Market Wrap Up - What is next for Fannie Mae and Freddie Mac?

Late last night the New York Times broke a story that the Bush administration had escalated their discussions on what to do about the problems facing Fannie Mae (FNM) and Freddie Mac (FRE). The article raised the possibility of these two companies becoming nationalized. What that means, if it were to ever happen, is that the US Government (and all of us tax payers) become responsible for nearly $5 Trillion worth of mortgage paper. Just the ‘thought’ of that happening sent the futures tumbling in the overnight hours and created our sell off this morning.

Throughout the day we had statements from all kinds of people. Hank Paulson said their focus is on backing Fannie and Freddie in their "current form". So was he saying the Government will not nationalize them? Then their was a statement that hit the media that was claimed to have been made by Ben Bernanke saying the Federal Reserve will create an emergency ‘lending window’ for Fannie and Freddie. But later the Federal Reserve denied that claim. Also during the day were statements from Fannie and Freddie who said they are ‘well capitalized. All of this action had the markets not knowing which way to go. It was one of the strangest days on Wall Street that I have seen in many years. As a matter of fact I have printed the intra-day chart of today’s S&P 500 trading and have placed it up on the wall in my office for this will be one to remember.

What is next for Fannie and Freddie? The companies say they have no problems, but the market thinks there is a problem and a big one at that. The stock market is the final arbiter of any matter. The stock market is the collective knowledge of millions of people. It is that collective knowledge that determines the final price for any stock. And what the collective knowledge is saying is that Fannie and Freddie are in big trouble.

History has proven to be correct just about every time when it comes to massive sell offs of a stock. We only need to look at recent events to see this like with Bear Stearns, Ambac, MBIA, and today IndyMac Bank. The facts are that Fannie and Freddie hold nearly $5 Trillion of mortgages and mortgage backed assets. It is a fact that foreclosure rates are rising at an alarming rate. It is a fact that home prices are still declining and numerous projections put the declines continuing as far as into 2010. It is a fact that the credit markets are not functioning properly at all. And it is a fact that the values of these mortgage backed assets are declining. So who is right? Fannie and Freddie, or the market arbiter?

Aside from the trading action in the stock market today was another important development. And that was in the bond markets. Typically bonds and treasury notes are the "flight to safety" trade. Meaning that when money gets pulled from the equities market there is a surge of money going into the bond market. Like a stock, when more people buy the notes the price of those notes goes up. But associated with the bonds is their yields, and the yield moves inversely to the price. So what happens is when the stock market goes down so do the yields (because people are buying into the bond market). What was witnessed today was yields rising even with the equities market going down. This signals something very bad. It says that as money is coming out of the stock market it was also coming out of the bond market. This can be for only one reason, declining confidence in the US Financial system as a whole.

If the selling in the bond market escalates it will raise the yields and subsequently just about anything tied to interest rates will rise as well. Everything from credit card rates to mortgage rates would be impacted. And that is a situation that would be disastrous to an economy already that is already in terrible shape. It would further erode the housing market, increase the cost to use credit, and push the economy down much further. Ben Bernanke says he has studied the Great Depression and is fully aware of how it happened. The man is really starting to scare me. I have to wonder with all the knowledge of the Great Depression he has if he is re-enacting it in his policy decisions. I sure hope not.

The action in the bond markets today signaled potential danger. If foreign governments decide to start selling some of their holdings of US treasury notes then the bond market could crash, sending the yields up much higher. Keep an eye on the 10 year note yield (symbol $TNX). Should that keep going up it says money is being pulled from the bond markets. With the announcement tonight that IndyMac Bank has failed and has been taken over by the FDIC we have to wait until Sunday evening to determine the impact to the markets because the futures market was closed at the time of the announcement. The stock market remains extremely oversold on a technical basis so we are really in a state that is difficult to gauge at this time. If the market takes the IndyMac news badly then we may very well see substantial selling again. And we also have the Fannie and Freddie situation to monitor.

I will have charts and additional commentary over the weekend.

IndyMac Bank (IMB) Has Been Taken Over By the FDIC

BREAKING NEWS

It is now official. IndyMac Bancorp (IMB) has failed and is being taken over by the FDIC immediately.

US Banking Regulators Close IndyMac Bancorp; FDIC Takes Over

Last update: 7/11/2008 6:15:33 PM
By Tom Barkley
Of DOW JONES NEWSWIRES

WASHINGTON (Dow Jones)–IndyMac Bancorp Inc. (IMB) became the biggest retail bank to fall victim to the U.S. mortgage crisis Friday, as regulators shut down the Pasadena, Calif.-based savings bank.
The Federal Deposit Insurance Corp. said it will take over operations of the bank, which is fifth bank to fail this year.
It also ranks as one of the largest banks to go under, with assets of $32 billion ranking only behind the demise of the $40 billion Continental Illinois National Bank & Trust Co. in 1984 - not accounting for inflation. Continental Illinois was the first bank considered "too big to fail" by regulators.
Even when considering inflation, it’s likely the biggest since the savings-and-loan crisis of the late 1980s., according to Bert Ely, president of the consulting firm Ely & Co.
The failure of IndyMac, the country’s ninth-largest mortgage lender last year, was widely rumored after the bank announced earlier this week that it was laying off half its workforce and halting mortgage-origination activity.
The FDIC set up a bridge bank to handle the dismantling of IndyMac, an unusual move that some analysts had anticipated given the size and complexity of the bank.
"It’s just too big to deal with overnight in this situation," said Ely.
A similar process was used to manage the failure of Superior Bank FSB of Hinsdale, Ill., in 2001, which had $1.8 billion in assets. The FDIC typically lines up a buyer to take over the deposits, as well as some assets, of a failing institution.
The new institution, IndyMac Federal Bank, will open for business Monday and be run by the FDIC, it said in a release.

Stock Market Close

What a week!  Everyone’s been talking about the possibility of an oversold bounce, and yet every time it appears to be happening…..belly flop!  The financial media and many analysts have been saying the "bottom is in", or a financial institution just showed "the kitchen sink quarter", and "the worst is behind us".  How many times can they say it and still have people believe them?  If a trader gets burned often enough, they will not follow the recommendations or listen to the rumors one more time.  Usually that’s because by this time, the trader is broke.  But, if they aren’t, they are sick of being taken!  Chuck has said many times that one must wait for confirmation of a move before placing a trade.  Call me Miss Impatience, because I hate waiting for that confirmation!  But, boy oh boy, has it kept me out of trouble and it’s very profitable.  Look at the charts and you will see the bloodied hands of the knife catchers.  I bet you could even see the empty wallets of the bottom pickers.  Don’t let this be YOU!

Today’s wild ride included all the talk of the GSE’s (government sponsored entities) Fannie Mae (FNM) and Freddie Mac (FRE).  Will the Fed take them over or not?  Are they insolvent or not?  Is it even a good thing if the Fed takes over?  The first answer is I don’t know.  Insolvent?  Probably.  And, no, it’s not good if the government takes over.  Chuck will write tonight about how this situation may affect the bond market.

The spike towards the end of the day was a combination of regular short covering and the speculation that the FED would open the discount window to Freddie and Fannie.  The Fed declined to comment on this rumor and the market sold straight back down.  Oil futures are about $144.70, lovely.  Gold is up again, and we see that as a ‘no confidence’ vote on the Fed.  The US Dollar has fallen and it can’t get up!  Medic!!

At the end of the week, in the last hour of trading, indecision reigned.  Should one close all positions, take a long position, or put on a short position?  It was a tough call, not knowing what would transpire over the weekend.  I’m sure we’ll hear more about the GSE’s and maybe even something about the IndyMac (IMB) rumor I posted earlier.  (OK, just typed that and this news came out):

FNM (Fannie Mae) ISSUES STATEMENT:  MAINTAINING A STRONG CAPITAL BASE, HAVE "AMPLE SOURCES" OF LIQUIDITY, HAS HIGHER CAPITAL SURPLUS THAN AT ANY TIME IN ITS HISTORY
- says issued $24B of debt this week and is generating solid revenues.
- notes its $3B note sale was oversubscribed.
- to provide full financial update with its Q2 results in early August

FRE (Freddie Mac) ISSUES STATEMENT:  FREDDIE IS ADEQUATELY CAPITALIZED AND HAS A "SUBSTANTIAL CASH CUSHION"
- FRE says it does not have an immediate need to raise capital and is not under any mandate to raise capital; has a number of options to manage capital.
- says has access to the debt market at "attractive spreads" and could use MBS as collateral for borrowing.
- notes it may consider cutting dividend on common stock.

So there you have it!  Fannie and Freddie have never been better.  All is well, please go back to your homes, nothing to see here.  Right!

See you tonight!

GSE’s and Other Updates

2:50pm  On Fannie and Freddie (news notes)

FED’S BERNANKE HAS REPORTEDLY TOLD A GSE CHIEF THAT FRE AND FNM COULD BE GIVEN ACCESS TO THE DISCOUNT WINDOW - UNCONFIRMED REPORT
- note:  Senator Dodd made a similar comment earlier

SENATOR DODD:  KNOW THAT THE FED AND TREASURY ARE LOOKING AT OPTIONS ON GSES INCLUDING ACCESS TO THE DISCOUNT WINDOW
- Dodd echoes other officials saying that the GSEs are fundamentally sound, notes the majority of mortgages held by the GSEs are solid 30Y mortgages.

Remember Senator Dodd received a loan from CFC, as a friend of Angelo Mozilo (FOA).  Don’t tell me Dodd has a home loan through Fannie, too.  Would that make him a friend of …..oh never mind.

2:23pm  The market remains weak, shrugging off bounce attempts.  Confidence is very low.  There is talk that IndyMac is now under FDIC control as of now.  This is just a rumor at this time, but it’s a pretty strong possibility.  Stay tuned.

12:07pm

I don’t know that FNM and FRE own these particular ones, but don’t they hold the most JUMBO loans?  Oops.

S&P CUTS 118 RATINGS ON 13 US PRIME JUMBO RESIDENTIAL MORTGAGE BACKED SECURITIES DEALS FROM 2005 AND 2006

 

US TREASURY’S PAULSON: FOCUS IS ON BACKING FRE AND FNM IN CURRENT FORM, REGULATORS IN TALKS WITH GSE’s
- Paulson appreciates efforts by Congress to pass housing bill

A government big enough to give you everything you want,

is strong enough to take everything you have.
   -Thomas Jefferson

The overall market remains weak.  Oil is jumping between $146-$147 and the US dollar is weak.  S&P futures have fallen to 1232 and are attempting to bounce.  Citigroup (C) says FNM is a buy.  Uh huh.

Special Update - S&P Futures

The market reaction to the New York Times article that we mentioned in our wrap up last night has created substantial selling on Fannie Mae and Freddie Mac. Additionally, the impact of this news is having a significant impact on the futures.

At this time the S&P futures are very close to their important support levels. We are watching very closely these levels.

Remember that a break below 1235 on the S&P 500 index may signal a significant market decline. Should the support level hold then we may bounce upwards. But, based on the overall sentiment of the market it is looking more and more like a significant selling event.

We should probably be on alert for some sort of major intervention coming from the Government, or as the market likes to call it.. "a stick save".

Be alert, this will be a crazy day.

 

 

 

 

 

 

 

 

 

S&P 500 Futures - 5 minute chart as of 8:20 am (US EST)

GE Earnings Report

General Electric (GE) reports these numbers this morning:

REPORTS Q2 $0.54 V $0.54E, R$46.9B V $45.3BE, PULLS IN Q3 EPS OUTLOOK
- Guides Q3 EPS $0.50-0.54 v $0.54e
- Reaffirms FY08 EPS of $2.20-2.30 v $2.22e as given on 5/21/08
- Total Company orders were $26.9B, up 8%. Major equipment orders grew 4% to $13.7B. Major equipment backlog was at $55B, an increase of 25%. Services orders were up 19%, and CSA backlog stood at $113B, an increase of 17% y/y
- CEO Immelt states "As announced yesterday, and consistent with our focus on a higher growth portfolio, we are reviewing strategic options for the Consumer & Industrial business. While we are exploring several options, we are now considering a spin-off to our shareholders as the best way to maximize value."
- Q2 Infrastructure Rev $17.55B v $13.93B +26% y/y    
- Q2 Commercial Finance Rev $9.26B v $8.14B +14% y/y     
- Q2 GE Money Rev $6.63B v $6.28B +6% y/y      
- Q2 Healthcare Rev $4.49B v $4.05B +11% y/y       
- Q2 NBC Universal Rev $3.88B v $3.63B +7% y/y     
- Q2 Industrial Products Rev $4.54B v $4.48B +2% y/y  

The futures have dropped even further since this release.  S&P futures hovering in the 1240-1245 area at 7:20am ET.