July 14, 2008

The Federal Government Breaks Out Their (Big Enough?) Buckets

First IndyMac, and now Fannie Mae and Freddie Mac, it’s been a mad week of bailing and pre-bailing backstopping for the Federal government. And what normally would have been an insignificant $3 billion auction of securities by Freddie Mac this morning, instead becomes an oversized test of confidence for the financial markets.

UPDATE: The debt market responds favorably to the Fed's implicit explicit backing. Goldman and Rogers (and ex SF-er), not so much.

IndyMac Seized by U.S. Regulators Amid Cash Crunch [Bloomberg]
Paulson Puts Treasury's Weight Behind Fannie, Freddie [Bloomberg]
Alt-A Powerhouse IndyMac Takes A Step Closer To IndyDependance [SocketSite]
When We Wrote Watch Your Fannie, We Really Weren’t Kidding [SocketSite]
Freddie Mac Gets Higher-Than-Average Demand for Bills [Bloomberg]
Fannie Plan a `Disaster' to Rogers; Goldman Says Sell [Bloomberg]

First Published: July 14, 2008 3:00 AM

Comments from "Plugged In" Readers

The Indymac failure and conservatorship by the FDIC has been suspected for months, and it basicalyl failed last week. But the FDIC dislikes taking over banks on weedays, it almost always takes banks over on Friday evenings.. so it just waited. Indymac is a big bank and one of the biggest ever to fail (maybe 4th biggest?). more bank failures will come. I will note that Indymac was NOT on FDIC's "watchlist" for failing banks... shows you how inept they must be since everybody and their grandma has known that Indymac was in serious trouble

I still don't think anybody knows what the Fannie/Freddie news means in full. However, a few things are clear:
1. Fannie/Freddie are "too big to fail". (no surprise)
2. Fannie/Freddie will be nationalized at some point (I still can't honestly understand why this is a surprise to anybody, but it is/was).
3. this will come at huge taxpayer expense. (again, I still have no idea why this is a surprise to everybody)

I can't exactly wrap my head fully around this plan (SO MY FOLLOWING ANALYSIS MAY BE IN ERROR). But overall it stinks to high heaven. what the government is saying is that Fannie and Freddie don't need any help. But if they do, the Govt will give it. They will do it by loans and by capital infusion (in other words the government itself will buy shares of those companies through the Treasury)

I'm not aware of our government EVER buying stock in a private company in order to prop up it's stock price. In other words, we will use taxpayer money so that a PRIVATE company can stay PRIVATE. Then if/when the company makes a profit (or manipulates it's financials to make it look like it made a profit... something both F&F were caught doing by the way), then the executives will make big bucks. If the company does poorly, it's stock price SHOULD fall, but instead the government will use taxpayer money to prop up the stock price, so the PRIVATE OWNERS Of the stock will still make a profit.

also: by propping the stock price and allowing this extra lending to go on, the F&F bondholders now hold bonds that are FULLY BACKED by the Federal Government. Thus, the risk of default of those bonds is near to 0%. However, the rate of return on F&F bonds is HIGHER Than treasuries.

This solution really doesn't make much sense. One can already see where this is going. F&F's stock will continue to TRY to decline, so the govt will have to purchase more and more and more of the stock (allowing current stockholders to get out WITHOUT A LOSS). Eventually, the govt will own ALL of the stock and the firms will be nationalized. This is a travesty, for all the stockholders will get out WITHOUT A LOSS.

The other option would be if the Govt bought Preferred shares. This would be progressively dilutive to the current stockholders, but still wouldn't totally wipe them out as they should be wiped out. I'm not clear on which type of equity the govt would buy.

Instead, F&F should stay AS IS. when their stock goes to zero, then it should be taken over (so equity holders lose it all).

I know why the govt is doing this, and it makes sense at first glance. They're hoping that this statement will make people have confidence in F&F again, so that F&F become strong again, and then they never need the bailout in the first place. A very risky gamble IMO. It hasn't worked yet.

Oh: and also not a surprise: oil and gold are rallying on this news.

One day people will realize that the housing prices seen in the mid-2000's were simply NOT sustainable or affordable. One day people will realize that we can't "prop up" housing because it costs more than people can afford. Or at least we can't prop up housing without significant corrollary damage. That day is not yet here.

Be careful all. This credit crunch is nowhere near finished. We will all experience significant economic pain (including me) no matter how much we have prepared. Uberbears: control your shadenfreude, because you may not be happy with the end result if you are proven correct. it doesn't help to be "right" and to have no job and high inflation. I am very worried, and very defensive right now.

Posted by: ex SF-er at July 14, 2008 8:28 AM

The tightening continues:
No more "no income no assets" loans or "stated income stated assets" loans.

Fed Bans Risky Mortgage Practices

Posted by: ex SF-er at July 14, 2008 8:50 AM

I don't know about you guys, but reading bloomberg.com daily is about as much fun as slowly giving myself paper-cuts on the skin between my fingers and toes.

Posted by: alex at July 14, 2008 8:56 AM

Great post ex SF-er. This is blatant govt corruption in a misguided attempt to keep housing prices high. If you are looking for the road to hell, just follow the Beltway to Wall Street.

Posted by: FSBO at July 14, 2008 9:19 AM

Relax ex-sfer,

The republicans are not going to bail anyone out and the democrats are not going to bankrupt the treasury just as they are about to get control of the government.

Everyone understands that housing prices are going to continue to fall. When that happens, FM/FM will need lots more money to pay for all of their guarantees. The goal of the government right now is to allow them to raise as much money as possible so that THAT money can be used to keep FM/FM afloat.

So the government just makes all these implied promises while trying to get these two clowns to raise more money so that the government doesn't HAVE to bail them out.

Will it work? I doubt it. At least the people buying bonds have continued to do that, so for now the panic has left the system. But people are still selling off the GSEs, so that little deception doesn't appear to be going anywhere.

Todays bond sale was a true "test" of the system. But the "test" was open book, and the professor was standing there ready to change your answer if you got it wrong. No way was anyone not going to ace it. If housing prices were going to rebound or even stay steady, no one would have needed to do all of that to get the bonds sold.

All this tells me is that we have a long way to go before housing prices reach a bottom.

Posted by: tipster at July 14, 2008 9:23 AM

It's eerie to watch the headlines unfold exactly as predicted here by the more thoughtful commentators. ex-sfer's explanations have been particularly prescient.

Bernacke and Paulson must understand the consequences of the huge debt creation of the last 20+ years, regardless of what they say publicly. Their actions are driven by political expediency and a hope they can build confidence without outright nationalization of Fannie and Freddie. I don't believe a word of it.

Posted by: michiko at July 14, 2008 9:26 AM

The equities market is obviously not sure of the implications of the government bailout. FNM/FRE opened higher but have drifted downward into losing territory. It is far from certain that stockholders will walk away from all this with anything left. Paulson is not fond of bailing out shareholders. However, ex SF-er is right on that the Govt has unambiguously signaled that debt holders will be protected. I presume the logic is that the higher return ex SF-er notes will decrease given this guarantee and thus reduce the GSEs' borrowing costs.

So FNM/FRE will clearly not be permitted to fail. You and I will pay for this safety net. But the rest of the finance industry is in real turmoil. Lehman Brothers is plummeting. Other banking firms continue to be hit with more massive writedown announcements coming this week. This housing crash (now spreading into a broader financial crash) has been far nastier than I ever imagined, and while we have a long way to go, let's just hope it at least eases a bit sooner rather than later. Interesting times.

Posted by: Trip at July 14, 2008 9:36 AM

In ex-SFers post, I don't understand why the shareholders need to be saved in order to keep up the lending. In the IndyMac case, the whole firm was nationalized. Would that not happen here?

Posted by: kel at July 14, 2008 9:48 AM

ex sf-er

from what I have heard, the federal government's purchase of an equity position in either Fannie or Freddie will carry a significant penalty cost to current shareholders = preferred shares.

thus, the federal capital will act as dilutive to current equity holders. this will have the effect of moving the price of common stock in these companies, in an asymptotic fashion, to zero.

i believe it is incorrect to state that current stockholders will be able to get out without a loss. perhaps less of a loss, but certainly no escape without a significant loss for the vast majority of holders of equity in these two 'companies.'

likewise, the debt obligations of these two GSE's will see their spreads relative to Treasuries narrow asymptotically until they are essentially equivalent, with the prices of the agency backed bonds and real Treasuries meeting somewhere in the middle.

the final result that is being engineered will be a slow and steady increase in the public debt, a slow and steady rise in the real interest cost to finance the debt, and a decrease in the strength of the dollar relative to many other currencies.

out and out immediate nationalization of these two agencies, with immediate wipeout of the current equity holders (who actual hold no equity given that both of these agencies are way underwater), would result in the above three events that I outlined, but it would happen in a metter of days, not years.

you can argue over the relative merits of increasing the public debt for the purposes of Star Wars in the 80's or to bailout our credit inflation of the 00's, but it must be realized that an immediate assumption of all of the agency debt would have disastrous financial consequences. The slow slide the federal government is engineering now is going to take years to play out, and in that time it is the hope of policy officials that by some unexpected miracle, an economic upswing will lift housing prices, and thereby make good debt out of the bad debt that the agncies currently are holding.

IF this miracle happens, then the federal bailout has bought time necessary for the agenices to become solvent, and then the equity stake that the government has could actually be sold at a profit.

WHEN the miracle does not happen we are looking at a lost decade or so of economic inactivity. We may also be looking at the death throes of the dollar and Treasuries as the placeholder for weatlth throughout the world.

Only time will tell who is right in this debate, but I would argue strongly that the dislocation from the government nationalizing immediately is unpalatable to all of us, while the slow burn that they are effecting is highly distasteful to most of us.

Posted by: enonymous at July 14, 2008 9:59 AM

I don't understand why the shareholders need to be saved in order to keep up the lending

kel: they don't.

The concern is that Fannie and Freddie are HUGE. Nationalizing them would come at huge cost to the government.

Leaving them private is preferrable to the government, but investors are losing confidence in F&F. as they lose confidence it is harder and harder for F&F to raise cash and remain private.

thus, the plan is NOT to save the shareholders... the plan is to show "the market" that F&F are "safe" and are FULLY backed by the government. In doing this the govt hopes that confidence will be restored in F&F and that F&F can raise cash trough private sources. if this works, then the govt need pay nothing! it is the government's position that F&F are stable and that this "pseudo-bank run" is unfounded. thus, the govt feels that we just need to reassure the public, and then things can go back to how they were. they feel (evidently) that the way to reassure the public is to open the fed window and also openly state that Treasury will buy shares. (I obviously disagree)

but it is a dangerous gamble. if the market doesn't believe the government, then the government will need to buy those shares.

There are different ways to buy the shares, and I am completely ignorant as to how the govt will do this. I have never known the govt to do such a thing, so I don't know the mechanics. so the shareholders may actually be wiped out. it depends on what Paulson means when he talks about the govt "buying shares". we'll find out later this week likely.

People ask why is the govt doing this? again, because the current administration does NOT believe in nationalizing F&F. They are trying to do anything so that this doesn't happen. (they will fail IMO). others who are very knowledgeable disagree with me. They feel that this action will perhaps stall off a nationalization, or at minimum will buy us some time which will cause more private money to get into F&F, and that private money will take the brunt of the losses before govt has to step in.

I will be shocked if the taxpayer gets out of this without significant pain but I have been wrong before.

there is a secondary problem as well. F&F are so huge that if/when we bail them out the govt will be super-cash-strapped, and not be able to bail out many other banks.

So what do we do if/when Washington Mutual, BofA, Fifth Third, Lehman, etc fail???

this secondary problem is partly why all the banks are getting slaughtered today. people are looking around and realizing that most of the banks are in big trouble for these exact same reasons.

so to repeat: it will be a Lonnnnggggg time (probably years to decades) before we get back to the easy lending terms that we saw in the mid 2000's.

Posted by: ex SF-er at July 14, 2008 10:08 AM

The only surprising thing about this collapse is that it hasn't drawn Satchel out of hiding to start commenting again....would be interesting to hear his opinion.

Posted by: Dude at July 14, 2008 10:09 AM

enonymous:

I agree completely with your analysis. (we cross posted)

to others: enonymous' ideas are the counterpoint to my ideas, but they are not incompatible ideas IMO (correct me if I'm wrong enonymous)

I've already stated that I'm not sure how the equity transfusion will happen and what its ramifications will be, as I'm not aware of this ever being done before (hence the need for congressional approval).

the key to me is when enonymous states this:
i believe it is incorrect to state that current stockholders will be able to get out without a loss. perhaps less of a loss,

getting out with "less of a loss" is still the taxpayers giving the shareholders a gift. the shareholders should get NOTHING.

My only other qualm: I agree that the govt hopes they can drag this out for years... but the equity infusions may need to start ASAP.

which is why I think this "bailout plan" is really more of a move to instill confidence, in hopes that a true bailout never happens.

I agree with every other word that enonymous wrote.

Posted by: ex SF-er at July 14, 2008 10:25 AM

One perhaps obvious suggestion -- if you have any account in any bank that is over the FDIC limits (generally $100,000), one would be wise to draw those down right away and spread them among multiple accounts under the limit. As noted above, IndyMac was not even on the watch list. Odd times -- there is no telling who could be next, and these things happen fast.

Posted by: Trip at July 14, 2008 10:26 AM

Anyone have a list of safe banks? Also, what about safer alternatives?

Posted by: kel at July 14, 2008 10:29 AM

What do people think about SIPC protection? Should I switch everything back to FDIC?

Posted by: Foolio at July 14, 2008 10:32 AM

I learned a lot from Satchel, but will always remember the short he posted on Google @$434/100 shares. That would have cost him and anyone who copied him $11k ... I made that betting against him (virtually).

Posted by: michiko at July 14, 2008 10:33 AM

since Satchel seems to have disappeared, and many clamor for his return (I am one of those clamorers, who, although I did not always agree with what he said, was generally thrilled with how he said it), I thought I would quote his thoughts on the eve of the (much smaller) Bear Sterns bailout:

Here is a quote (from his "Human Action", published 1940) that is popular on the internet from my favorite thinker on economic cycles, von Mises. I'm sure most have seen this before, but for those who haven't it is really worth reading and pondering over:

"The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Just a little light Sunday morning reading....

Posted by: Satchel at March 16, 2008 6:37 AM

Posted by: enonymous at July 14, 2008 10:34 AM

SIPC is for stock accounts up to $500 K. You would have to liquidate and transfer to a bank account.

"I learned a lot from Satchel, but will always remember the short he posted on Google @$434/100 shares. That would have cost him and anyone who copied him $11k ... I made that betting against him (virtually)."

It may get back there in short order at the rate its going. No bets on this though.

Posted by: kel at July 14, 2008 10:36 AM

@kel:

Yeah, I was thinking more of money market balances under $100k that some people may have. Doesn't seem like now's the time to invest that, so whether it's parked in a SIPC- or FDIC-protected account may make a difference...

Posted by: Foolio at July 14, 2008 10:46 AM

kel,

No question about that, but being early is as bad as being wrong. Anybody that be trading better be a pro.

Posted by: kel at July 14, 2008 10:48 AM

"Yeah, I was thinking more of money market balances under $100k that some people may have. Doesn't seem like now's the time to invest that, so whether it's parked in a SIPC- or FDIC-protected account may make a difference..."

BTW, SIPC will not protect you if the money market you are holding defaults. SIPC does not cover changes in the value of your securitiesm.

Posted by: kel at July 14, 2008 11:04 AM

"I learned a lot from Satchel, but will always remember the short he posted on Google @$434/100 shares. That would have cost him and anyone who copied him $11k ... I made that betting against him (virtually)."

Not that it's relevant, but I looked back at the GOOG thread. Satchel's short was actually at $568 with a stop at $445. He would have made over $12K.

Posted by: Dude at July 14, 2008 11:07 AM

Glad you corrected me. Satch rules.

Posted by: michiko at July 14, 2008 11:14 AM

credit unions may be a better alternative than traditional banks.

Posted by: view lover at July 14, 2008 11:14 AM

michiko,

"I learned a lot from Satchel, but will always remember the short he posted on Google @$434/100 shares. That would have cost him and anyone who copied him $11k."

Thanks for the kind words about learning from some of my posts... and kudos for understanding that only a challenge to my trading acumen could draw me out of hiding! Sorry this is OT, but my trading of GOOG was masterful, and timing was near perfect, if I do say so myself!

I sold at $568. I never recommended anyone go short at a particular level, but I posted the short position at the time and later:

"I'm just having fun with GOOG! Yes, I am short. Sold at $568 or so. I posted my analysis a while back:

http://www.socketsite.com/archives/2008/02/now_about_that_google_effect_

[snip]

It's pretty much going as I expected, albeit a little more quickly. I have a tight stop, so I may or may not be in it at the end of April. [snip]

Posted by: Satchel at March 10, 2008 3:40 PM"

I covered the short position at around $446, actually earning about $12K:

"$100 is my (admittedly very aggresive) TARGET. I HOPE it gets there, and quick! But my stop is around $445. If it goes back up there, then I'll be stopped out, and I will only have booked a roughly $120 per share profit. It's only 100 shares (a fairly small position for me), but every $ counts when you are staring down the teeth of the coming credit deflation monster!

Posted by: Satchel at March 10, 2008 4:56 PM"

Both of those quotes are from the March thread on a Noe SFH:

http://www.socketsite.com/archives/2008/03/another_singlefamily_apple_on_a_noe_valley_tree_480_dun.html

Only a very inexperienced trader would trade without stops. Now, for those people who do not understand stops, well, they should not be involved in short selling at all!

With GOOG out of the way, and back to the topic, isn't this credit wipeout that is gathering pace a wondrous thing to behold? Absolutely magnificent. The only thing I would add to the good discussions above (especially those of ex-SFer and enonymous)is that most people still labor under the illusion that the government and the Fed case about the population. As I have said many times, remember that the Fed and the USG came out of the Great Depression stronger than ever.

There is still this implicit belief that a collapse in the economy (or by extension, the housing market) is not desirable because of the ensuing collapse in confidence and consumption spending. I don't have the talents to "win" the argument, as this belief is rooted in faith and is akin to religious zeal. In fact, for much of Western History, many governments have been engaged in a back and forth struggle with organized religion for control of the population. It looks like governments have won this round..... and they now accede to the faithfulness of the population, which having "lost" its organized faith nevertheless retains the need to believe in something....

The gameplan has not changed one iota with Fannie/Freddie. At some point the USG will buy a "super secured" preferred stock issue, then another and another.... All the while, credit will slowly be constricted. At some point the Fed will start printing money (can you believe they haven't done any printing yet!! Amazing) but it will not be enough to stave off the deflationary collapse. Their only goal is to slow down the fall and "trap" as many people in depreciating assets as possible. Someone needs to take the losses, and TPTB are hell bent that it won't be them!

P.S. - For those who have been wondering, I've been out of pocket for a while, and have been VERY busy with a few things, and won't be able to post much over the next few months.

Posted by: The Return of Satchel at July 14, 2008 11:33 AM

Basically, Feds are spreading the bad debt of people with bad judgement over the entire population, including those who have stayed away from the craze.

For instance, I have no debt (zero, zilch, nada)and my RE equity is only 40% of my assets. Bought low, sold high and stayed away from buying RE starting 2004.

I don't NEED debt.

I don't WANT debt.

I pay my CCs in full (thanks for the dididends on purchases, though!) and shred all those stupid checks credit card companies send me.

But I will get debt down my throat nonetheless:

- Tax "rebate" check. This is simply put just a credit check put on the big national credit card.
Spend now, pay later. The check just made it into a CD, therefore it will offset the final bill in a few years somehow.

- The Feds (you and me) keeps on buying bad debt from FNM, FRE and others.
As half-wits who bought at the top of the housing market (and still do in SF) get bailed out, we all have to pay for their bad judgement. Not only they made the life or many people harder by pushing prices to the moon, but now we have to help them...

Anyway, just a Monday morning rant.

Posted by: San FronziScheme at July 14, 2008 11:34 AM

Welcome back Satchel. Sounds like it really is you.

Posted by: michiko at July 14, 2008 12:05 PM

first off - good to have you back satchel

I'm not familiar with the expression 'out of pocket' but I hope that you have been made whole and are back in good shape.

Since we have your ear for a second, I would ask you your opinion on this question:

Which is preferable The Great Depression (U.S.) or the Lost Decade (Japan)?

In my question I am asking that in both the economic and value sense. You make the point that goverment has replaced religion (in the U.S. and many other 'Western' nations). If that is the case, then allowing an economic meltdown to be laid bare would undermine the population's belief in the government as its great protector (as opposed to their favorite deity (or deities)). From an economic perspective a swift and stunning collapse is best in my mind. From a 'value' sense, such a collpase can create a volatile and unstable paradigm shift. Perhaps you have seen the movie "The Matrix." The blue pill is what the feds are trying to engineer. The red pill is the collapse and rebuilding that would cause likely mass upheaval. Which is best depends on your value system.

ex Sf-er:

I wish others here would realize that thoughts can be counterpoint but not incompatible. You are correct, I agree with you and you agree with me on almost every view of this debacle. As you noted, I was simply pointing out the 'logic' behind what is happening.

With regard to this statement:

'getting out with "less of a loss" is still the taxpayers giving the shareholders a gift. the shareholders should get NOTHING.'

I would take issue only with your use of the word should. I would say that the shareholders 'ought to' get NOTHING. From a moral/value standpoint I agree (hence my use of the word ought) that they deserve nothing.

But 'should' they receive nothing. That is very tricky. They own equity in a company that is worthless, insolvent, etc. Yet the debt obligations of this worthless company are very highly valued (i.e., I don't want any of their common stock at a steep discount but if you want to sell me their debt obligations at a steep discount I'll give you money all day).

This dichotomy makes no sense, of course, but since it exists, we then have to ask, quite simply, 'should' the shareholders get nothing. If so, why? I may think they should get close to nothing, with the belief that because of the tension of dichotomy I outlined above, the shareholders were (falsely?) led to believe that their stake would always be worth something, however small it might be. Call this the 'i own a stake in the US govt' premium. I believe that this is the only thing that makes the value of these GSE's >0. I also beleive that the government created this dichotomy, and thus stockholders should be renumerated for it.

The opposing contention is strong, no doubt, and I look forward to the lively discussion.

Posted by: enonymous at July 14, 2008 12:07 PM

can our gov't really afford to back-up FM/FM in the event that it actually had to? we have a deficit and our dollar is in the tank already.

Posted by: view lover at July 14, 2008 12:19 PM

enonymous,

I totally agree that swift collapse is without question preferable from a purely economic point of view. The faster the rot is eliminated, the less continuing malinvestment will be made. But the government will intervene, just as it did in the Great Depression and in Japan. The GD was definitely NOT a swift collapse, as happened in 1873 (which was over after 3 or 4 years, and did NOT require a world war to pull the actors out of the depression - btw, that depression was instigated by governmental sponsorship and promotion of credit to the growing railroads - sound familiar?). What was that famous quote from the 1930s?, something like "the best way to ensure a depression is to resist it"....

The values question is interesting: which is preferable. I guess I do not foresee an Armageddon Mad Max situation. It will be bad, but not terrible, and certainly "easier" than the Great Depression. Probably akin to Japan's "lost decade", perhaps worse as we will also have to swallow a huge loss of international influence (basically, the unwinding of the US' hegemony over financial institutions following WWII). I doubt we would get a paradigm shift, say back to organized religion. As the population endures more pain, they will turn to the familiar, ie government. But who knows?

Posted by: Satchel at July 14, 2008 12:38 PM

SATCHEL RULES!

Dont disappear again!


Posted by: Britter at July 14, 2008 1:28 PM

So happy for the return of Satchel! Post when you can. And to the other commenters above, it's been a fun morning of telephone calls and filling out forms in an effort to move money in $100K increments to other banks.

Posted by: crockergal at July 14, 2008 2:00 PM

Waiting in lines Then and Now

Posted by: badlydrawnbear at July 14, 2008 3:35 PM

bdb - pretty amazing to actually see people lining up to pull their money out of a bank. I saw other similar pictures today from other IndyMac branches. I agree with Satchel that we are likely in for a Japan-style lost decade - but a Mad Max scenario isn't that far from these pictures of runs on banks. FDIC deposit insurance is a good thing - and an appropriate role for the govt to protect small investors (and prevent bank runs). But their should be no taxpayer bailout for the bond or equity holders of any private bank or GSE. A swift collapse and rebuilding is what we need (and what we won't get).

Posted by: FSBO at July 14, 2008 3:46 PM

I have a post on Trulia's blog on the consumer confidence and the Presidential election. Then later that week the rimor mill starts on F&F> Regardless of what the reality is the herd is stampeding. "Ex-sfr is very scared and defensive". The only thing to be scared of is the hystericall reations of the public. Nothing changed and F&F just some analyst says if this happens and then if this happens then this could happen and it's time to run for the hills.
The current administration has everyone so on edge that we are running scared and creating out own mess.

Posted by: Jed Lane at July 14, 2008 4:25 PM

I think the verdict is still out as to whether the equity holders of the GSEs will be bailed out. And I don't think anyone is talking about a significant bailout of equity holders of any private bank. It is true that Bear Stearns' shareholders were given a little gift -- $10/share, but it is not clear yet that the public will eat that. And IndyMac's stock is going to zero as it should. I'm also not sure we have seen any significant bailout of any debt holders for a private bank. In any bankruptcy, the equity holders lose just about everything as do unsecured creditors, but the bond holders tend to recoup pretty close to everything except in unusual cases. It's the same here. These banks have lots of assets, and the bond holders don't seem to need a bailout to be made whole. I certainly have not studied IndyMac's debt, but I haven't read about debt holders being concerned. Not my area, so I could be way off base.

I don't agree, however, on the debt side for the GSEs. It's pretty clear that we faced a nasty mortgage freeze-up and worse if the GSEs could not issue debt, and this new guarantee to bondholders may be the lesser evil (I see the other viewpoint, however). The vast majority (something like 95%) of mortgages backed by the GSEs are performing just fine. Those that aren't are a whopping number in terms of raw dollars, but I am not convinced that backing those wishing to continue to finance the GSEs is worse than letting the whole thing collapse. We don't want to prolong the inevitable, but uncontrolled catastrophe is extremely risky.

Posted by: Trip at July 14, 2008 4:29 PM

Satchel - Glad you are back, even if it is fleeting. Something you had wrote about before that I have been meaning to get clarification on from you, if you ever re surfaced. I think you wrote that you feel that the government's goal is self aggrandizement, so that they use these economic shocks to enhance their own power. Is this correct? I get the feeling the current USG is really just carrying water for their private sector banking counterparts, and that is who they are trying to keep rich and powerful. Maybe these are not mutually exclusive goals, but I sense there is more worry about ex Goldman executives keeping current Goldman executives rich than about enhancing their own power while in office. It seems to me that public office is just a stepping stone or ego trip for those on their way back to gorge on the private trough, or those trying to get to the trough for the first time. I'd be interested to hear your thoughts on this.

Posted by: The Bunk at July 14, 2008 4:52 PM

The only thing to be scared of is the hystericall reations of the public

are you Phil Gramm?

There are enormous structural problems with our entire economy right now. Housing is just but a sideshow. The real problem is that we had massive credit bubble (housing, credit cards, auto loans, private equity, commercial real estate, leveraged buy outs, etc). we have a huge and unprecedented unwinding of extreme amounts of leverage occuring.

it is unclear if our economy can survive this in its present form. I personally think we will survive, but I also think there will be considerable pain and our economy will be very different in 5-10 years from how it is now. I also think that a lot of uber-bears who are cheering for this will find sorrow as they or loved ones lose their jobs and/or life savings.

Why do you think that the President, the Treasury Secretary, The Federal Reserve Chairman, the director of OFHEO, the head of the FDIC were up all weekend? do you honestly think it was only due to hysterical over-reactions of the public? even if it were, the hysterical overreactions of the public can wipe you out.

it was only the hysterical overreaction of the public that caused Argentinia's recent monetary crisis as an example. it was also hysterical overreaction of the public that caused the Salem Witch Hunts. Do not underestimate the damage hysterical overreactions can cause.

your argument doesn't hold much weight. I agree, NOTHING has changed in the last week regarding F&F, except that the public is finally understanding the essential structural problems with F&F (60x leverage anyone?). This is why nothing that's happened in the last week or so is a surprise to me (I've predicted F&F failure and subsequent nationalization for about 2 years now). It's also why I have profited handsomely from this, while the govt (and "professional" economists) are caught unawares. It is also why I am afraid despite my "winnings" because I realize what is at stake.

Mr. Lane: you can do whatever you want. My goal has been to warn people who care that all is not well and to give them time to prepare. I know Satchel (a kindred spirit) is like minded, as is enonymous (even thoug I argue with him/her sometimes). Many people who understand what is going on are NOT like us. they feel that the uninformed are "sheeple" and deserve to get wiped out. We believe otherwise (since we were once the uninformed and have a shred of decency/compassion). Thus, we come to regular boards such as these and try enlighten people. what they do with that info is then their business.

As I've said:
-reduce your debt as much as possible
-now is not the time to get into more debt
-spread your savings around into multiple banks in case one or more of them fail
-keep less than US$80k TOTAL in a single banking entity
-raise a 3-6 month emergency fund in CASH or CASH equivalent (highly liquid) accounts. Such as savings or checking or a safe. Not a money market or mutual fund or HELOC or HEL or something.
-keep about 3-7 days of CASH (actual bills) on hand and accessible just in case.

again, this isn't doomsday. It should be done even in boom times. There is a chance that this all turns to be a nothingburger... if that's the case my above advice will have harmed nobody.

perhaps one person listened to me even as late as last week and pulled their excess money out of Indymac, so we have 10,000 people who foolishly kept >100k in Indymac instead of 10,001. if so then I'm a happy man.

if you are a cynic, you can say I'm talking my book. But in general I've tried to disclose my positions so that people know I'm talking my book. And my message has not changed on this site even when I was 100% long the market (last fall).

so yeah, I'm afraid. I'm not afraid to admit it. but I have good reason to be afraid and feel as though I've outlined my argument as to why.

Posted by: ex SF-er at July 14, 2008 8:47 PM

enonymous:

I think I understand your distinction between "should" and "ought".

I agree with you that there was a unique dichotomy that existed due to the blurring of governments role due to the "implicit" gaurantee.

however, I also feel that most rational investors undersood that this implicit gaurantee was only for the debt, and that nobody in their right mind felt it would extend to the equity.

The stock benefitted from the implicit relationship through F&F's ability to secure financing at lower-than-market rates, thus boosting "value" and EPS and hence share price.

but even using the "should" argument I can see no reasonable investor who ever thought that the govt would support the stock price, especially not in the manner proposed (intermittent stock purchases through the Treasury)

not sure if I'm elucidating myself well.

but like I said, I agree fully with you as to WHY the administration is choosing this path, especially since Hank and GWB really don't want to nationalize...

I just don't think their gamble will work. Time will tell. I've been wrong before.

Posted by: ex SF-er at July 14, 2008 8:54 PM

Bunk,

The concepts of government self-aggrandizement and government's support of private banking elite interests are not mutually exclusive. IMO, in the current system, they are actually supportive of one another.

Government, like any human organization, seeks to grow, marshalling its influence and exerting control where possible. In US politics as currently constituted, this yearning for growth typically takes the forms of increased regulation, taxation, growth of budget, etc.

Recognizing this increasing growth of the state, the smart people (mostly Wall Street and the banks) "saddle up" to government and try to insert themselves into the contant streams of money that are being extracted from the population and then foolishly allocated by government fiat. In addition, they write the regulations under which they will either thrive or struggle. As regards the budget alone, it's a $3 TRILLION endeavor, which makes even the biggest CEO look like a piss-ant. And when the gatekeepers (Congress) are such morons, and the population is so clueless, well, the temptation is just too great.....

(In our system, it gets even worse. The private banks have the ability to simply create "money" by lending it into existence - $3 trillion is not enough of a lure I guess - with only the banks' wholly subservient, bought and paid for "regulator" - the Federal Reserve - to put the brakes on anything, which it does from time to time in order to keep the system from fully imploding. The Fed started a policy of restricting the growth of the money supply in Feb 2006 with the insertion of Bernanke. The last time it engaged in significant restriction was the early 1980s under Volcker - and before that you really have to go back to the early 1930s....)

And so, a partnership between the monied interests and the USG is struck, mostly unspoken I'm sure. This is to be expected, and is really no different in concept from what goes on in any form of government (for instance, think of how the Soviet system spawned an "elite" - business interests primarily in defense, energy and agriculture - that fed off the population). Because capitalism works so well, the pickings here have historically been orders of magnitude greater than those produced by more inferior systems. IMO, the "solution" for this inevitable concentration of business and government interests is to keep government as LIMITED in scope and SMALL in size as possible. Thus, the business and monied interests will compete with one another, rather than organize a "cartel" to effectively seize the government. Unfortuniately, this is an obvious insight that was well known in the 19th century but forgotten today.....

Posted by: Satchel at July 15, 2008 6:35 AM

Satchel - Thank you for the further explanation, I appreciate your insight. I could probably have a very long discussion on this topic as I believe the current "small government" talk of the current administration and minions has been subverted to mean something very different than what you are talking about. We probably differ in view on what is the proper amount of government and where the tax receipts should actually be spent, but I understand your argument and there is no doubt this is the scenario we are living under now, where the gov't and the private sector have formed cartel's that enrich and empower both at the behest of the rest of the polulation.

If I only had your trading acumen, or that of Ex-Sfer, then I would be feeling better than I am now, that's for sure.

Posted by: The Bunk at July 15, 2008 8:14 AM

Government spending as a percentage of GDP has been relatively constant for the last 30 years, so I am sure where people get the idea that government has grown. There are more regulations though.

I think we are in for a garden-variety recession, worse than the recession-lite we had in 2001, but not as bad as the terrible double dipper in 1980-2.

It is true that for people that have never been through a real recession before, it will be quite a shock, but the US economy has withstood much worse. I actually think it is a good time to buying stock, especially bank stock. We shall see how it all turns out.

Posted by: NoeValleyJim at July 15, 2008 5:06 PM

-reduce your debt as much as possible
-now is not the time to get into more debt
-spread your savings around into multiple banks in case one or more of them fail
-keep less than US$80k TOTAL in a single banking entity
-raise a 3-6 month emergency fund in CASH or CASH equivalent (highly liquid) accounts. Such as savings or checking or a safe. Not a money market or mutual fund or HELOC or HEL or something.
-keep about 3-7 days of CASH (actual bills) on hand and accessible just in case.

This is all good advice, rain or shine.

Posted by: NoeValleyJim at July 15, 2008 5:13 PM

^^^I agree with some of that for sure, but if you've got cash on hand, now seems to be a great time to take out some loans (with fixed rates). We're likely heading into a hyper-inflationary time, so getting any money you can now at fixed rate (as long as you have a way to pay it back) seems pretty tasty to me.

Posted by: anon at July 15, 2008 5:50 PM

NoeValleyJim,

"Government spending as a percentage of GDP has been relatively constant for the last 30 years, so I am sure where people get the idea that government has grown."

Well, for one thing, some of us get the idea because it is true! I'm on the road right now, so I can't give a detailed analysis, but I think you are missing two very important considerations. First, I don't think you are accounting for aggregate state and local governmental expenditure, which has exploded in the post war period (I like to look at the seeds of the decline of the US through increased governmental seizure of the economy as beginning with FDR, and reaching its full expression of fraudulent misallocation of the wealth of the population under LBJ - although the current Congress and occupant of the WH aren't too shabby in the misallocation department either!).

Second, I don't think that you're considering the changes to the measurement of inflation that were instituted under Clinton/Greenspan (primarily the move to chain weighted inflation measures, and the widespread and fraudulent use of "hedonic adjustments" that were applied to all price data series. These changes had the effect of understating price inflation in the deflator measures, and coordinately overstating GDP ("real" GDP = nominal GDP / [various deflator measures].

Anyway, when I am back, maybe for the fun of it, I'll run the numbers. For those, who just can't wait, you could run them yourselves. They will be in the BEA NIPA data, primarily tables 1.1.5 and 3.3, available here (it's all downloadable, so you can make some pretty excel charts...):

http://www.bea.gov/national/nipaweb/SelectTable.asp

Of course, you will be stuck with the phony government numbers, but you will see the trend. The real fraud with respect to GDP did not occur until the 1990s, so you can see the explosion of government spending from, say, 1950, through 1993 or so (when the effects of the changes in the deflator calculations began to show up in earnest). Just going by memory, I think aggregate government spending went from something like 25% of GDP to roughly 37-38% by the early 90s, after which the fraud in the calculation caused it to regress a bit towards 35% or so. Again, only from memory.

About your idea that this will be a garden variety recession, well, we'll see. Anything can happen I guess. But the macro picture today is MUCH different than the early 80s. At that time the US had relatively little debt, but massive monetization of deficits beginning under the gangster LBJ. The Fed stopped inflating, causing massive recessions in 1980 and 82-83. Today we have massive debt, and almost NO monetary inflation (look at http://research.stlouisfed.org/publications/usfd/page3.pdf and note the scale). The 60s and 70s saw MONETARTY inflation, while the mid-80s through 2007 or so saw massive CREDIT inflation. Conditions today are much more akin to 1929-31 IMO than 1979-80. It's about time to post the chart again I guess (I keep looking for an updated one - if anyone knows of one, please post it):

http://comstockfunds.com/files/NLPP00000%5C292.pdf

Of course, the debt/gdp numbers are even worse than the chart indicates, because everyone uses the fraudulently overstated GDP series after the early 90s... :)

Posted by: Satchel at July 15, 2008 9:55 PM

http://www.usgovernmentspending.com/downchart_gs.php?year=1977_2010&view=1&expand=&units=p&fy=fy09&chart=F0-total&stack=1&title=

Overall government spending as a percentage of GDP was 33.93% in 1977 and is 35.39% now.

There *was* a big move up from 1950 to 1975, but it has been level since then.

Of course, if you believe there is a vast conspiracy to cook the books, you can convince yourself of anything. Misreporting inflation should have no effect on this value, since it is just the portion of overall GDP we are talking about.

Posted by: NoeValleyJim at July 16, 2008 12:50 PM

The debt/GDP ratio is scary, but I don't understand why you keep mentioning inflation adjustments. That chart must be in nominal, not real (inflation adjusted) dollars. Right?

If both the numerator and the denominator are in nominal dollars, it doesn't matter what the real inflation rate is.

Posted by: NoeValleyJim at July 16, 2008 5:15 PM

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