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  • How Oba-Mae Will End Fannie Mae's Conservatorship

    President Obama succeeded in ending the Iraqi and Afghanistan wars ordered by former President George W. Bush. Will President Obama be successful in ending the conservatorship for Fannie Mae enacted by former President George W. Bush? The recent swings in Fannie Mae certainly call for ending the conservatorship with an Oba-Mae.

    What will an Oba-Mae look like? The debate on the Corker-Warner draft bill has certainly triggered serious thoughts on what reforms should be introduced into Fannie Mae in order to make an Oba-Mae. The Corker-Warner draft bill appears to have the potential of exaggerating political and financial problems in the housing system on several fronts:

    (i) Higher mortgage cost for all homeowners. Fannie Mae benefits from cheaper foreign savings and by bringing private sector efficiency and closer government oversight, and thus has been able to help lower the mortgage costs. When Fannie Mae is completely privatized as proposed in the Corker-Warner draft bill, mortgage costs will jump immediately, if not even earlier.

    (ii) Even higher mortgage cost for middle income families. As designed in the Corker-Warner draft bill, lower income families will be supported by FHA - a public interest agency. Middle income families will be left to the mortgage market.

    (iii) Lower assistance to lower income family homeowners. Since the Federal budget for the new subsidy program under FHA will be debated by Democratic and Republic Parties every year, there will be less and less chance for getting more assistance to lower income families due to the persistent budgetary deficits. Under Fannie Mae, Democratic members can always find ways to secure more favorable programmes for lower income family homeowners.

    (iv) Higher costs to taxpayers in case of crisis. A rough calculation has shown that Fannie Mae was one third cheaper than a private alternative for the rescue in the recent Great Recession.

    (v) Slower house recovery after crisis. In the absence of private sector interests, Fannie Mae has been able to take up 90% of new loans in the past few years, contributing to the quicker overall recovery from the Great Recession.

    But Fannie Mae must be reformed. The to-do-list for President Obama needs to include at least the following:

    (1) Private sector must take the loss first - an idea advocated in the Corker-Warner draft bill. The recent US lawsuits against big banks indicated that big banks simply passed their wrongdoings to Fannie Mae. If all can be recovered from big banks, Fannie Mae does not need any financial assistance from taxpayers. But during the crisis like the recent one, taxpayers have to rescue big banks directly or through an institution like Fannie Mae. Oba-Mae needs to weigh which way is less costly for taxpayers, and establishes rule-books so that future rescues can lay more fair blames on Fannie Mae, or Fannie Mae is enacted to resist being a scapegoat.

    (2) Management reform at Fannie Mae. Oba-Mae needs to re-introduce incentive measures such as bonus to encourage better management performance at Fannie Mae. It is unfair for current management at Fannie Mae who are doing a remarkable job.

    (3) Re-affirmation of honoring foreign debts and private property. By keeping the essential characters of Fannie Mae intact, Oba-Mae will send a strong signal to foreign and domestic investors that: Fannie Mae is back, and they should feel safe with their investments.

    By doing these without causing any hassle to the mortgage market, President Obama is building another legacy in history.

    Jun 14 1:09 AM | Link | Comment!
  • Initial Price Target Of $19.8 For Fannie Mae

    The severely depressed stocks can always see remarkable recovery. Many stocks have shared the same pattern in the past few years. Las Vegas Sands' share has jumped from $1.38 of March 9, 2009 to over $56 soon after, an increase by 4,058%, 40 times higher. Fannie Mae's share price has also been severely depressed, but will Fannie Mae see the same recovery pattern.

    The stock market has been struggling on appropriate pricing for Fannie Mae in the past few weeks, and made Fannie Mae share swing substantially. A few hedge funds are shorting sell Fannie Mae in order to get more Fannie Mae at lower costs.

    The price depression of Fannie Mae had its justification: it was designed to avoid another Great Depression. The mission was achieved gloriously: it was only a Great Recession, and a quicker recovery (Fannie Mae has shouldered over 90% of new loans during the ongoing recovery). The recent US lawsuits against big banks have shown that the planned so-called rescue funds for Fannie Mae are simply equivalent to the amount by which big banks wronged Fannie Mae. Fannie Mae was simply a scapegoat for what went wrong at big banks. This is perhaps partly the reason why analysts at big banks continue to be reluctant to show genuine interest in Fannie Mae and would rather like to see Fannie Mae to shut down or get liquidated with zero value to common shares.

    The public-private partnership model of Fannie Mae has not failed. It was not designed to help avoid another Great Depression at no cost. Indeed, there was a cost of frustration only. State-owned Chinese companies are trading well in China and also in New York. Fannie Mae has been closely monitored by politicians to assure public interests and by private investors to ensure profitability. This kind of scrutiny is not available for any other business model. It is a great example of check and balance in the housing market.

    Fannie Mae share price may be considered for two scenarios.

    First scenario: liquidation. In this case, new shares will be issued to private investors. The liquidation experience of Sallie Mae can be relevant. During Sallie Mae's liquidation, its share price increased by three times. Fannie Mae's share reached $5.44 on May 29, 2013. With Sallie Mae's multiplier, Fannie Mae share can be expected at $16.32.

    Second scenario: decent return to market. In this case, the standard analysis can be applied. KBW analyst Bose George estimated that Fannie Mae can generate normalized annual EPS of around $2. The average P/E for mortgage industry stands 9.9, and can be much higher. With EPS at $2, Fannie Mae share should be expected at a value of $19.80.

    However, the first scenario is unlikely to happen, since any new model of Fannie Mae will have to subject to the following four tests:

    1. Foreign borrowing test. Fannie Mae has been a useful tool to tap foreign savings (such as Chinese and British) at low costs for financing US housing market. The liquidation debate has already pushed away foreign investors, and US Treasury and the Federal Reserve have had to buy bonds from Fannie Mae recently. Implicit government support has been indeed used for the advantage of American national interests. There is serious doubt that any other business model can attract the same level of foreign interests.
    2. Built-in economic stabilizer test. Fannie Mae was designed to help avoid the disaster of Great Depression. The benefit of Fannie Mae to Americans in the recent great recession is the relative intactness of $6 trillion mortgage market. The former U.S. Treasury Secretary Henry M. Paulson confess at that time that without Fannie Mae, mortgages would be harder to obtain and much more expensive. The benefit of Fannie Mae to American per capita amounted to $19,737. Going back to a pre-1938 system with public insurance will be much more expensive in the case of similar economic crisis.
    3. Recovery boost test. During the recovery up to now, Fannie Mae has been responsible for 90% of new loans while private sector is still waiting for market turnaround. It would take much longer to recover without Fannie Mae, definitely beyond this Administration. President Obama has been very smart in allowing Americans to benefit from Fannie Mae by not endorsing any different business model for Fannie Mae. The benefit of Fannie Mae to Americans in the recovery is $3.5 trillion mortgage market, and the benefit to every American on average is $11,364. Without Fannie Mae, President Obama may not be able to see housing recovery during his presidency.
    4. Public scrutiny test. Mortgage market is not only a business but also a politics since three fourths of American families are involved. The housing system cannot be tailored to only public interests, or private investors. It should be designed to address both perspectives. Hybrid public-private business models offer the only opportunity to accommodate both public and private interests.

    Given the above considerations, far-sighted politicians in Washington will unlikely opt for liquidation. The initial price target for Fannie Mae should be set at $19.80, which is calculated under the second scenario.

    Disclosure: I am long RDN.

    Jun 12 12:40 PM | Link | 8 Comments
  • Corker-Warner Windfalls For Fannie Mae Investors

    On April 2, 2013, U.S. Senator Bob Corker, R-Tenn., a member of the Senate Banking, Housing and Urban Affairs Committee said: "I'm glad Fannie Mae is showing an increase in income, but we have to remember that this is largely because we have crowded out private capital and made Fannie or Freddie the only viable execution option for new loans. So while I am hopeful that taxpayers can quickly be repaid for their investment in the GSEs, we must focus now on building a more sustainable 21st century system of housing finance that restores the private mortgage market after years of government dominance. I hope Congress will take the necessary steps to ensure housing finance reform can happen as soon as possible." (http://www.corker.senate.gov/public/index.cfm/news?ID=5e9a8631-bc65-460f-b567-7bcd924c6a03)

    On his own website, U.S. Senator Mark R. Warner (D-VA) indicated: "Moving forward, I will continue to participate in hearings and discussions about how to foster sustainable recovery in our housing market. An important part of that debate is determining the appropriate role of the government in our housing finance market. The current financial state of Fannie Mae and Freddie Mac is not sustainable. You can find the Department of Treasury's recommendations for the future of the housing finance market at www.treasury.gov. I look forward to thorough debate of this report as Congress considers options for improving our housing market for the long term." (http://www.warner.senate.gov/public/index.cfm/help-for-homeowners)

    These are the publicly announced official positions of Bob Corker and Mark Warner: Bob Corker is prone to a private sector solution to the US housing system, while Mark Warner wants help for homeowners in danger of losing their home. When these two senators come to together, something beautiful can happen. On June 4, 2013, Reuters reported that U.S. senators mull timetable for liquidating Fannie Mae, Freddie Mac ( http://www.cnbc.com/id/100789277), and the less informed analysts jumped out announcing that common share holders will be wiped out completely (CNBC offers a rather good collection of these opinions at: http://data.cnbc.com/quotes/FNMA%2C).

    But careful observers and seasoned investors see things differently. As in a typical Capitol Hill game, serious politicians always start with something beyond what they truly want to get at the end. In this particular case, what would Bob Corker and Mark Warner truly want to get at the end?

    For Mark Warner: he wants subsidies for his constituencies: less privileged home owners, but this can be very unpopular if taxpayers have to pay for it in one way or another. The huge loss expected at FHA (see the report on June 6, 2013 at CNBC: http://www.cnbc.com/id/100791651) is gravely compromising his chance of securing more funds for homeowners from a new pure publicly-financed house agency, i.e. FHA. Given the political resistance from the other Party to subsidies in every future year, less privileged homeowners will more likely receive less assistance than under the pre-crisis public-private partnership model of Fannie Mae. Mark Warner is likely already prepared to make compromise if a new Fannie Mae can be secured to continue to provide assistance to the needful.

    For Bob Corker: he wants to bring in private capitals, but also very well informed about the performance of the private sector in the housing system. The creation of Fannie Mae during the Great Depression already offer convincing testament that a purely private system can become a great disaster for the market economy. A recent serious study (please read: http://www.fhfa.gov/webfiles/16711/RiskChars9132010.pdf) has shown a better performance of Fannie Mae versus private counterparts. Taxpayers would have had to inject over US$175 billion into a private system that would play the role as Fannie Mae did during the past great recession. Remember, only US$117 billion was required for Fannie Mae - one third lower than a private alternative. Fannie Mae is also playing a great undeniable during the housing recovery, which cannot be expected from a private alternative as a private alternative would have to wait for more housing certainty. But Bob Corker's cause can be better served by bringing private capitals into Fannie Mae than through an untested new private system. Apparently, Bob Corker is likely already prepared to make compromise if a new Fannie Mae can be secured with more space for private sector so that the more effective private sector influence can be exerted on a publicly-linked entity.

    The current version as reported of Corker-Warner draft bill is at most a response to the darkest moment of Fannie Mae's history during the darkest time of the US economy since the Greatest Depression. But US housing does not need a support system that is only good for the darkest moment: it needs a system that is good for most of the time. Fannie Mae is not a perfect model when less well managed, but its problems and shortcomings have been made known, and solutions are also readily available. Unless Great Depression is preferred to Great Recession, there is no reason to return to the pre-1938 jungle at a time when Chinese economy is fast catching up.

    So the merit of the Corker-Warner draft bill is to provoke reflections now, in order to boost further recovery of the housing market, and seek quicker politically and economically acceptable solutions. Its merit does not rest with the draft per se, since it is not in Corker's best interest nor in Warner's interest to pursue the proposal to liquidate the private-public partnership model of Fannie Mae.

    The Corker-Warner effort should be appreciated by Fannie Mae investors for contributing to triggering the debate on Fannie Mae's exit from conservatorship to allow Fannie Mae to fully contribute to the housing market. If time is money, the potential earlier coming back into the market triggered by the Corker-Warner effort should be taken as to bring windfalls for Fannie Mae private investors.

    Disclosure: I am long RDN.

    Tags: FNMA, mortgage
    Jun 09 8:17 PM | Link | Comment!
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