Fannie and Freddie Waterfalls are Too Big to Bail

It's been a wild ride for Fannie and Freddie recently. James Lockhart, director of the Office of Federal Housing Enterprise, said the GSEs are "well capitalized".

William Poole, former Fed governor disagrees. Poole Says "Fannie, Freddie Insolvent".

The market agrees with Poole as share prices have continued to plunge and Fannie Mae Pays Record Yield Spreads on Sale of Two-Year Notes vs. two-year treasuries.

Fannie Mae Waterfall



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Freddie Mac Waterfall


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Institutions Must Be Allowed To Fail

Today Paulson Says Financial Institutions Must Be Allowed To Fail.

I would like clarification from Paulson as to what "fail" means. What it should mean is Fannie and Freddie go bankrupt, the government gets out of the GSE sponsorship business, and home prices fall to their natural level.

What I suspect Paulson means is We're All Homeowners Now, Nationalization of Fannie, Freddie Unavoidable. In this scenario, the share price of Fannie and Freddie will drop to zero yet taxpayers will foot the bill to keep Fannie and Freddie in business.

Wachovia and Washington Mutual at Risk

Yesterday Wachovia Named New CEO and Warned Of Big Loss. Larry Smith, interim CEO said "the company plans to remain independent, despite rumors of a possible takeover". My thought is no one in their right mind would want to acquire Wachovia and besides, no one is big enough to take them under as JPMorgan did Bear Stearns.

Both Wachovia (WB) and Washington Mutual (WM) are loaded to the gills with Alt-A, liar loan garbage. Wachovia is barely a teenager at $13.13 while Washington Mutual is hanging on for dear life around $5.25 a share.

WMALT 2007-0C1

Chris Puplava has new charts available of the Washington Mutual Alt-A pool WMALT 2007-0C1.That pool has been the "poster child" for what is happening with Alt-A. Although it is just one pool, it is arguably indicative of the rotten nature of liar loans in general.

Pool Stats



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REOs are Soaring



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Tranche List



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The tranche breakdown shows total deal size. Total size is 519.159M, "A" Tranches are 476.069M total, "M" Tranches are 30.112M total, "B" tranches 7.788M total and "C" tranche is 5.19M total

Cesspool Math

As of today, tranches A1 through A5 are all still rated AAA . Those 5 tranches constitute $476.069M out of an original pool size of 519.159M. In other words, 91.7% of this entire mess is still rated AAA even though REOs are now up to a whopping 10.48% and 60 day delinquencies are 32.69%. Moody's and the S&P should be embarrassed by this.

Too Big To Bail
The credit bubble has popped. Fannie Mae (FNM), Freddie Mac (FRE), Washington Mutual (WM), Wachovia (WB), and Lehman (LEH) are all at serious risk. Many smaller payers are at huge risk as well.

Meanwhile, the Fed continues to orchestrate "takeunders" like the shotgun marriages between JPMorgan (JPM) and Bear Stearns (BSC), and Bank of America (BAC) and Countrywide (CFC). The Fed's idea seems to be for the strong to take over the weak. The reality is the strong become weak through these efforts.

Paulson's statement "Institutions Must Be Allowed To Fail" is in reality an implicit admission the Fed is powerless to stop a credit implosion whether the Fed wants to do something about it or not. We have finally reached the point at which the mess is too big to bail. All that remains at this point is the final numbers on how much taxpayers have to cough up when Congress foolishly tries to make water run uphill.

Comments

[fxtrader07:]

michael, making the so far implicit backing by the govt of fre and fnm an explicit one will surely cost a few hundred billion $ but it will definitely be much much cheaper than any other alternative that comes to mind.
and given that subprime losses are currently in all likelihood massively OVERESTIMATED by analysts and market participants (as tom brown has argued very reasonably a couple times here at SA) then the backing may turn out to be much cheaper than the doomsayers and you (please, note the distinction, i am not throwing you into that camp) currently assume.
i wouldn't be surprised if we rise over the next weeks, gradually in the stock indexes; the previous days had the smell of a panic bottom - if not in the vix (which everybody keeps watching now) then in the 'felt' sentiment

2008 Jul 11 09:03 AM

[Vox Rationalis:]

"What it should mean is Fannie and Freddie go bankrupt, the government gets out of the GSE sponsorship business, and home prices fall to their natural level."

And the mortgage market crashes, WM, WB, LEH, MER, several mid-sized and hundreds of small banks immediately become insolvent, JPM, BAC, and C are close, and every bank and investment bank has to unwind huge amounts of its books to bring leverage back to reasonable levels. The restriction of credit pushes interest rates up dramatically, while the contraction of the money supply creates massive deflationary pressure. The Fed then has the dicey proposition of how expansionary its policies need to be, and foreign capital, while attracted by higher interest rates, retreats because of the risk in the market.

Should the government have been in the business of backing mortgages? Maybe, maybe not; I think not. But now that we're here, the way to change that situation is not by pulling the rug out from under the mortgage market.

A well-structured, long-term plan to gradually move out of that circumstance may be the best possible course of action. The financial markets are too interconnected to simply allow FNM and FRE to fail. Without some assurance of the government's backing of the mortgages, a sufficient common equity raising is simply not possible; the asset base is simply too large. I don't even think a preferred would fly; if they go under, they will go under BIG.

How about this: the government certifies that it backs the mortgages, issues new, stringent rules for mortgages to be backed in the future, and buys billions of dollars of FRE and FNM convertible zero-coupon bonds. Current shareholders are diluted, the mortgage market is stabilized somewhat (which means the capitalization of FNM and FRE becomes less of an issue), and once the market recovers (which could be a while), we the people profit handsomely.

2008 Jul 12 02:53 PM

[optionsgirl:]

The printing presses will work overtime to pay for this boondoggle. The real question is, if the U.S. Government is backing all of these multi-trillion dollar losers, what is backing the federal government of the U.S.? How can we ever regain dollar stability? And how many pamp suisse bars will it cost to heat your home, educate your children, and sustain a comfortable life? How will the baby boomers, the largest population to retire, afford that luxury while their personal weath disappears. What legacy are we leaving our children and grandchildren?

2008 Jul 13 02:41 AM

[Vox Rationalis:]

"The printing presses will work overtime to pay for this boondoggle. The real question is, if the U.S. Government is backing all of these multi-trillion dollar losers, what is backing the federal government of the U.S.?"

The sky is not falling. Here's your worst-case scenario in terms of government losses should it take over FNM and FRE. They insure or own some $5T of mortgages. At this point, more than 98% of mortgages backed by FNM/FRE and current. Let's suppose there's a massive increase in foreclosures from this point going forward, and the percentage reaches 4%. Further, let's assume that the average bad mortgage is twice as big as the average mortgage. So the percentage of loan value that gets foreclosed is 8%, or $400B. But this is not the amount of the loss; the underlying property is not worth zero. Let's continue the doomsday scenario and say that real estate values fall by half. Basically, there's no way, without a depression-like failure of the economy, that the federal government would lose more than $200B.

A lot of money yes, but for perspective: since 2002 FY, we've accumulated more than $3T in debt (including that held by the trust funds). So the worst-case scenario is that an assumption of FNM/FRE would add to the debt no more than 7% of what we've added under the current administration, or about 2% of the overall debt.

2008 Jul 13 11:33 AM

[tuckfinitee:]

Your numbers may be right BS but you're missing the big picture. Only political thugs win at the spend and print game. Everyone else loses. Either net or lost potential. FRE and FMN are just more info that the game is rigged. Everyone who believes more regulations will fix things raise their hands. What do safe regulated investments have in common? Losers. Without speculation(and phony stats)how would you hide how poor a deal the dollar really is? Or other fiat currencies for that matter. What a coincidence everything is looking suspect(stocks,bonds,r... estate)except liquid commodities that are freely exchangeable at markets. Too much speculation in commodities? Commodity markets are becoming a kind of de facto world reserve currency. And where would we be if not? You notice the world economy is still functioning fairly reasonably. Without the growth of commodity markets we'd be in a severe recession right now.

2008 Jul 13 03:53 PM

[fxtrader07:]

@tuckfinitee: I can't see how and why the explosion in commodities prices prevented a severe recession. Rather, it will be the nail in the coffin for the u.s. recession starting in q3 or q4/2008.
commodities markets are WAY too small to get anywhere near a 'reserve currency' status. most of all they lack the distinct characteristics of a currency: they are in most cases difficult and costly to store, to transport and to exchange, sre pretty illiquid, not durable (except the metals) etc. they are a place to hide - for some time. but not more than that. in fact, i would argue that people start slowly to realize that all paper currencies are basically worthless ious and that in fact there is NO real place to hide, except perhaps prescious metals

2008 Jul 14 08:53 AM