceably.

We have the confluence of several other forces that add up to a train wreck:

1) Oil prices . . . effectively a giant tax increase, and a regressive one

2) excessive borrowing leaving homeowners with too little equity

3) interest rates which were so low that there's now a paradox-- the Fed can't push rates below zero, and with a collapsing dollar the Fed's in a bind. Drop rates and the dollar price of oil probably will go right up . . . so net stimulative effect will be zero.

So back to the rumors part. Turns out that the actual situation of Bear Stearns was far _worse_ than rumored. The "seemingly decent" balance sheet wasn't.

July 11, 2008 at 1:15 PM

What makes you say that the Bear assets were worse than it seems? I have seen nothing to indicate that.

You are right about a confluence of other events (I have been trying to write a post about bearish factors over th elast few days but can't pin down my thoughts)... however, some of those factors have little to do with the financials being sold off. For instance, Lehman is off something like 20% right now and what does oil price have to do with that? Oil will slow down the economy and possibly cause slightly higher mortgage defaults but most of the problems faced by financials have to do with asset quality. It's all based on wild rumours...

I think some of the points you raised have more to do with the broad market or other sectors...

synchro
July 11, 2008 at 5:35 PM

Sivaram, you must have missed the memo on Fed's off-balance entity that's holding the Bear Stearns' assets as a result of the JPMorgan/Bear Stearns bailout.

IT HAS ALREADY LOST $1 Billion, wiping out JPMorgan's thin layer of protection charade for taxpayers.

I wonder if your Main Man "Calamity Bill" is still holding his Fannies and Freddies.

Fannie is now trading where it was in 1990 -- 18 years ago.

I am going to stop before I get even more sarcastic and abrasive.

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