Saturday, September 6, 2008

Getting it wrong again! Phoney and Fraudy edition

If the details of the Fannie plan as rumoured are correct (including serious impairment to GSE Preferreds) then I might have been a day early covering my WestAmerica Bancorp.

Ouch. They say on Wall Street that you can't go broke taking a profit - but I think that is wrong. You take plenty of losses and taking small profits is not an antidote to the losses. I missed what could be a big profit. [Monday will tell...]

I had no position in the stock or preferred of the GSEs but was leaning towards buying preferreds on the basis that whilst the GSEs were probably insolvent they were not massively insolvent. [Fortunately I did not ever actually buy any stock.] I covered Fannie quite carefully in Part I, Part 1A, Part II, and Part III. It was enough to realise how little I knew and enough to keep me out of that game.


Having got it wrong on WestAmerica you should probably ignore anything I say on the follow up - which is what does this massive move mean to the rest of the financials.

So far no details on the plan so I have no opinion.

But so far the cost of mortgage funding has remained high because of high spreads on all mortgage lenders. If the new Fannie and Freddie have better access to money at government rates and hence can lend at lower rates then it is good for everyone else's back book but not good for prospective margins... It would benefit those with bad back books (WaMu, Wachovia) and hurt those few who are still firing on all cylinders.

If the new Fannie and Freddie (sometimes called Phoney and Fraudy) do not have such access then there will be hell to pay at the banks with capital shortage.

A few banks are going to take huge losses on their GSE preferred stock if the rumours are correct.

Yours in contrition for error

John Hempton


steve said...


Could you take a minute please to speculate on how things play out if the preferred is protected, as actually seems very likely? A relief rally onmly, or will the financial sector now get the full-in rotation and become the market leader given the damage to the rest of the economy?

Also, long bond up or down from here?

John Hempton said...

Can't speculate until I have seen the detail. But the long bond story seems obvious enough short term.

Until very recently - and there is plenty of annecdotal stuff and better - see Sester's blog - the foreign central banks have been selling Fannies and buying Treasuries.

The long bond has had a big rally - and the Fannies have been weak.

That reverses short term - so the long bond should be very weak on Monday. Pure speculation of course because i have not seen the plan.

I doubt that Fannie and Freddie are more than about 100 billion insolvent each. Even if you double it that winds up about fiscally equivalent to about a year in Iraq.

But the commitment here looks pretty open ended.

Then again the commitment in Iraq is pretty open ended.

Weaker bonds overall - but the short term trade should do it.

Other people are FAR more bearish than me.


David Pearson said...

There are lots of implications to consider beyond the cost of mortgage losses:

First, will Treasury issue an explicit Agency guarantee? Anything short of that and the Central Banks have no reason to continue to hold the paper. Fine, maybe they won't sell on Monday, but unless you publicly spell out Agencies=Treasuries, I don't think the PBOC will have $350b worth a year from now.

Second, what happens to the balance sheet? Assuming they can roll the debt, does the new management (post-recap) continue to hold the mortgages? If they get sold, how much can rmbs spreads fall?

Third, what is the political implication of a gov't-controlled entity throwing people out of their homes? Isn't a Shiela Bair-driven forbearance program inevitable? How does that complicate a recap?

Fourth, if mortgage spreads do collapse, what happens to private sector competitors (i.e. banks)? Doesn't it effectively kill all mortgage issuance outside of F&F and FHA? If so, then the major determinant of credit availability to housing becomes government-controlled underwriting guidelines. Do these loosen, tighten, or stay the same?

My bet is it will be some time before we know the answers -- the initial details will be sketchy beyond a promise to inject equity to make up losses, and some clarification on the status of the preferreds. The market will have to make lots of assumptions, especially if there is no explicit guarantee on the debt.

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