The Fannie / Freddie Saga Benefits Short Sellers of Dollars, Financials

by: Grace Cheng

Early this year there has been talk about how the US economy could experience a V or W or L-shaped economic situation, and now it seems that the economy could indeed be heading towards further deterioration. Although this past week has been one bereft of many major economic releases from the US or Eurozone, traders and investors have been subjected to more negative news coming from the US financial sector.

On Friday, the US dollar fell sharply against the Euro, Swiss franc, British pound and the Japanese yen in the currency markets as crude oil futures reached another all-time high of $147.27 on worries that Israel may be preparing to attack Iran, and on concerns that Fannie Mae (FNM) and Freddie Mac (FRE) - the two biggest sources of financing of home loans in the US - are insolvent, owing more money than what their assets are worth, and are having problems with raising enough capital to stay afloat. If you don’t know these two catchy-sounding entities, it’s time you do as these listed companies (they are actually Government-Sponsored Entities or GSEs) own or guarantee almost of the $12 trillion worth of US home loans, owning $5 trillion of debt.

If Fannie and Freddie are finding it difficult or too expensive to borrow money, they won’t be able to buy mortgages from mortgage lenders, which are firms or banks who lend you, the consumer, money to purchase your house, and that in turn makes home loans more difficult to obtain for the people in the street. And if loans are hard to come by, the already anemic US housing market could sink into a coma - without much activity going on.

Panic about these two giants grew on Thursday after the New York Times said the Bush administration discussed the possibility of placing the companies into a conservatorship if their problems worsened. To cut it short, that could result in almost worthless stock for people who hold their shares. Former St Louis Fed’s Poole said on Friday that “it would produce a worldwide financial crisis of unspeakable magnitude if they were allowed to default.”

Fannie shares fell as much as 49% on Friday but ended the day 22% down. Freddie finished 3% lower. Expect a rollercoaster ride with these stocks. The Dow, S&P 500 and Nasdaq all ended the week lower again; the Dow briefly fell below the 11,000 level Friday for the first time in two years, but ended the day at 11,100.54.

Profit From Dollar Weakness

Fresh concerns about another eruption of financial crisis in the US are leading traders to short the US dollar in the forex markets against other currencies. Even a narrowed US trade deficit reported Friday did little to soothe the dollar’s pain. The US dollar’s fate doesn’t look well at all now, and bearish sentiment is likely to haunt the currency in the near-term. The Fed’s ability to raise interest rates by the end of the year is now being questioned seriously in the face of an already weak economy.

EUR/USD rose to a 11-week high of 1.5950, just 70 pips away from its record high of 1.0620 reached in April. The Euro also reached a record high against the yen at 169.65. USD/CHF fell to a low of 1.0135. Next bear targets around 1.0090, 1.0110. 1.0200-10 could attract more shorts.