Fannie and Freddie on Christmas eve

I just couldn’t help myself, and had to post this: U.S. Uncaps Support for Fannie, Freddie. This article from the WSJ.com highlights that the administration is sneaking through legistlation hoping the public doesn’t read about it. I’m going to quote liberally from the article (all bold is mine):

…Treasury announced the moves in a Christmas Eve press release, a week before its authority to change the terms of its agreements with the companies was set to expire. After Dec. 31, Treasury would need the consent of Congress to make such changes.

So far, the government has pumped $60 billion into Fannie Mae and $51 billion into Freddie Mac to keep each company solvent since it seized the firms in September 2008 under a legal authority known as “conservatorship.” The companies, threatened by mounting mortgage defaults, were headed toward collapse.

At the time, the Treasury pledged to inject up to $100 billion of capital apiece as needed into the companies in exchange for preferred stock paying a 10% dividend. The Obama administration earlier this year doubled that commitment to $200 billion.

The new terms announced Thursday would allow the cap on Treasury’s support to increase by the amount of the total net loss the firms experience over the next three years, beginning on Jan. 1. The cap in place at the end of 2012 would apply thereafter.

The changes come as Fannie’s and Freddie’s regulator, the Federal Housing Finance Agency, on Thursday approved multimillion pay packages for the firms’ top executives. The pay announcement and the sweeping increase in the government’s commitment to backstop the companies are certain to stoke anger from the companies’ critics on Capitol Hill.

“The Obama administration’s decision to write a blank check with taxpayer dollars for the continued bailout of Fannie Mae and Freddie Mac is appalling,” said Rep. Scott Garrett (R., N.J.). He argued the timing of the announcement, on Christmas Eve, was “designed to try and sneak the bailout by the taxpayers.”

A senior Treasury official said he didn’t expect either company to need the additional authority Treasury is creating by ending the caps on its support. Rather, the changes would provide reassurance to investors in Fannie’s and Freddie’s debt and mortgage-backed securities so that they would continue to invest, the official said.

…Treasury also on Thursday moved to relax a requirement that the companies shrink their portfolios of mortgage securities by 10% per year beginning next year. Treasury will allow them to base the 2010 reduction on the maximum limit on the size of the portfolios — $900 billion — rather than their actual size at the end of 2009.

The move would allow the companies flexibility to avoid selling off securities next year just as the Federal Reserve and Treasury are ending programs to purchase mortgage-backed securities, a senior Treasury official said. Currently, each firm’s portfolio stands at more than $700 billion.

Treasury also said it would waive for one year a fee charged the companies in exchange for the government aid. The Treasury official cited the poor conditions in the mortgage market.

Read the full article here.

I just don’t know where the limit is anymore. On the one hand, pay is being monitored across the banks and street, then for a government entity, it goes unchecked. Second, by increasing the cap on support, the government is 1. again distorting the market for these securities, 2. distorting the viability of Fannie and Freddie, and 3. socializing losses, while still paying the top executives for continuing bad policies. Talk about a sham. And a shame. Obama & Co. had an opportunity with the backlash against the Bush administration to really make a change and a difference; unfortunately, they are not only not taking the opportunity to move in the right direction, but taking us further down the wrong one. The eventual correction that will come will be that much more painful because of these types of policies.

Happy and healthy New Year!

We’re taking a break for the holidays, but will be back January 4th. In the meantime, have a healthy and happy holiday season!

GDP Revisions

I’ll admit it, I just don’t understand: first, we had a reported 3.5%, revised down to 2.8% (about 20% off the mark), revised down again to 2.2% (about 37% off the original mark). So what we have is a reported estimate, give or take 40%? That doesn’t sound like it has much value to begin with. Now I’m not a conspiracy theorist, but I do believe people in power like to stay in power, and they’re often willing to massage numbers to achieve that goal. Hence we see periodic “updates” to how certain statistics are calculated, as an example. Here, what is interesting is that we have a massive downward revision, driven mainly by inventory drawdowns and cash-for-clunkers spending. Now, what will happen next quarter? Well, some new government stimulus will have to be announced to replace cash-for-clunkers and the new home tax credit that’s holding up purchases, and inventories will be built up from depressed levels. Add to that some massaging of 40% to the upside estimate, and I assume that next quarter’s initial estimates will somehow make Obama and Co. geniuses. See some economists reactions here from the wsj.com.

Unfortunately for them, I don’t think the bond market is buying it, and for that matter, neither is the stock market. As of this writing the Dow is up 30+ points and heading down. Treasuries continue to be weak, and the year isn’t over, so look for the upcoming issues’ performance for more signs of strength or weakness in the appetite to lend to Obama & Co

More on Detroit

It seems like everyone is a contrarian these days, with article titles supporting the thesis that “Being a Contrarian Is Difficult”. So let’s talk about a difficult play right now – Detroit. The American automakers failed (it only took 30+ years for some to recognize it). The unions failed, as Detroit, a city with one of the highest union participation rates is also ranked as #1 in people living under the poverty line. American industry is facing tough times on all fronts. And the list goes on. Detroit faced urban flight for years, as the wealthy left the city for the suburbs. And so, it should come as no surprise that the real estate in Detroit is in dismal shape. The average house in Detroit sells for $12K, with many selling for $50 (yes, just $50), just so that people can stop paying taxes and carrying costs. Banks don’t want it on their books. Rental prices…well, you should feel lucky if you could find good renters. Also, I took an informal poll of investors and colleagues, and not one of them was interested in Detroit real estate.

What does it point to? Well, maybe I’m crazy, but it’s starting to look like an opportunity I like. I don’t particularly like speculative real estate, since I’m a value investor at heart, which means you need cashflows to discount, P/E’s to compare, rental yields, etc. So in the next few weeks, I’ll be looking at some ways to implement this idea. It will be a difficult investment, since financing is limited, and investors don’t want to hear about Detroit, but that’s exactly the kind of investment arena I like best.

I’ll be posting some links as I get them, but here are a few to get you started:

• From Mark Perry, some facts about Detroit: http://mjperry.blogspot.com/2009/12/facts-of-day-about-detroit.html
• From cnn.com: http://www.cnn.com/2009/US/03/17/rtr.detroit.opportunity/index.html

For the record, I have no stake in anything mentioned above at the time of the writing, nor anything mentioned in the articles. This is in no way a recommendation to buy any security or real estate.

China: Never liked it, now like it even less

Long time readers know that I do not like the idea of investing in command and control markets, with little or no transparency, pegged currencies, and imminent social unrest; I dislike investing in these markets even more after they go up, even as their biggest consumer market is struggling.

So it is with that in mind that I encourage you to read the following:

1. Chanos is shorting China: http://www.thedailycrux.com/content/3656/Jim_Chanos
2. Mike Shedlock has a piece on the Chinese bubble: http://globaleconomicanalysis.blogspot.com/2009/12/china-faces-crash-scenario.html

And we’ll continue to present more. The only question is “so what”? I looked for ways for individual investors to play this idea, but the options are slim. For starters, there is FXP, but…be careful. This is not necessarily getting you the short exposure you need. For starters, it’s a levered ETF, which we have an inherent fear of. Then, it only shorts 25 stocks. Then it turns out it only shorts the Hong Kong listed shares, not the mainland shares (which can’t be shorted). For more details, click here.

A better way to play it, but less directly, is to short the things that went up because of (supposed or anticipated) Chinese demand. Yup, commodities are up there, such as copper, aluminum, etc.

I personally haven’t found a great way to play this theme, but I’m working on it and am happy to hear thoughts and suggestions.

Bank failures graph from Calculated Risk

140 bank failures this year, with aggregate assets of over $470 billion. The FDIC will need more assets next year to cover additional bank failures. Calculated Risk estimates that there will be somewhere between 140 and 500 bank failures next year. If that is correct, FDIC will need to shore up it’s fee income and balance sheet somehow; perhaps it too will need to be recapitalized and made even less transparent as were Fannie and Freddie. See full story here.

Pimco’s Gross boosting cash position

Yes, cash is an asset class. And yes, some of the best managers use it, especially if they see opportunities on the way. This move by Gross (to raise cash) is actually incredibly deflationary on his part. It’s saying that cash will outperform bonds. Cash hoarding in anticipation of lower prices is a deflation bet and I believe others are moving in that direction more and more, not willing to lend out their cash, even to sovereigns…even to Uncle Sam.

http://www.bloomberg.com/apps/news?pid=20601087&sid=afujGCGEdlp8&pos=3

The fact that Congress is raising the debt ceiling, certainly doesn’t lend confidence to the Treasury market, especially given last weeks performance : http://www.marketwatch.com/story/house-aims-to-pass-debt-increase-jobs-bill-2009-12-16

Confirmatory bias: Yup, I don’t like the Euro

A national government that willingly gives up its sovereignty is not going to last, which is exactly what a common currency requires. In the US, States did it only after a lot of turmoil and war. Will the Euro-zone be able to pull it off long-term? I highly doubt it. It’s another soon-to-fail experiment. http://globaleconomicanalysis.blogspot.com/2009/12/eh-tu-germany-finance-minister-says-no.html

What’s interesting is that I’ve been hearing rumors that some Middle East countries are considering a common currency (Dubai is upset because the Saudis hope to be at the center of this movement). This comes about every few years as oil producing countries get tired of accepting dollars. The only thing worse than the dollar for them is their neighbors currency, which they know for sure they won’t be able to trust, so I doubt it will get anywhere, probably to the benefit of all players.

Real estate – the high end is not holding up

Contrary to what you might hear in the popular press, the numbers we are seeing do not point to a stabilization (yet) of the real estate market.

I want to highlight one paragraph from a recent Bloomberg article:

Payments on about 12 percent of mortgages exceeding $1 million were 90 days or more overdue in September, compared with 6.3 percent on loans less than $250,000 and 7.4 percent on all U.S. mortgages, according to data from First American CoreLogic Inc., a Santa Ana, California-based research firm. The rate for mortgages above $1 million was 4.7 percent a year earlier.

12%? That’s crazy. Up from 4.7%? Yikes. I think a lot of places haven’t faced up to the fact that the high end properties are going to end up being the more damaging – at least at this stage – to balance sheets than the low end.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aQED_96QBBkk

Sometimes a picture is worth a thousand words

This is a chart of JPY. I am not a big chartist, but I do believe that sometimes charts are able to efficiently summarize a lot of data. With that in mind, some people will see JPY heading to a top of a channel, others will see a bottom, some other pattern, what have you. As stated before, I’m currently short JPY vs. USD via YCS as well as short the Euro vs USD via EUO, so you know my bias.

(from Bloomberg, HT MacroMan)

Keep an eye on Citi

After hours it’s trading more than SPY traded throughout the day. It’s down around 3-4% as of this writing. The government is saying they might not be selling their entire stake; the implications around the tax benefits that Citi will retain has been a main source of reports, their secondary is facing a tough market. All in all, the financials won’t be able to lead this market in the near term.

Slow vs. Fast Knowledge

This article posted in The Atlantic Monthly, uses medicine as a foil, but the implications are actually very relevant across disciplines. For the full article click here.

In summary, it makes a distinction between “fast knowledge” and “slow knowledge”…

In brief, fast knowledge (and I am interpreting Orr’s work to the medical setting):

• Celebrates lab tests, imaging, consultations and the more the merrier–you can never have too many tests or images.
• It suggests that what counts are only the things one can measure (and counts more than the patient’s or the family’s subjective observations and their verbal reports).
• It presumes that an error made from misinterpreting the existing data can be overcome with even more data. (More tests can help you claw your way out of a clinical impasse, in other words.)

Slow knowledge by contrast has a different purpose:

• It celebrates wisdom more than cleverness, a sense of the individuality of the patient and the need for a tailored treatment, rather than one-size-fits-all algorithms.
• It recognizes that the volume of tests ordered and the results that come back can compound mistakes.
• It suggests that mistakes are often generated in part by the fact that there is no filtering function to the data.

The article actually talks about the need for both (the science and art of the discipline). The conversation is one that is being dealt with continually in finance, with information overload, how do you distill what’s important, etc. This article is not meant to start any debate on the medical industry per se, but rather for us to think about the nature of knowledge, especially in the information age. Thought you’d find it interesting.

Placing speculative limits is BAD – now if only the Fed will heed it’s own research

In a recent paper published by the New York Fed, Erkko Etula shows that speculators help stabilize commodity markets. To quote:

Taken together, my results highlight the importance of speculative capital for the stability of commodity markets. In this way, the paper not only contributes to the broader literature on limits of arbitrage pioneered by Shleifer and Vishny (1997), but also shows that recent arguments in favor of speculative
trading restrictions have been starkly misguided.

Another interesting outgrowth of this research is that Etula is able to model some of the volatility of commodities based on the flow of funds report. For those trading in the options arena, especially those using quant based approaches, this might point to an interesting factor to test further. For the full report click here.

CPI and Earnings and Current Account

So let’s review:

1. CPI notched up 0.4%, mainly driven by a rise of about 4% in energy. Click here for a summary from CBS Marketwatch. Here’s the official BLS statement:
   On a seasonally adjusted basis, the CPI-U increased 0.4 percent in November after rising 0.3 percent in October. The index for all items less food and energy was unchanged in November after increasing 0.2 percent in October.
2. In the meantime, real earnings were flat, or negative after taking into account the CPI:
   (From BLS) Real average hourly earnings fell 0.5 percent from October to November 2009. This decline stemmed from a 0.5 percent increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) more than offsetting a 0.1 percent increase in average hourly earnings. Over the year real average hourly earnings decreased 0.1 percent.
3. At the same time, the current account deficit widened to $108 billion in the third quarter. At 3% of GDP, it’s still way below 2005 when it was 6.5% of GDP, so hopefully the trend is improving, although still ugly. http://www.marketwatch.com/story/current-account-gap-widens-in-q3-2009-12-16

All in all, certainly not inflationary on the surface, so the Fed, afraid of being labeled 37′ers, will have no motivation to move on interest rates.

Gold Buying by Central Banks Signals Sell as Past Haunts Future

If the past is any guide, central banks buying gold is a strong contra-indicator. Just something to think about as you send me more emails about gold going up forever. http://www.bloomberg.com/apps/news?pid=20601087&sid=arhlK7_y34Mg&pos=4