"Double
Eagle" The
Housing Bubble On October 14, 2004, Standard & Poor’s lowered its long-term credit rating, on General Motors, to one step above “junk.” Standard & Poor’s cited several factors for this downgrade:
Of course, General Motors’ highly leveraged balance sheet was a factor in the decision to downgrade GM to the lowest investment-grade rating possible—“BBB-minus.” So what does this have to do with the real estate market? Actually, quite a bit—and more. The imminent bursting of the United States’ housing bubble could bring down one of the world’s largest companies. So let’s take a look at General Motors’ precarious financial condition. The following information can be garnered from GM’s 12/31/03 annual report:
With such a fragile balance sheet, one would hope that GM has a strategy to rebuild its balance sheet by retaining earnings generated by profitable automobile sales. In 2003, GM’s total revenues were $185.5 billion with a corresponding net income of $3.8 billion. However, only $1 billion of this net income came from automotive sales. The $2.8 billion balance came from financing and insurance operations (including mortgage lending). In other words, only 26.3% of General Motors’ net income came from automotive sales. Clearly, GM has become a financial services company (that happens to also manufacture automobiles) and its future success is directly linked to its ability to compete in the financial services industry. After all, America now has a finance/debt-based economy. Within the financial services industry, GM has become a significant player in the mortgage lending marketplace—through GMAC. For example, in 2002 and 2003 respectively, GMAC sold or securitized $106.5 billion and $80.8 billion of mortgage loans. Moreover, as of fiscal year-end December 31, 2003, GM was carrying $104.4 billion of residential mortgage receivables on its balance sheet. To say the least, mortgage lending has become an important part of GM’s business plan. For the third quarter ending 9/30/04, General Motors’ results were not encouraging. GM’s global automotive operations generated a loss of $130 million during the quarter—including a $22 million loss in its North American operations. Of course this means that GM isn’t making money from selling cars. Fortunately, GMAC’s financial services operations earned a net profit of $656 million during the quarter. In fact, the mortgage operations earned $302 million of GMAC’s $656 million net profit for the third quarter. Overall, with third quarter earnings of $440 million, it is painfully clear that General Motors would have lost money had it not been for its “success” in the financial services arena. Unfortunately, more pain may be forthcoming for General Motors. There is anecdotal evidence that the U.S. home mortgage refinance market may be slowing significantly. This is what Eric Fry, the editor of The Rude Awakening, had to say in the October 29, 2004 issue of this newsletter: Your editor is particularly interested in the fact that demand for home loan refinancings is drying up, even in one of the "friendliest" interest-rate environments of all time. Apparently, most of the folks who wished to refinance their homes - and suck out some equity in the process - have already done so. If, therefore, the refinancers have already refinanced, it would follow that most of them have already spent the "disposable" portion of the equity they have extracted from their homes. Your editor would conclude, therefore, that one extremely significant source of consumer spending has disappeared for the balance of this particular economic cycle. GMAC generated revenues, in the home refi market, through its wholly-owned subsidiary ditech.com. First and foremost, with a slowdown in home refinancings, this will negatively impact GMAC’s earnings. Secondly, as home equity loans are often used for purchasing automobiles, a decline in refi activity may produce a negative impact on automobile sales as well. Without a doubt, GM’s business model is built upon the willingness of Americans to become saturated with debt. Perhaps the declining home-refi market is an indicator that Americans are becoming maxed out and can’t handle going much further into debt. At this point in time, GMAC’s mortgage finance earnings will continue to carry the day for General Motors. Although refi earnings will drop, GMAC’s earnings from originating mortgage loans (related to the sales of new and existing homes) should continue to do well—for the time being. This comment is buttressed by the following information garnered from Doug Noland’s October 29, 2004 Credit Bubble Bulletin: Housing activity remains on record pace, with stronger-than-expected new and existing home sales reported for September. Existing sales of 6.75 million annualized were up strongly from August to the third-highest on record. Average prices were up 9.5% from one year ago to $237,300. And with sales volume up 1% from a strong year ago level, calculated transaction value (CTV) was up 10.7% to $1.6 Trillion. CTV was up 43% over two years (prices 22%, volume 18%), 73% over 3 years (prices 35%, volume 28%), and 102% over six years (prices 35%, volume 49%). Year-to-date sales are running 8.3% ahead of last year’s record, with y-t-d CTV running up 17%. September new home sales jumped strongly from August to an annualized rate of 1.206 million (up 7% from Sept. 2003), also to the third-strongest on record. At $255,100, average prices were down $14,200 for the month and were up only slightly from one year ago. Year-to-date sales are running 9.7% above last year’s record, with y-t-d CTV running 21% ahead. CTV is up 35% over two years (prices 14%, volume 28%), 77% over three years (prices 41%, volume 25%), and 95% over six years (prices 40%, volume 40%). The inventory of unsold new homes increased 5,000 units to 404,000, the highest level since 1979. Clearly, the U.S. housing bubble is continuing to expand—which is good news for GM. However, as all economic bubbles must eventually burst, the recent sharp decline in average housing prices and the spike in inventory of unsold new homes may be indicating that the housing bubble is about to burst. This would prove to be disastrous for General Motors. With GM losing money in automobile sales, this company can ill afford to see its earnings, from mortgage lending, evaporate—the news on the mortgage refi front is not encouraging. If such earnings dry up, then it is quite possible that General Motors (as a whole) may start losing money. When a company with a precariously leveraged balance sheet starts losing money, then the possibility of Standard & Poor’s downgrading GM’s debt rating to “junk” becomes highly likely. To me, a junk rating seems inevitable. Upon receiving a junk rating, General Motors balance sheet will begin to melt down. For example, a junk rating will eliminate GM’s ability to fund operations using the commercial paper market—keep in mind that GM’s finance and insurance operations had $13.2 billion of commercial paper borrowings at 12/31/03. This source of cash will dry up. Additionally, GM’s ability to float additional intermediate and long-term debt will be difficult. Moreover, it is common for banks to have lending agreement covenants that allow loans to be called should the borrower’s debt rating fall below investment grade. A liquidity crisis could easily emerge here and a company with more debt than many third-world countries could prove difficult, if not impossible, to bail out. GM will literally be crushed by its own heavy debt load. Who would have ever thought that the once-mighty General Motors could have its fate held in the “hands” of the housing market? Yet, this unbelievable thought is now reality. Once the housing bubble bursts, it is quite likely that GM’s financial future will be held in the hands of its creditors or perhaps even a bankruptcy judge (a federal bailout may even materialize). At this point, tens of thousands of GM’s 326,000 worldwide employees will be facing layoffs and the negative economic ripple-effect will be felt globally. Indeed, if too much debt is bad for GM, then it is certainly bad for the rest of us. ©
2004 "Double Eagle"
Hamlet
Meets Mr. Jefferson To be, or not to be: that is
the question: WHEN, in the Course of human Events, it becomes necessary for one People to dissolve the Political Bands, which have connected them with another, and to assume, among the Powers of the Earth, the separate and equal Station to which the Laws of Nature and of Nature's GOD entitle them, a decent Respect to the Opinions of Mankind requires that they should declare the Causes which impel them to the Separation. We hold these Truths to be self-evident, that all Men are created equal, that they are endowed, by their CREATOR, with certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness.--That to secure these Rights, Governments are instituted among Men, deriving their just Powers from the Consent of the Governed, that whenever any Form of Government becomes destructive of these Ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its Foundation on such Principles, and organizing its Powers in such Form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate, that Governments long established, should not be changed for light and transient Causes; and accordingly all Experience hath shewn, that Mankind are more disposed to suffer, while Evils are sufferable, than to right themselves by abolishing the Forms to which they are accustomed. – Declaration of Independence, Thomas Jefferson Money -- Ye shall have
honest weights and measures.
Author: James E. Ewart. Financial Terrorism. Author: John ("Jack") McManus. Visit http://www.aobs-store.com/ The Creature From Jekyll Island. Author: G. Edward Griffin. Visit http://www.realityzone.com/creature.html The Federal Mafia. Author: Irwin Schiff – Book Banned in America While Troops Die for Freedom, www.newswithviews.com. Guaranteed Monopoly and the “American Dream” The Government Sponsored Enterprises were established by the US Congress, just like the Federal Reserve Fraud, but the FED came first in 1913 under Mr. Wilson’s tenure in the White House. We don’t have much very good to say about Mr. Wilson, who was hoodwinked by Colonel House, his sidekick friend who had some really dangerous liaisons with the European banking cartel folks and big politicians. The GSEs came later first appearing under FDRs New Deal [which was no new deal at all, but a prima facie step toward the modern socialist welfare state we currently find ourselves in]. Both the GSEs and the Federal Reserve have a Congressional mandated monopoly. The GSEs on the secondary mortgage market. The Federal Reserve on our money system. The GSEs operate as a second tier of central banks through money market fund intermediation. The actual dates of creation of the GSEs are of little importance. How they operate is of more importance. Both the FED and the GSEs are private companies created by Congress. What Congress can create, it also can destroy or abolish. We doubt that will happen since all of the above give the nice folks in Congress a license to steal. Both the GSEs and the FED give the nice folks in Congress the ability to destroy civil liberty, freedom, and property [money, personal property, and real estate]. The last sentence in the Declaration of Independence is pretty short and sweet, but in its brevity, mighty awesome: And for the Support of this Declaration, with a firm Reliance on the Protection of DIVINE PROVIDENCE, we mutually pledge to each other our Lives, our Fortunes, and our sacred Honour. It is of historical fact that many of the Founding Fathers who signed the Declaration of Independence lost their lives, fortunes, families, and were devastated and ruined by the Revolutionary War, and the ruthlessness of the British Crown [Bank of England] and their mighty professional army and navy. One thing we can say – none of these Founding Fathers lost their “Sacred Honour.” I wish I could say the same about Mr. Wilson, but I cannot since he violated the intent of the Founding Fathers and The Constitution. Welcome to the Isle of Capri! Place Your Bets! The GSEs operate in many ways like a giant hedge fund [Go for it Sol!] with their derivatives and counter-party agreements, which are not regulated. They bet on interest rates, currencies, and probably the price of tea in China as a means of protecting themselves, since they don’t really have any cash. Sure, they buy mortgages and bundle these puppies up and sell them to investors, then repeat the process. They operate like a central bank in that they have the ability using money market fund intermediation, to tap cheap money from so called cash account money market funds to grow their portfolio. They can create more loans this way, than they otherwise could, basically creating money out of thin air for the housing industry [yes, I call it a bubble]. This process creates more loans beyond their means and cash ability to cover if the housing market does a face plant riding the financial tsunami. Given that real estate has always been, currently is, and will forever be a depreciating physical and immovable asset, Houston we have a real problem. Better Living Through Chemistry – Free Prozac for Everyone! Even some of the more astute folks are under the impression that if the GSEs get into trouble, that the US Congress will have to vote to bail these rascals out, if they do a Long Term Capital Management or Enron/Arthur Anderson derivative implosion. John Dizard cuts to the chase in Alarm Bells Sound for Fannie and Freddie, that the Federal Reserve won't actually be bailing out the GSEs [dispelling the myth that Congress will have to “approve the bailout”.] Sports Fans, the mechanism is already in place: The problem with Fannie and Freddie's party line is that there is no "empirical evidence" because history has no precedent for their risk concentration. The failure of Drexel Burnham or Long Term Capital Management's problems, which Mr Culp cites, are two or three orders of magnitude smaller than the mountains of GSE paper. Mr Greenspan and Mr Mankiw don't think they'll have to bail out Fannie and Freddie. They think they'll have to bail out the half dozen largest swaps and derivatives dealers who are the big banks and investment dealers. In a rapidly rising interest rate environment, the "gamma", or the rate of the rate of increase in their hedging of their obligations to the GSEs, could, or, if you believe the chairman, will, require the Fed to act as the derivatives counterparty of last resort. The math tells him this could be seriously inflationary. Why the warning now? Here's a thought: the GSEs' purchases of their own mortgage-based securities peaked last summer and have been gently declining since, reducing its requirements for derivatives purchases. However, Fannie has privately been telling bank fixed income securities analysts that they intend to start to increase their purchases, and to achieve double-digit portfolio growth for 2004. I
think that talk set off the alarm bells at the White House and the Fed. We suspect the GSEs have the ability to lose more money in a matter of minutes given the right financial conditions, than anyone can imagine – the implosion of Long Term Capital Management will look like a melting ice cream cone by comparison! I provide the links to John Dizard’s essay which opens with this dead pan one-liner: Ordinarily, Alan Greenspan's testimony to Congress gives Prozac serious competition for medicating the over-anxious. Now that Rocking Rodney Dangerfield is no longer with us, Dizard could do well as a stand up comic! The FED already is the derivative lender of last resort. Talking Heads, Obfuscated Rhetoric, and Magicians Trick the Smoke and Mirrors With the accounting tricks and fun and games at the GSEs, now being in the National Soap Opera Spotlight, the elitists who have been ignoring the manner in which the GSEs operate are now calling for more transparency, regulation, and control of the GSEs, namely Fannie and Freddie and all their cousins. Knowing that Sir Alan of Green Eggs and Ham does not want derivatives to be regulated since they are the next best thing to Parfait [smart Donkey!], we find the rhetoric somewhat mundane, if one stops to think about it and follows the money trail. I am certain that the Federal Reserve Cartel would love to have the GSEs directly under its thumb centralizing and “regulating” them directly instead of Congress. Besides, Congress has better things to do since the Number One Priority for Congress: Spend, Spend, Spend! We suspect that our Behinds are already in one heck of a financial fiscal crisis. One of these days the US Treasury is going to hold a debt auction and no one’s going to show up [Japan and China]. The link I provided above is an editorial on the “open letter” a bunch of smart dudes that was signed by 100 signatories from some of the top drawer business schools in the USA, sent to President Bush on October 4, 2004. It is a great read. With the Loan to Deposit Ratio at 1.06 for the combined 9,079 FDIC insured institutions, the liquidity crisis is already here. Sir Alan of Green Eggs and Ham needs direct control over these rascals to keep the financial system in tact.
Prince of Denmark is walking around looking at the tall ceiling which is sort of similar to the Grand Hall back at Daddy’s, ehhh I mean Step-Daddy’s Castle. Mr. Jefferson is over in the corner in one of the red leather chairs, musing to himself about how the hotel architects wasted a lot of money on such elaborate staircases. Guess they never heard of Monticello, he’s musing to himself. All of a sudden, the lights go inside the Prince’s head, and he walks over to Mr. Jefferson, and says: Hamlet: Say aren’t you Thomas Jefferson, the dude who penned the Declaration of Independence? President Jefferson: Yes, I did, and I also was the third President of the united states in America, and I am guy who financed the Napoleonic Wars by [buy] purchasing Louisiana for my country. I also starred on Broadway in 1776, as I sing, dance, and play the violin… besides having a good pen. Hamlet: Yeah, sure…. He got the gold, but you got the real estate! President Jefferson: Exactly, and you are Hamlet, Prince of Denmark. Hamlet: Yes, Mr. President, I am. President Jefferson: Nice to know you, Son… say we have a lot to talk about before this Senator Aldrich, Assistant Treasury Secretary Andrew, Vanderlip, Davison, Norton, Strong, and Paul Warburg show up….what do say we find us a nice bottle of unblended Scotch and get acquainted… Hamlet: That’s a no-brainer, Mr. President… I already like the way you think. ©
2004 Gale Bullock Professor
Piggington To
GSE or Not to GSE? The California Association of Realtors' "Affordability Index" purports to measure what percentage of residents in a given area can afford to purchase that area's median priced home. In recent months the Affordability Index for San Diego has been hovering at a mind-numbing 10%. Which is to say that only the top 10% of San Diego wage earners can "afford" the median-priced home. How can this be? Almost 4000 homes were sold last month--was all this activity comprised of San Diego's richest 10% trading houses back and forth? Of course not. The fact is that the Affordability Index is based on some faulty premises: it assumes that the buyer makes a 20% down payment and attains a 30-year fixed-rate loan. Here in San Diego, nothing could be further from the truth: over 75% of loans are of the adjustable-rate variety, and 25% of new mortgage borrowers make no down payment at all. The Index has another flawed premise as well: it assumes that anyone actually cares whether a buyer can afford to purchase a house. Given the euphoric view on real estate espoused by most residents of Maniaville, California, it’s no surprise that they consider affordability as outmoded an idea as slide rules, tailfins, and down payments. What’s more surprising is that the lending industry appears to feel the same way. And for that we can largely thank our friends Fannie Mae and Freddie Mac. The so-called GSEs have been a prime mover in the freefall that lending standards have undergone in recent years. In the old days, lenders had to care whether their money was paid back. But that’s no longer a concern: they can just sell their mortgages to the GSEs, who package them up into bond issues which, due to the ostensible guarantee of the US Government, sell like hotcakes. Now, lenders can lend to everyone. They don’t concern themselves with a lender’s income or credit history, nor with the actual value of the loan collateral. They just write the loan, get their fees, pawn the mortgage off on one of the GSEs, line up the next 100% loan-to-value mortgage, and repeat the process. Everyone’s a winner! Everyone, that is, except for San Diegans and the holders of GSE bonds. The latter group made their collective bed and, as far as I’m concerned, can now lie in it. But the residents of San Diego did not sign up for the loose-credit-induced housing binge that has resulted from the GSEs’ market interference:
Of course many a San Diegan has profited greatly by participating in the real estate pyramid scheme. But many a San Diegan will be financially devastated when credit tightens up (as it always must) and prices come back down to earth. And those few San Diegans who are unwilling to buy into an enormously overpriced market or to take on a potentially crippling amount of debt are effectively locked out of the perfectly reasonable goal of owning a home. While government intervention in the marketplace never works out as planned, the GSEs seem to be a particularly resolute failure. They have helped to engender a complete breakdown of risk avoidance at every level of the market and have undermined the chances that housing can achieve “soft landing.” But at the local market level the GSEs effects have been most ironic: the set of institutions whose charter was to help lower-income workers buy housing has actually played a crucial role in running home prices up to the point where it's nigh impossible for San Diegans to purchase a house without going into dangerous levels of debt. To GSE or not to GSE? I choose "not." © 2004 Professor
Piggington To GSE or Not to GSE? So, what does it all mean anyway? GSE? No doubt, most would argue that it means Government Sponsored Entity like Fannie Mae, Freddie, Farmer or even Ginnie – and they wouldn’t be wrong for thinking that way, at least in a narrow sense. In a broader sense, however, GSE could stand for lots of other things. Take the letter “G” for instance. It could stand for Greenspan or perhaps even Gold. The letter “S” is the first letter in submarine or submerged – both of which evoke connotations of sneaky or stealth – a couple of other fine words that begin with the same letter. Then there’s “E.” E also stands for exposed or it could even stand for exuberance – the rational premeditated kind. Now I’ve got to be honest with you, every time I think about Greenspan, Gold, submarines, sneaky, stealth, and exposing exuberance of the premeditated kind – this picture always seems to come to mind:
Table 1: Compliments G.M. Bolser http://www.interventionalanalysis.com The man who created this graph, Mike Bolser, describes the relevance of the std. dev. spikes as follows, “The numbered spikes are correlations to other gold-related events as follows: (1) Federal Reserve assumes two board seats at Bank for International Settlements; (2) steadily rising gold price threatens to pierce $400; (3) important change downward in the long-term gold price; (4) failure of Long-Term Capital Management, reportedly involved in the gold carry trade; (5) Washington Agreement provokes sharp rise in gold prices; and (6) Canadian Imperial Bank of Commerce works to resolve Ashanti hedge book failure.” Have you ever heard the saying that a picture is worth a thousand words? In all likelihood, this one might be worth a little bit more than that – I feel that it tells a whole story that goes a little bit like this: Once upon a time, there was a Democratic President. His administration was mired in scandal [something to do with a real estate transaction that didn’t smell quite right], the economy was faltering and his prospects for re-election looked very bleak. He needed a special “something” to reinvigorate or ignite the economy, get the stock market up to give himself a “fighting chance” to get re-elected – but how? Well, the first thing he does is call in his Treasury Secretary and develops a game plan. His Treasury Secretary just happens to have a side kick who; as a professor of economics, did some academic work on Gibson’s Paradox and theorizes that interest rates could be lowered [stimulating the economy and thus stock market] without having the U.S. dollar tank [provided the gold price remained stable or fell [rigged]]. To misdirect and obfuscate his true intentions, he began “spouting off’ and advocating his support for a strong dollar policy. Sounds like a great plan eh? Well, it’s an even better stage illusion. So how does one go about instituting such a plan? First, one would have to have access to or unleash a “secret” stash of gold bullion. Everyone knows how secret places like Fort Knox and West Point are, and heck, no one has laid eyes on the gold alleged to be there since the Eisenhower administration. The next thing, as table 1 shows, in July of 94 one launches a “stealth” torpedo at the gold market on the COMEX exchange to prevent the price from going up knowing full well the Central Bank is going to lower rates. One can’t have its currency getting “trashed” or the plan doesn’t work. The first torpedo measures in excess of a 3 standard deviation move in the pre-emptive selling of gold – a signature that would help serve to identify the perpetrators years later. Standard deviation is literally defined as: the average amount by which scores in a distribution differ from the mean, ignoring the sign of the difference. In layman’s terms, standard deviation is a unit of statistical measure that also expresses the probability of a given outcome arising. The higher the standard deviation is, the less likely the event being measured is to happen. Standard deviation of pre-emptive selling is a comparative measure between prices on COMEX and prices the same day in London. Its best literal description is given by Mr. Bolser himself, “Recall that preemptive selling, which is a fraud detection algorithm, measures very aggressive COMEX gold market selling when compared to the London gold market (LBMA). Table 1 displays the percentage of days per month in which the COMEX gold price falls 300% more than the London gold price. The probability of changing macroeconomics being the cause for such extreme New York price drops is highly diminished because the two markets trade the same commodity on the same day. Preemptive selling should not be confused with price volatility or rate of change, which are measures of rapid price fluctuation. In addition, preemptive selling is a measure of relative activity between two markets. Recall also that it does not measure the volume of comparative selling, only its effect as measured by gold market prices.” Well, the first torpedo cripples the golden battleship but doesn’t sink it, so, the submariners load torpedo tube number 2 with a nuclear tipped torpedo somewhere around June of 96 – just in time for the “run up” to the fall elections. They fire the nuclear torpedo at the COMEX and score a direct hit, measuring 4.22 on the standard deviation scale. This virtually impossible event [once in every 1,538 years] clearly and utterly delineates the spot where the gold price sinks - just like the torpedo that sank the Lusitania. To ensure that the golden battle ship remains on the bottom, the next administration fires two more torpedoes at the COMEX in July 00 and June of 01 [both in excess of 3 std. deviations] – after all, why should the new administration get left holding the bag when the dollar collapses and gets exposed for what it really is? You see folks; movements in the pre-emptive selling of gold of standard deviations pictured in table 1 do not happen in “free” random markets or by accident. They are “man made” events. The whole plan is so underhanded, in fact, that the new administration’s Treasury Secretary resigns – after all, he doesn’t want his sterling reputation sullied by a scandal this large! Then he writes a book which, if you read it a certain way, cryptically sends a message [something like Fed Speak] that “things are not right” in the financial house of the U.S. of A. So what does all or any of this have to do with real estate bubbles you might ask? Simple! Asset bubbles this size cannot happen without gargantuan amounts of cheap credit. The cost of credit is directly proportional to perceived risk or confidence on the part of the lender. In the case of countries this confidence [measured by interest rates], or lack thereof, is expressed in large measure through the strength of their currency. The strength of currencies is largely dependent on measures such as inflation. Historically, currency debasing - inflationary policies spur a flight to gold as a safe haven to preserve purchasing power. A falling gold price would “mask” inflation. Therefore, a country such as the U.S. could pursue inflationary policies but have the consequences masked by inducing a sell off in the price of gold. The induced sell off in the price of gold took the form of relentless selling [torpedoes], launched by agents of government or Central Banks through recognized exchanges like COMEX. This would create the illusion of a “strong currency” when the underlying fundamentals suggest exactly the opposite. Without an “illusory strong dollar,” we would never have had low interest rates like we do now – because – if the fundamental truth was know about the dollar, no one would buy our debt advancing credit in seemingly endless amounts. A weak or falling dollar prohibits debt bubbles. Debt is the money pump which fuels real estate bubbles – it’s all a fraud, get it? The moral to the story: This is why magicians [and submariners] never reveal their secrets. The math behind this story is here in Table 2. Ironically, I learned it from a training program, to become a retail stock broker, at a bullion bank: Table
2
The folks shooting the torpedoes know this math ladies and gentlemen – they measure everything! ©
2004 Rob
Kirby Sol
Palha To
Bleed or Not to Bleed The
shame that arises from praise which we do not deserve Once again since realty is not my area of specialization I am going to keep this short and sweet and attempt to attack only those parts that fall into my area of specialization. One of the biggest examples of GSEs are Fannie Mae and Freddie Mac, both of which it could be argued have suddenly grown to big for their breeches. In reality they provide a secondary market for almost all the mortgage paper out there. The banks issue the mortgages and then Fannie and Freddie like two crack heads swallow it all up. It is for this reason that banks have kept finding ways to be more creative at issuing mortgages – things have gotten so bad now that almost anyone with a pulse and the ability to sign X on the signature line can qualify for one. It’s a beautiful scam; the banks have almost no risk because all they do is simply resell this junk to Fannie and Freddie, who in turn sell to many of the big financial houses. Most of these big houses buy this paper because technically it provides a risk free guaranteed source of income; this is much better than parking the money in a bank and earning next to nothing. Everything works fine; everyone makes money and lives happy ever after right? Wrong! This only works if we have a stable interest rate environment. In other words, if interest rates were fixed this beautiful game could go on forever. The problem begins when rates start to rise as they have been doing so for the last year. Then these GSEs have to take on more risk and start hedging their bets to make sure that the paper they sold 2-3 years ago does not end up robbing them of profits. To make matters worse, no one really knows exactly what they are doing. For all we know they could be going long certain currencies, shorting others, shorting or going long bonds and the list goes on. Hold on – it gets even better! If you just look at these hedging techniques, you are suddenly shocked when the thought hedge fund leaps into your mind. Hedge funds periodically hedge their bets, go long Dow futures, SP 500 futures; while at the same time shorting other international indices, go long certain currencies, while shorting others, et cetera, et cetera, et cetera. At least with hedge funds we know that only accredited investors are taking this risk – in other words individuals who have large amounts of capital above and beyond what they need to survive. Now Fannie and Freddie are not hedge funds, nor are they dealing with accredited investors. Most of the paper they are buying is coming from hard working middle class families; so how can they take on twice the risk of a regular hedge fund. That’s where the Feds come in; the Feds have decided Fannie and Freddie do not have to inform the public on what techniques they use to hedge their bets. There is no transparency and there is no regulation, since it’s nothing but one big free for all. Freddie and Fannie have another huge potential problem to worry about. The main problem starts from the microscopic level. The average Joe who has a mortgage could start to feel the pinch when interest rates really take off, such that he can no longer afford to pay his mortgage. Remember Interest rates are still at multi-decade 40-45 year lows, even with the recent rise priced in. Multiply this effect a million times over and you have a catastrophe on a scale that boggles the mind waiting to happen. If the average chap cannot pay his mortgage and simply walks away, it’s going to first precipitate a calamitous fall in the price of real estate. Second of all, it’s going to force Fannie and Freddie into bankruptcy (they both have very little cash on hand), which in turn will force many of the big investment houses, who purchased millions of mortgage notes from these GSEs into a black hole [the Black Hole of Calcutta comes to mind!]. The end result is just simply too horrible to envision. One thing won’t change – the consumer [American Taxpayer] will end up footing the bill. It would appear that we would be far better off without Fannie or Freddie around, or at the very least have several other large companies so that the risk is evenly distributed. However, totally eliminating Fannie and Freddie would severely restrict the average person’s chances of getting a mortgage, which in turn would bring the housing market to a grinding halt. The Feds are in a Catch-22 position – they helped create this monster by providing a fake low interest rate environment. Now if they try to curb the beast they created they could end up knocking out the last spoke in the wheel that is holding this fragile economy and market up. So perhaps the question should be: To bleed or not to bleed? A
pint of sweat will save a gallon of blood. ©
2004 Sol Palha |
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