Sunday, September 7, 2008

The last of the Fannie & Freddie buzz? Don’t count on it.

September 6th - UPDATED

Until the true details come out about the treasury’s bailout plan, we will only have speculation. The leak of the bailout finally materializing was taken as great news in Friday’s after-hour trading, for all financial institutions, except Fannie and Freddie for obvious reasons. If it hasn’t been said yet, the common and preferred share holders will receive next to nothing for their equity.

The thing that I am still grappling with is how the market will respond to this come Monday…will we have another bottom like we saw after the Bear Stearns rescue? Or will we see the market rejoice on this seeming messiah-like bailout of our mortgage markets….I like to see what the guys on Fast Money have to say on issues like this, as they usually give a pretty accurate pulse of the market. Here’s a recap courtesy of

Melissa Lee hosted CNBC’s “Fast Money” Friday night. She started the show with a discussion on late-breaking news that the Treasury is planning to backstop Fannie Mae and Freddie Mac. The plan would include changes to senior management. Steve Liesman, senior economics commentator for CNBC, joined the traders to discuss the plan by the Treasury to inject capital into the two companies. He said the rumors on the Street are that the Treasury will offer a convertible preferred or a warrant offering. Guy Adami asked Liesman if the stocks are going to zero. Liesman said he was unsure and said we’re back to where we were before on these equities.

If the government wipes out the preferred holders, it will create other problems in the banking sector, he added. Pete Najarian said the problem is that we don’t have enough clarity on what this means for the Freddie and Fannie shareholders. Jeff Macke added that both stocks are screaming sells, along with the Financial Select, SectorSPDR Trust.

Adami mentioned that if the backstop of Fannie and Freddie can lower mortgage rates, the entire problem could begin to unwind itself. Karen Finerman said the plan is bad for the Treasury and bad for the U.S. dollar.

The one thing which should be clear, is that this will not be cheap; someone (by that I mean the taxpayers) will have to finance this operation. If it turns out that Paulson doesn’t plan for the taxpayers to cover everything in one hefty dose (~$1 trillion divided by 340 million people), then we will need to print more dollars and dilute our currency…after all, what would you do if you didn’t have enough money to cover the losses? Simply print more money!

Since everyone else is guessing about what’s going to happen, I’ll give it a shot…

Friday’s trading leads me to believe it’s entirely possible that we have a pretty big rally, but I think any rational person who reads into the repercussions of this bailout will not be so optimistic in the longer term.

1) Suddenly, the prospects of serious inflation are back; this time, not driven by expensive commodities, but by high rates of growth in the money supply…Think of the market for the dollar like a stock: the value of the dollar is driven by factors of supply and demand. However, what happens when a company holds another stock offering…Using Merrill Lynch as an example, they dilute their shares and make each share in the company worth less than before. Adding more dollars into the economy would effectively be the same as a company diluting their share base. When there is more of something, it does not have the same purchasing power/value as before.

2) Personally, I do not think this directly translates into good news for financial institutions, because we shouldn’t forget that they (big and small banks) hold much of Fannie and Freddie’s paper, whether its equity or debt. The good news, which is an indirect byproduct of the bailout, is that any exposure pertaining to mortgages may finally have a price floor in place, since now they are essentially insured by our government. Maybe the treasury could employ some trickery to allow people to make their mortgage payments, which could calm the housing slowdown.

Here are some places to find good literature on Fannie and Freddie in the coming days (not newspapers, as they’re afraid to be controversial enough to write anything good):

The Big Picture, (He’s usually the best…)

Macro Man, (if he posts anything on the issue, it will be good)

Nouriel Roubini, (if he has anything to say, it’s a must read)

Naked Capitalism, often has good insights.

No comments: