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.
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Not to be overly gloomy about these financial times, but how comfortable should I be if I am sitting mostly in cash? I have never been concerned about holding cash until recently. Earlier this year, I checked with my money market accounts to determine their exposure to subprime debt (almost nil), but I am starting to become concerned (nothing specific, just a nagging uncertainty) that the money market funds may have exposure to other things that could cause them to “break the buck.” Any thoughts on this and, if not cash, what else would you hold? Foreign currencies not pegged to the USD? Gold? I have never bought gold, but I have some friends who are beginning to look at it. I don’t want to be an alarmist, but I don’t want to be stupid either.
What do you say to your mom and her nvestment advisor, when he accuses you of trying to time the market, just because you want your mom to move to cash?
Charlie, I am sure Chuck and Lisa will have their own answer too, but this is what I did in the spring of 2006 when I got out of stocks for the first time in 19 years (!) and moved to cash. (I also missed the tech bubble because I went into vanguard small cap index funds, berkshire hathaway, ups, fannie mae, etc and did not buy tech stocks, but this is the first time in my investing life that I got out of the stock market).
I bought yen and swiss franc via ETFs, inverse funds (double inverse S&P500, Dow, and Nasdaq), gold and silver miners, physical gold and silver, and the majority of my money is in a Vanguard Treasury Money Market (the trading desk told me at the time that it was 100% treasuries and they had no intention of buying anything else although they could). I also have cash, physical. I would not keep this at home, by the way, because it’s too easy to be robbed. Safety deposit boxes are one alternative.
I disagree with Peter Schiff that you can make money in foreign dividend-paying stocks. China is going to fall, just like the Japan Miracle and the Southeast Asia miracle….all 3 were built on exports and that is not a true foundation for prosperity. All 3 were built in hot money inflows, hidden losses in the banking sector, and speculation in their stock markets. China is about to go the way of their other “miracles”. High inflation is just one of their problems.
THE PERFECT STORM….PEAK OIL AND PEAK CREDIT OCCURRING AT THE SAME TIME. GOLD STARTED A BIG MOVE LAST WEEK.
INDYMAC WAS SEIZED BY THE FEDS AFTER THERE WAS A RUN ON THE BANK BY DEPOSITORS.
IT WAS THE FAILURE OF THE LARGEST SAVING AND LOAN IN HISTORY.
ON MONDAY, THERE COULD BE A RUN BY DEPOSITORS AT DOWNEY SAVING, WASHINGTON MUTUAL, AND WB IF THE SERIOUS NATURE OF THE SITUATION BECOMES WIDELY KNOWN BY THE PUBLIC.
REMEMBER, THE FDIC ONLY GUARANTEES CERTAIN DEPOSIT, BUT DOES NOT SPECIFY WHEN YOU WILL RECEIVE THE MONEY. YOUR DEPOSITS COULD BE FROZEN FOR MONTHS OR YEARS.