How Will Freddie and Fannie's Lifeline Affect US and Asian Banks?

Excerpts from Dr. Enzio von Pfeil's July 14, 2008, appearance on CNBC Asia:

1. The U.S. government is throwing a lifeline to mortgagers Fannie Mae (FNM) and Freddie Mac (FRE) (the two "Fs" below) -- will this mark a shift to a more volatile phase of the credit crisis? How much will other financial companies in Asia struggle with their earnings?
   • This lifeline is only a band-aid, not a solution.
   • Thus, I agree that this is going to cause greater volatility: because both Fs have had to get government support, they will not be as keen to take on more and more mortgages, as before. So the banks that originate the mortgages won’t want to grant as many.  Besides, the reason that house prices are falling is because people are SELLING homes, not buying them. This suggests that the volume of mortgages must fall, too.
   • Indeed, the last mortgage “up” cycle lasted from September 1999 (when annual growth in mortgage lending contracted by 5%) until November 2005, when it peaked at an annual rate of 44%. Back of the envelope work suggests that “down” cycles last an average of three years, suggesting that the current down-cycle will last until around the middle of 2010.
   • So, volatility rises because banks don’t lend.
   • The stinger is what happened last Friday in California, however: America witnessed its third-largest bank collapse ever! Mortgage lender IndyMac Banccorp [IMB] went under. According to the South China Morning Post of July 13, 2008, it “specialized in mortgages that often required minimal documents from borrowers for income proof.”
   • Along with others, my view is that there are plenty more such banking collapses on the way: as in any cobweb cycle, this is downsizing time.
   • That will further stress not only America’s, but also foreign banks.
2. Oil breaks new record above $147 a barrel after Iran test-fired missiles and tensions escalated in Nigeria. Venezuelan President Hugo Chavez threatened that the price of crude will go to $300 a barrel if Exxon Mobil (XOM) succeeds again in freezing the financial accounts of Petroleos de Venezuela SA overseas. How closely are you watching oil?
   • I watch oil on a macro basis, and do not claim to be an energy specialist.
   • “Get used to high oil prices”!
     • High prices are here to stay mainly because of supply constraints.
       • Except for “the people,” I cannot imagine anyone having a serious interest in establishing proper peace in the Muddle East (no typo!).
       • Besides, why would other oil producers “all of a sudden” want lower oil prices? These are truly boom times for producers.
       • Finally, it takes years and billions to find and start new oil wells.
   • From a demand perspective, income growth in China and India means that locals want cars and better utilities such as air conditioning and cooking. So energy demand stays high. Besides, the poorer the public transport system, the less “price sensitive” the demand for energy, as in gas and oil, is: people have to get around some how!
   • So, from a macro perspective, “get used to high oil prices”!
3. MSCI's main world equity index and U.S. indexes have joined European and Japanese counterparts in bear market territory, falling at least 20 percent from recent cycle peaks. Is there still money to be made in Asia with so many bears around us?
   • I find it disgraceful that the world's top economists at the investment banks have "flagged" recession/stagflation only recently, and suspect that there is more to this than meets the eye: the avarice of those who sit on the gold at investment banks. Here is how it works
     • The props (i.e. proprietary trading) desks at major banks rule the roost because they sit on the gold – they make most of any large I-bank’s profits. So they are in bed with the bank’s top management.
     • Until at least the first quarter of this year, they had huge “long” positions regarding their stock holdings.
     • So they sat their chief economists/strategists (“CE”) down and intimated something along the following lines: “We are long of stock.
       • You must keep talking the economy/markets up until we can divest of these long positions.
       •  If you do not help us doing this, we will have cut your bonus – if not fire you.
       • You help us and we will help you.”
     • “All of a sudden” as of this Spring, you “name” CEs timorously muttering something about “recession” or indeed “stagflation” (my “call” since Spring, 2006).
     • So why would the CEs be talking what should have been obvious even to the blind for a good year, at least? Step in the props boys again. This time they start saying to the CE: “Now that we have unloaded our long positions, we are short of stock – we have invested in huge “short” positions.
       • So now, you must start talking the economy/markets down: the more you talk it down, the more the value of our “short” positions rise.
       • If you do not help us doing this, we will have cut your bonus – if not fire you.
       • You help us and we will help you.”
     • I am NOT saying that ALL CEs have been playing this game, nor do I have any axes to grind as I know many of them. These CEs have to be pretty bright to maintain their jobs and be paid so well, which is great. But I AM saying that their lacking objectivity has been conspicuous in its absence, and this is what made me wonder what the motivation was. We all know that in life, most things boil down to two things. Money is one of them.
   • Asia offers very few money-making opportunities: I hope that the last months’ bad news has put to rest this rather quixotic notion of “de-coupling”!
   • The internet means that news is instant. So, when the world’s most muscular market falls, everyone else gets nervous.
   • That drop in the US market has a huge impact on consumer psychology: people won’t spend anymore, now that the “tax hike” of higher energy costs, coupled with the sharp slowdown in credit growth, means that people have to tighten their belts.
   • All of which implies that the global Economic Time™ must keep worsening – for another good year.
   • This will drag Asia down with it. Add to this a sociological one: rising social unrest will undulate more and more.
   • So, other than some commodity-related investments, cash is king – worldwide!

Comments

[BS Detector]

"both Fs have had to get government support..."

Not at all. Strictly speaking, no additional support has occurred. The news is that the government is working on changes that would provide greater support IF IT'S NEEDED. It hasn't yet been needed.

"...the last mortgage “up” cycle lasted from September 1999 (when annual growth in mortgage lending contracted by 5%) until November 2005, when it peaked at an annual rate of 44%. Back of the envelope work suggests that “down” cycles last an average of three years, suggesting that the current down-cycle will last until around the middle of 2010."

Um, if the last up cycle ended in 11/05, and down cycles last three years, how do you get to mid-10?

[Serge]

Yes, clearly the stock market is one big conspiracy.