Next To Fall: The Publicly-Traded Government-Sponsored Mortgage Lenders

When the housing bubble burst, the optimists were quick to call for a bottom -- again and again.

Later, when the fallout from that still unfolding meltdown helped trigger a category five hurricane in the subprime mortgage sector, the rose-colored glasses types kept saying the situation would remain "contained."

Then, when the reverberations from that snowballing disaster caused credit spreads to start shooting higher and losses to pile up at a growing number of financial operators, the Pollyannas said it wouldn't affect "liquidity" -- the life blood that has kept the LBO game of musical chairs alive and the stock market floating on nothing but air.

And now, the Mr. Magoos -- and no small number of "smart money" investors who've been piling into the shares -- appear to be saying that all of these various shockwaves are unlikely to have much impact on what many consider to be the poster children of ponzi finance, the publicly-traded government-sponsored mortgage lenders.

Unfortunately, as a recent report from BusinessWeek seems to indicate, "Why Fannie And Freddie Are Fidgety," the delusionists are about to be proved wrong once more.

The financial giants are loaded down with dicey loans as defaults increase

Fannie Mae (FNM) and Freddie Mac (FRE) have been cast as saviors in the housing drama that's roiling the financial markets. After they stepped in to snap up billions of dollars in subprime loans earlier this year, some politicos declared the duo a point of strength: "Freddie and Fannie aren't the problem. [They] are the good part," Representative Barney Frank (D-Mass.) said in a recent hearing.

But that doesn't mean they're immune to the pain. Like the big private- sector players, these government- sponsored companies, which own or guarantee 45% of all residential mortgages, have taken on more risk in recent years. Now they hold a sizable piece of subprime and other potentially toxic debt--securities and largely illiquid loans that could take a hit after the recent fire sale prompted by two Bear Stearns hedge funds. And given the state of the broader housing market, more trouble may lie ahead. That would be bad news for shareholders and investors who own their mortgage-backed securities. "We don't know how much trash is on their balance sheet," says Josh Rosner of researcher Graham Fisher & Co. "It seems they've shot themselves in the foot." Fannie declined to comment. Says a Freddie spokeswoman: "We are well positioned to withstand even a severe and enduring period of heightened credit risk."

Driven by market competition and regulatory mandates, the two have become big buyers of adjustable-rate mortgages, or ARMs, and MBSS that include them. Those items accounted for 18% of Freddie's volume in 2006 and 22% for Fannie in 2005, the latest data available. That's up from virtually nothing in 2001. A large chunk comes in the most exotic flavors, such as payment-option ARMs and interest-only loans.

With home prices falling, ARMs, both prime and subprime, are especially scary. Some $300 billion in ARMs guaranteed by the agencies will automatically reset through 2011, according to Banc of America Securities. The unknown is just how many homeowners will default. By Fannie's own estimates, 18% of the subprime ARMs industrywide that reset in the first three months of 2007 have gone south.

The two have also moved more prominently into low-documentation loans, which require little or no proof of the borrower's income. That segment has proven to be rife with abuse in recent years. A study by the Mortgage Asset Research Institute found that 90% of borrowers with so-called stated income loans upped their annual incomes falsely to qualify for more money. In almost 60% of low-documentation loans, the borrower's income was inflated by more than 50%.

Much of Fannie and Freddie's shift into riskier parts of the mortgage market has been driven by the government's affordable housing mandates, which require the two to fund a lot of loans for low-income borrowers, first-time buyers, and people living in mobile homes or economically distressed neighborhoods. Their regulator, the Office of Federal Housing Enterprise Oversight, estimates that Fannie holds $292 billion of such mortgages, or 40.6% of its portfolio, on its books because the loans are less liquid and can't easily be repackaged and sold to investors. Freddie owns $68 billion of those loans, some 9.5% of its portfolio.

Problems from Fannie's and Freddie's risky loans are mounting. Foreclosures are on the rise, and it's harder to sell the houses they own as a result. Some are worth pennies on the dollar. Fannie has a "charming colonial" on the market for $7,000 in Detroit, despite the $59,000 outstanding on the loan. The property, repossessed in May, has been looted, with the kitchen sink and drainpipes stolen. Meanwhile, agent Debbie Leslie of Le Valley Real Estate has cut the price on a home Freddie owns in Flint, Mich., five times this year, from $10,900 to $5,250. The mortgage is $26,250. "We're waiting to see where the floor is," says Leslie.

Such exposure is taking its toll. Freddie upped its loan-loss reserves by $125 million in the first quarter in response to higher foreclosure rates; the company reported a $211 million loss during that period. Fannie, still reeling from an accounting scandal earlier this decade, hasn't reported its financials for 2006 or 2007, but will likely face a similar fate when it does. Looking at the numbers, says James B. Lockhart III, director of OFHEO, "you can see the impact not only on their portfolios, but also their MBSs."

The tsunami rolls on.

Comments

[olretred:]

There are just four people who control all of the U.S. markets through their use of dangerous and explosive DERIVATIVES. They are risking the assets and retirement funds of all Americans. Because of their manipulations, especially since 2001, U.S. financial markets are now based on the gambling whims of a special fraternity of Federal Government DERIVATIVE dealers.
This group is known among Wall Street as the Plunge Protection Team (PPT). Their "official" role was to prevent another 1987 "Black Monday". They have the entire U.S. Treasury at their disposal to manipulate the markets through DERIVATIVES (futures options). In other words, they are using the assets behind the U.S. Treasury to rig the prices of commodites (gold, currencies, etc.) and stocks.
This fraternity comprises of Fed Chairman, the Secretary of the Treasury, and the heads of the SEC and the Commodity Futures Trading Association. It works closely with all the U.S. exchanges and Wall Street banks, including the largest DERIVATIVE risk holders Citibank and JP Morgan Chase.
Few people are aware of Executive Order 12631 signed by Ronald Reagan on March 18, 1988. In a nut shell, this is the "authority" behind the four dictators and the [sic] "laws" and "regulations" that have backed their casino-style DERIVATIVE gambling spree since 2001. Here are some highlights of this Executive Order to ponder:
Executive Order 12631 - Working Group on Financial Markets - Mar. 18, 1988; 53 FR 9421, 3 CFR, 1988 Comp., p. 559.
"By virtue of the authority vested in me as President by the Constitution and laws of the United States of America, and in order to establish a Working Group on Financial Markets, it is hereby ordered as follows:
Section 1. Establishment. (a) There is hereby established a Working Group on Financial Markets (Working Group). The Working Group shall be composed of:
(1) the Secretary of the Treasury, or his designee; (2) the Chairman of the Board of Governors of the Federal Reserve System, or his designee; (3) the Chairman of the Securities and Exchange Commission, or his designee; and (4) the Chairman of the Commodity Futures Trading Commission, or her designee.
Section 2. Purposes and Functions. (a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence, the Working Group shall identify and consider:
(2) the actions, including governmental actions under existing laws and regulations (such as policy coordination and contingency planning), that are appropriate to carry out these recommendations.
(b) The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.
Section 3. Administration. (c) To the extent permitted by law and subject to the availability of funds therefore, the Department of the Treasury shall provide the Working Group with such administrative and support services as may be necessary for the performance of its functions."
Get out of the markets before the inflated DERIVATIVE bubble bursts
The pre-911 U.S. markets showed an astounding - yet confounding and puzzling - rise for the 4 months proceeding 911. The U.S. media dubbed it a "patriotic rally". The European Press called it a "PPT [Plunge Protection Team] rally". Obviously, the U.S. markets were manipulated and rigged to an inflated value in advance of the 911 disaster. Was this a coordinated measure in anticipation of what was to come? Only The Powers That Be can answer that question directly.
Since 911, there have been at least three major long-term stock market rallies. In all 3 instances, when the markets opened all the indexes began to quickly plunge. In each incidence, by early afternoon the markets were brought back from the brink of collapse to the surprise of everyone, including historical analysts.
An event that should have sent markets spiraling downward was the Enron, et al, unprecedented corporate accounting scandals. Yet despite this, an unprecedented accross-the-board markets rally began on July 24, 2002. Once again, the European Press called it a "PPT rally".
Outside the U.S., it's no secret who is behind these secretive "no-name" purchases of high risk DERIVATIVE gambling wagers:
On September 16th, 2001, The Guardian reported "that a secretive committee... dubbed 'the plunge protection team'... is ready to coordinate intervention by the Federal Reserve on an unprecedented scale. The Fed, supported by the banks, will buy equities from mutual funds and other institutional sellers... "
On Feb 21, 2002, the Financial Times featured an article about Japan's Stock Buying Body. The article stated that "...government backed equity markets, as Japan has recently become aware, do not work... Plunge protecting the world's markets may be a hazardous pursuit."
In each of these occurances, a large "no-name" buyer in the futures market secretly plunged in and bought up massive quantities of DERIVATIVES through banking groups such as JP Morgan. These were completely reckless gambling bets that the futures index [S&P] would rise even though it was obvious that it was going to fall. Because such a large amount of money was wagered on the S&P's rise, in each instance, it reversed the market's free-fall.
At the Federal Open Market Committee meeting on Jan 29-30, 2002, the Federal Reserve System (Greenspan) openly discussed the use of "unconventional methods" to stimulate the economy. Recently, the Financial Times of London quoted an anonymous U.S. Fed official who stated that one of the extraordinary measures "considered" in January 2004 was "buying U.S. equities".
These gambling interventions by the "Four Financial Dictators" have successfully brought the markets back each time... despite the inflated financial realities that existed. The purchase of these gambling DERIVATIVES at a great loss have transformed each market crisis into a rally. By manipulating the markets in this way, they have further inflated the highly overvalued market indexes.
Perhaps Americans can now understand why the major U.S. banks, such as JP Morgan, are holding TRILLIONS of gambling derivatives on their books as the PPT group of four use them to rig the markets. Sooner or later, these market "fixes" will no longer hold the bubble from bursting.
Thus, we have witnessed the creation and growth of the financial bubble that is on the brink of explosion... and we know who rigs and controls the markets to create this inflated bubble of gambling debt.
Paper Stocks Rise as Metals Loose - PTT Rigging is Obvious
In the same motus opperandi, the PPT group of 4 are currently buying metals futures (DERIVATIVES) in great amounts on the New York and Chicago exchanges. For the past two weeks, they have created a loss in silver and gold indexes by purchasing (at U.S. taxpayer's expense) large gambling bets (derivatives) against the true value of intrinsic metals.
The result is that they have rigged the value of metals to discourage investors from purchasing gold and silver instead of U.S. Federal Reserve Notes. This is a measure by the PPT to plug a large hole in the bursting dam of the financial bubble, but even Hans Brinker cannot stop this leak.
The bottom line? Stick with history and prepare for the financial explosion. When the bubble deflates and pops, economic deflation will control our daily lives. The PPT cannot continue to spend what it doesn't have. The retirement funds they are "borrowing" from are already exhausted. Get yourself some gold and silver... it will buy your bread to survive in the coming future... while paper Federal Reserve Notes will burn in your furnace to heat your homes.

2007 Jul 25 07:28 AM

[Daniel Jones:]

Meanwhile FRE is floating $500 million tranches of preferred stock in order to support its common via buybacks. Interesting tact to alter the balance sheet and fund the losses to equity that are happening.

Disclosure: Long FRE and FNM puts. (and writing about it on seeking alpha too).

Daniel Jones
Nice Job Michael.

2007 Jul 25 09:13 AM

[Bhakta:]

I do not trust or believe anything or anyone speaking or acting for the USA Government. they may manipulate everything they like, but they do not control the hearts and minds of the other 6 billion people on the earth outside the USA, and from what I see out here is the world wants the USA to sink and the dollar to become worth toilet tissue.

2007 Jul 25 12:56 PM

[m7m:]

Well who ever wants the USA to sink and the dollar to become worth toilet tissue, will be coming right along with the USA. For as the US goes so goes the world. I know many people in the world, and the people I know, do not wish the USA ill. Whoever you are talking to are not very smart or not thinking logically when then wish for such calamities.

2007 Jul 25 05:26 PM

[jonathan:]

Is it the PPT now? I thought the Illuminati still controlled the world.

2007 Jul 25 01:55 PM