I Love the Smell of Repos in the Morning...

by: Barry Ritholtz

Last night, I asked the assembled multitudes what was the Fed's motivation behind their big 50 bp whack. Let me add some spin to the question: OFHEO will now allow Fannie Mae (FNM) and Freddie Mac (FRE) to increase their portfolios by 2%/year above cap.

"In another sign of an administration shift, the regulator for Fannie Mae and Freddie Mac, the Office of Federal Housing Enterprise Oversight, agreed to relax restrictions on the mortgage-finance companies' investment holdings. Ofheo's new policy allows Fannie Mae to increase its portfolio by 2% a year, a level comparable with an existing limit on rival Freddie Mac.

Fannie Mae called on the regulator to allow bigger increases. "We still believe the more effective response, given the extent of the market disruption, would be to raise our portfolio cap by at least 10%," Fannie Mae spokesman Brian Faith said."

The details will come out over the next few weeks -- but there are expectations this will eventually include Jumbo Mortgages, Sub-Primes, etc.

Thus, a GSE, originally established to make purchasing homes more affordable for the middle and lower classes, has now become a subsidy for speculators and the purchases of McMansions.

These are your tax dollars at work . . .

In a recent letter to Rep. Barney Frank, FOMC Chair Bernanke opposes the increase. We must assume Helicopter Ben does not want competition for their "Credit From Above" air cavalry unit (via a bastardized version of “Apocalypse Now” and Lt. Col. Kilgore’s ‘Death From Above’ moniker for his helicopter/air cav unit).

And, as Bill King notes, we cannot answer the question of whether the Fed plays “Ride of the Valkyries” before injecting credit or cutting rates. But he is hard at work spreading the rumor that Ben ‘loves the smell of repos in the morning.’ He says, “It smells like...victory.”

Less sarcastically, and more specifically, King observes:

You know all that crappy paper, particularly mortgage-related, that is circumnavigating the universe in search of a home? Ironically, Helicopter Ben might have just made it harder to unload the crap on patsies.

The intent of the 50bp rate cut is to:

1) alleviate the urgency to unload crappy paper, and

2) to prevent a panic and Northern Rock-like run on US financial institutions.

Unintended consequences of the 50bp rate cut include:

1) re-popularizing ARMs, especially with so many pundits forecasting more rate cuts. (Isn’t ARM excess a major factor in the current mess?)

2) Long rates have increased smartly.

Helicopter Ben’s dual rate cuts have cut the legs off of bonds and the non-ARM mortgage market. Higher long-term yields will force the price of crappy paper lower. Ben better hope that his scheme to lower the ‘cost to carry’ on crappy paper mitigates the urge to avoid capital losses.

We need some context to comprehend this: Alan Greenspan's 1% rates created what looked like a huge Housing boom. But what it really created was a credit boom, which then in turn led to a derivative boom and ultimately a structured finance boom. Thus, the so-called sub-prime crisis was merely the match that ignited a much wider breakdown.

I like this quote from Christopher Wood, chief strategist at the broker CLSA:

“This is not a sub-prime crisis. Sub-prime has merely exposed the bigger scam of structured finance; a scam that is about pretending that bad credit is good credit.”

That's as good an explanation as any of the others that have has been proffered so far . . .

Credit Markets Show Revival After Rate Cut

WSJ, September 20, 2007; Page A1

Chief strategist at CLSA predicts record gold run
Leo Lewis in Hong Kong
Times online, September 19, 2007