Monday, September 29, 2008

Bailout Bill Defeated

As I write this blog, the Dow Jones Industrial Average is down 625.4 points. By far the largest single day loss of capital in the history of the US financial markets. Instead of discussing if Speaker Pelosi's negative rhetoric prior to the vote soured the momentum, I'd like to turn your attention to what's next. In my opinion the core of the financial challenges isn't the 4.1% of all mortgage loans which are delinquent. It isn't the 2 million home owners who may lose their home this year. It's the lack of clarity of the markets, or simply put... it's the fear of the unknown. I choose the word "fear" cautiously. It's a powerful emotion made even more powerful given the demographics of this country. When banks end up in the news, people right or wrong will look to put their money elsewhere. When deposits are pulled, banks lose the ability to keep the necessary funds on hand for the loans in which they have written. Additionally, they lose the ability to lend additional money. In short, they fail to do what they are designed to do. When banks fail, either the government or another bank must step in to pick up the outstanding obligations. Jobs are lost and perhaps more importantly, the competitive landscape for lending decreases. Those left standing are left to profit immensely.

Release Date & Time
Economic Indicator
Consensus Estimate

Mon. Sept. 29, 8:30 a.m. ET
Aug. Personal Income
PCE Index
+0.2% vs. last -0.7%
-0.3% vs. last 0.4%
+0.2% vs. last +0.3%
Mortgage investors will focus almost exclusively on the core personal consumption expenditure index component of this data set. The number barley edged up by a revised .01 percent in July, a weaker than the consensus estimate of a modest 0.1% drop in the underlying inflation rate. Given the attention at the Bailout Bill will be receiving, this will not likely create much of a stir in the mortgage market.

Tue. Sept. 30, 10:00 a.m. ET
Sept. Consumer Confidence
55.0 vs. 56.9
I anticipate this report will also be overshadowed by news of the financial market rescue agreement from Congress and Friday’s non farm payroll data that it is virtually guaranteed to do nothing more than take up space on this week’s calendar.

Wed. Oct. 1, 10:00 a.m. ET
Sept. Institute of Supply Mgmt.
49.5 vs. last 49.9
The modest anticipated 0.4% decline in the level of activity in the manufacturing sector will likely go unnoticed – particularly if investors are still sorting through the details of the financial markets rescue package. Only a reading of 51.0 or higher will likely have enough “power” to cause investors to push mortgage interest rates notably higher as a direction result of this report.

Thurs. Oct. 2, 8:30 a.m. ET
Initial jobless claims for the week ended 9/27
Down 18,000
This report will may have little, if any impact on direction of mortgage interest rates should the report be close to the estimate of 18,000. That said, if the number is as high as I anticipate, (say 25,000+) expect headline news and additional gloom and doom from all media outlets.

Thurs. Oct. 2, 10:00 a.m. ET
Aug. Factory Orders
-2.5% vs. last +1.3%
As business credit conditions continue to tighten factory orders are getting squeezed. If the consensus estimate proves accurate, this data will likely add a little encouragement to the prospects for steady to fractionally lower rates today.

Fri. Oct. 3,
Sept. Non farm Payroll
Jobless Rate
Avg. hourly earnings
+0.3% vs. last +0.4%
Most mortgage investors have already “priced-in” expectations for a very weak September employment reading. If the data confirms investors broad presumptions, the direct impact on the mortgage market will likely be minimal. On the other hand, if overall payrolls decline by 50,000 or less and/or the jobless rate slips back to 6.0% or lower -- look for surprised investors to respond by pushing mortgage rates sharply higher.

Thursday, September 18, 2008

The Other Shoe Dropped...

This article is about as spot on as I have read over the last several weeks... I thought I would share.

Few options as world faces what may be the greatest loss of wealth ever
By Steven Pearlstein
The Washington Post
updated 1:15 a.m. CT, Thurs., Sept. 18, 2008

You know you're in a heap of trouble when the lender of last resort suddenly runs out of money.
Having pumped $100 billion into the banking system and lent $115 billion more to rescue Bear Stearns and AIG, the Federal Reserve was forced to ask the Treasury yesterday to borrow some extra money to replenish its coffers. If there was any good news in that, it was that investors here and abroad were eager to help out, having decided that the only safe place to put their money is in U.S. government securities. Indeed, demand was so brisk at one point yesterday that, for an investor, the effective yield on a three-month Treasury bill was driven below zero, once the broker's fee was figured in.
This is what a Category 4 financial crisis looks like. Giant blue-chip financial institutions swept away in a matter of days. Banks refusing to lend to other banks. Russia closing its stock market to stop the panicked selling. Gold soaring $70 in a single trading session. Developing countries' currencies in a free fall. Money-market funds warning they might not be able to return every dollar invested. Daily swings of three, four, five hundred points in the Dow Jones industrial average.
What we are witnessing may be the greatest destruction of financial wealth that the world has ever seen -- paper losses measured in the trillions of dollars. Corporate wealth. Oil wealth. Real estate wealth. Bank wealth. Private-equity wealth. Hedge fund wealth. Pension wealth. It's a painful reminder that, when you strip away all the complexity and trappings from the magnificent new global infrastructure, finance is still a confidence game -- and once the confidence goes, there's no telling when the selling will stop.
But more than psychology is involved here. What is really going on, at the most fundamental level, is that the United States is in the process of being forced by its foreign creditors to begin living within its means.
Cheap money days That wasn't always the case. In fact, for most of the past decade, foreigners seemed only too willing to provide U.S. households, corporations and governments all the cheap money they wanted -- and Americans were only too happy to take them up on their offer.
The cheap money was used by households to buy houses, cars and college educations, along with more health care, extra vacations and all manner of consumer goods. Governments used the cheap money to pay for services and benefits that citizens were not willing to pay for with higher taxes. And corporations and investment vehicles -- hedge funds, private-equity funds and real estate investment trusts -- used the cheap financing to buy real estate and other companies.
Two important things happened as a result of the availability of all this cheap credit.
The first was that the price of residential and commercial real estate, corporate takeover targets and the stock of technology companies began to rise. The faster they rose, the more that investors were interested in buying, driving the prices even higher and creating even stronger demand. Before long, these markets could best be characterized as classic bubbles.
At the same time, many companies in many industries expanded operations to accommodate the increased demand from households that decided that they could save less and spend more. Airlines added planes and pilots. Retail chains expanded into new malls and markets. Auto companies increased production. Developers built more homes and shopping centers.
Suddenly, in early 2007, something important happened: Foreigners began to lose their appetite for financing much of this activity -- in particular, the non-government bonds used to finance subprime mortgages, auto loans, college loans and loans used to finance big corporate takeovers. What should have happened at that point was that the interest rate on those loans should have increased, demand for that kind of borrowing should have decreased, the price of real estate and corporate stocks should have leveled off, takeover activity should have slowed and companies should have begun to cut back on expansion.
Mostly, however, that didn't happen. Instead, the Wall Street banks that originally made these loans before selling them off in pieces decided to try to keep the good times rolling -- and, significantly, keep the lucrative underwriting fees pouring in. Some used their own "AAA" credit ratings to borrow more money and keep the loans on their own balance sheets or those of "structured investment vehicles" they created to hide these new liabilities from regulators and investors. Others went back to the foreigners and offered to insure those now-unwanted takeover loans and asset-backed securities against credit losses, through the miracle of a new kind of derivative contract known as the credit-default swap.
As a result, when the inevitable crash finally came, it wasn't only those unsuspecting foreigners who bought those leveraged loans and asset-backed securities who wound up taking the hit. It was also their creators -- Bear Stearns, Merrill Lynch, Citigroup, Lehman Brothers, AIG and others -- who made the mistake of doubling-down on their credit risk at the very moment they should have been cutting back.
We are now nearing the end of the rocky process of uncovering the full extent of the credit losses of the major Wall Street banks and hedge funds. But as Robert Dugger, an economist and partner in a leading hedge fund likes to points out, the markets have only just begun to force some financial discipline on the majority of U.S. households that relied on borrowed money to maintain their lifestyles.
Two choicesWith nobody willing to finance those lifestyles, there are really only two choices.
One is to turn to Uncle Sam to keep the economy and the financial system afloat. Unlike businesses, households and Wall Street firms, the Treasury can still borrow from foreign banks and investors at incredibly attractive rates. And by acting as an intermediary, the Treasury and the Federal Reserve have shown a newfound willingness to use those funds to keep the housing market and the financial system from totally collapsing.
Last spring, the government borrowed $165 billion to send tax rebates to households in an effort to boost consumer spending. Now, some Democrats want to create a new agency that would use money borrowed by the Treasury to recapitalize troubled financial institutions by buying some of their unwanted loans and securities at discounted prices. The same strategy was used successfully during the Great Depression and the savings and loan crisis of the 1990s, and even some Republicans are warming to the idea.
In the end, however, there is only so much the government can borrow and so much the government can do. The only other choice is for Americans to finally put their spending in line with their incomes and their need for long-term savings. For any one household, that sounds like a good idea. But if everyone cuts back at roughly the same time, a recession is almost inevitable. That's a bitter pill in and of itself, involving lost jobs, lower incomes and a big hit to government tax revenues. But it could be serious trouble for regional and local banks that have balance sheets loaded with loans to local developers and builders who will be hard hit by an economic downturn. Think of that, says Dugger, as the inevitable second round of this financial crisis that, alas, still lies ahead.

Tuesday, September 9, 2008

Expect a Rally

Markets, whether they are equity, bond, or futures focused are most successful when risks are removed from the marketplace. We witnessed that over the weekend with Fannie and Freddie moving into conservatorship. This weeks economic numbers may fall on deaf ears as markets should rally throughout the week with all of the liquidity currently sitting idle being moving into action.

Release Date & Time
Economic Indicator
Consensus Estimate

Mon. Sept. 8
Fannie and Freddie will dominate mortgage trading. Expect to see sizeble gains with the FMN 4.5, 5.0 5.5, 6.0, 6.5 for both Fannie and Ginnie instruments.

Tue. Sept. 9, 10:00 a.m. ET
July Wholesale Inventories
+0.7% vs. last +1.1%
This bit of old, stale macro-economic data will likely do nothing more than take up space on this week’s calendar. Expect a continued rally with Fannie and Ginnie instruments.

Tue. Sept. 9,
Most mortgage-backed securities “roll” to October delivery
This is a standard monthly administrative function of the mortgage market. The impact of this event is already reflected on most investors’ rate sheets.

Wed. Sept. 10,
Thurs. Sept. 11, 8:30 a.m. ET
Initial jobless claims for the week ended 9/6
Down 4,000
This report will likely have little, if any impact on direction of mortgage interest rates today.

Thurs. Sept. 11, 1:00 p.m. ET
Treasury auctions estimated $11 bil. 10-year notes.

Fri. Sept. 12, 8:30 a.m. ET
Aug. Retail Sales
Ex. Auto
+0.2% vs. last -0.1%
-0.2% vs. last +0.4%
Major incentives from auto manufacturers and sharp discounting from retailers likely combined to nudge headline retail sales higher last month. Slumping labor market conditions and high energy costs probably took a toll on the ex. auto component of this data set. If my assessment proves correct, this report will have little, if any impact on the direction of mortgage interest rates today.

Fri. Sept. 12, 8:30 a.m. ET
Aug. Producer Price Index
Core Rate
-0.5% vs. last +1.2%
+0.2% vs. last +0.7%
Energy and other commodities fell sharply during the month. Few doubt headline and core inflation (a value that excludes the volatile food and energy components) at the producer level remained benign in August.

Mon. Sept. 15, 9:15 a.m. ET
Aug. Industrial Production &
Capacity Utilization
-0.2% vs. last +0.2%
79.7 vs. last 79.9
The modest expected decline in both elements of this data set will likely have little if any impact on the direction of mortgage interest rates today.

As a partner of mine often says, Be Well.

Sunday, September 7, 2008

The Domino's Continue to Fall....From GSE to GCE

Fannie Mae and Freddie Mac are no longer Government "Sponsored" Entities, but Government "Controlled" Entities. The following series of statements were made by Secretary Henry M. Paulson, Jr. on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers
Good morning. I’m joined here by Jim Lockhart, Director of the new independent regulator, the Federal Housing Finance Agency, FHFA.
In July, Congress granted the Treasury, the Federal Reserve and FHFA new authorities with respect to the GSEs, Fannie Mae and Freddie Mac. Since that time, we have closely monitored financial market and business conditions and have analyzed in great detail the current financial condition of the GSEs – including the ability of the GSEs to weather a variety of market conditions going forward. As a result of this work, we have determined that it is necessary to take action.
Since this difficult period for the GSEs began, I have clearly stated three critical objectives: providing stability to financial markets, supporting the availability of mortgage finance, and protecting taxpayers – both by minimizing the near term costs to the taxpayer and by setting policymakers on a course to resolve the systemic risk created by the inherent conflict in the GSE structure.
Based on what we have learned about these institutions over the last four weeks – including what we learned about their capital requirements – and given the condition of financial markets today, I concluded that it would not have been in the best interest of the taxpayers for Treasury to simply make an equity investment in these enterprises in their current form.
The four steps we are announcing today are the result of detailed and thorough collaboration between FHFA, the U.S. Treasury, and the Federal Reserve.
We examined all options available, and determined that this comprehensive and complementary set of actions best meets our three objectives of market stability, mortgage availability and taxpayer protection. Throughout this process we have been in close communication with the GSEs themselves. I have also consulted with Members of Congress from both parties and I appreciate their support as FHFA, the Federal Reserve and the Treasury have moved to address this difficult issue.
Before I turn to Jim to discuss the action he is taking today, let me make clear that these two institutions are unique. They operate solely in the mortgage market and are therefore more exposed than other financial institutions to the housing correction. Their statutory capital requirements are thin and poorly defined as compared to other institutions. Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions.

I support the Director’s decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs.
I appreciate the productive cooperation we have received from the boards and the management of both GSEs. I attribute the need for today’s action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither. New CEOs supported by new non-executive Chairmen have taken over management of the enterprises, and we hope and expect that the vast majority of key professionals will remain in their jobs. I am particularly pleased that the departing CEOs, Dan Mudd and Dick Syron, have agreed to stay on for a period to help with the transition.
I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.
To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size.
Treasury has taken three additional steps to complement FHFA’s decision to place both enterprises in conservatorship. First, Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between the Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations. It is more efficient than a one-time equity injection, because it will be used only as needed and on terms that Treasury has set. With this agreement, Treasury receives senior preferred equity shares and warrants that protect taxpayers. Additionally, under the terms of the agreement, common and preferred shareholders bear losses ahead of the new government senior preferred shares.
These Preferred Stock Purchase Agreements were made necessary by the ambiguities in the GSE Congressional charters, which have been perceived to indicate government support for agency debt and guaranteed MBS. Our nation has tolerated these ambiguities for too long, and as a result GSE debt and MBS are held by central banks and investors throughout the United States and around the world who believe them to be virtually risk-free. Because the U.S. Government created these ambiguities, we have a responsibility to both avert and ultimately address the systemic risk now posed by the scale and breadth of the holdings of GSE debt and MBS.
Market discipline is best served when shareholders bear both the risk and the reward of their investment. While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.
Similarly, conservatorship does not eliminate the outstanding preferred stock, but does place preferred shareholders second, after the common shareholders, in absorbing losses. The federal banking agencies are assessing the exposures of banks and thrifts to Fannie Mae and Freddie Mac. The agencies believe that, while many institutions hold common or preferred shares of these two GSEs, only a limited number of smaller institutions have holdings that are significant compared to their capital.
The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred shares, whether realized or unrealized, are likely to reduce their regulatory capital below “well capitalized." The banking agencies are prepared to work with the affected institutions to develop capital restoration plans consistent with the capital regulations.
Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today’s action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.
The second step Treasury is taking today is the establishment of a new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Given the combination of actions we are taking, including the Preferred Share Purchase Agreements, we expect the GSEs to be in a stronger position to fund their regular business activities in the capital markets. This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July, and will be available until those authorities expire in December 2009.
Finally, to further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we’ve seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers. While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability. Treasury will begin this new program later this month, investing in new GSE MBS. Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury’s temporary authorities in December 2009.
Together, this four part program is the best means of protecting our markets and the taxpayers from the systemic risk posed by the current financial condition of the GSEs. Because the GSEs are in conservatorship, they will no longer be managed with a strategy to maximize common shareholder returns, a strategy which historically encouraged risk-taking. The Preferred Stock Purchase Agreements minimize current cash outlays, and give taxpayers a large stake in the future value of these entities. In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward. To that end, the steps we have taken to support the GSE debt and to support the mortgage market will together improve the housing market, the US economy and the GSEs’ business outlook.
Through the four actions we have taken today, FHFA and Treasury have acted on the responsibilities we have to protect the stability of the financial markets, including the mortgage market, and to protect the taxpayer to the maximum extent possible.
And let me make clear what today’s actions mean for Americans and their families. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today.
While we expect these four steps to provide greater stability and certainty to market participants and provide long-term clarity to investors in GSE debt and MBS securities, our collective work is not complete. At the end of next year, the Treasury temporary authorities will expire, the GSE portfolios will begin to gradually run off, and the GSEs will begin to pay the government a fee to compensate taxpayers for the on-going support provided by the Preferred Stock Purchase Agreements. Together, these factors should give momentum and urgency to the reform cause. Policymakers must view this next period as a “time out” where we have stabilized the GSEs while we decide their future role and structure.
Because the GSEs are Congressionally-chartered, only Congress can address the inherent conflict of attempting to serve both shareholders and a public mission. The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk. I recognize that there are strong differences of opinion over the role of government in supporting housing, but under any course policymakers choose, there are ways to structure these entities in order to address market stability in the transition and limit systemic risk and conflict of purposes for the long-term. We will make a grave error if we don’t use this time out to permanently address the structural issues presented by the GSEs.
In the weeks to come, I will describe my views on long term reform. I look forward to engaging in that timely and necessary debate.

Look for additional releases over the next several days from Paulson and others to this and other GCE's matters. I would also expect announcements from the 4 major mortgage lending firms discussing hopefully business as usual or futher pullbacks on capacity or product depth.