GSE's Falling Into the Abyss
By Frank Barbera CMT. July 8, 2008
Last week, we alluded to financial margin call rippling through US Capital markets as falling real estate collateral values continue to undermine loan portfolios and balance sheets. In Monday’s trading, we saw still more manifestations of high anxiety as the contagious cloud of financial fears settled atop the GSE’s. Ironically, the concerns hovering above the GSE’s in Monday’s session centered on a potential change in a new rule at FASB (Financial Accounting Standards Board). The Rule, FAS 140, is said to consider removing the ‘qualified special purpose entity‘ which in the case of the GSE’s, would force Fannie Mae and Freddie Mac to repatriate off balance sheet ‘assets.’ If enacted, the fear suggested by Lehman Brothers analyst Bruce Harting is that the GSE’s would be on the hook to raise huge new sums of money to meet minimum capital requirements. Bandied about were figures of $46 billion in new capital for Fannie Mae, and $29 billion in new capital for Freddie Mac. In both cases, the result would undoubtedly be a fast track ticket into bankruptcy, as raising that type of capital in today’s market might be all but impossible.
However, it seems on closer inspection, that the rule is not aimed at the GSE’s which may actually be exempted from these FASB requirements. In the case of Fannie Mae, the company currently has 2.27 Trillion in off-balance sheet mortgage backed securities while Freddie Mac has 1.42 Trillion. Nevertheless, the GSE’s remain in the center of the housing maelstrom with the Mortgage Bankers Association reporting last Thursday that the amount of foreclosed properties rose more then 70% in the first quarter of 2008. According to the MBA, that data suggests that 1% of all mortgages in America have been foreclosed in the first three months of 2008.
For the same three months in 2007, the figure was .58%. In its latest press release the MBA also noted that foreclosure rates currently reside at a 29 year high, noting that the last time rates were this high was all the way back in 1979, during the last stagflationary recession. Among the most disturbing notes for advocates that “the housing market is close to a bottom” are the statistics that show a sharp jump in foreclosure rates for Prime Mortgages with 117,000 prime mortgages entering foreclosure in the first quarter, with that figure catching up to the sub-prime data which totaled 195,000. On a year-over-year basis, foreclosures for prime mortgages are now running at a faster rate than foreclosures for sub-prime, representing quite a dramatic turn of events. In an attempt to stem the rising tide of foreclosures, it is expected that later this week the US Senate may vote on a mortgage rescue plan that will seek to expand the FHA (Federal Housing Administration) with a new $300 Billion dollar program to allow debt-ridden homeowners who are currently too financially risky to qualify for government-backed loans to refinance into safer, more affordable mortgages. In recent months, President Bush has threatened to veto the bill, with the Senate now looking to generate an overwhelming vote, necessary to override a potential presidential veto.
In the case of Fannie Mae, even without the FAS 140 negative impact, the company currently sports about $40 billion in overall capital. Within the loan portfoliom FNM currently has around $80 billion in sub-prime loans, and another $200 billion in tier Alt-A. Assuming a 40% loss rate on the sub-prime loans and 30% loss rate on Alt-A (which we believe could actually be considerably higher), that’s $32 Billion (sub-prime) + $60 Billion (Alt-A) for a total of $92 billion in poor quality mortgage losses. In our view, those types of losses equate to nearly twice the companies' total capital suggesting that FNM is insolvent and heading for a further collapse. Shareholders may end up losing everything with the demise of the GSE’s, likely to carry devastating implications for the U.S. housing market which could accelerate lower in crash like behavior. Of course, FNM and FRE will probably both end up being nationalized by the US government along with the remains of the airline industry and other casualties of the current down cycle. Of course, there are those who point to the idea that the GSE’s have some degree of mortgage portfolio insurance, with Fannie and Freddie having SWAP agreements with bond insurers like PMI, MGIC, Genworth and others.
Above: MGIC Investment Corp (MTG) collapsing toward $5.00, clearly a strong warning that GSE’s will face huge counter-party risk as defaults continue to mount.
Above: All but disintegrated, PMI group plunges under $2.00, a $50 number one year ago,
now vaporized…the Greater Depression is digging in.
Above: Genworth Financial (GNW) collapsing to new multi-year lows.
Unfortunately, a glance at the collapse in bond insurers of all types suggests that when the time comes for Fannie and Freddie to look for insurance re-payment, the odds are high that none of the insurance entitites will be able to pay off, creating a daisy chain of counter-party risk and collapsing corporations. For those with any doubt, the worst of this crisis is still in front of us, and as I said a number of weeks back, ‘the only light at the end of the tunnel’ is a large freight train rolling down the tracks.
Above: Median Home Price
Looking at the long term chart for Housing, we devote a moment to the Census Bureau and its long time tracking gauge, the Median Home Price. Seen from the view of a Technical Analyst, instead of an economist, I would suggest that after a long period of topping process, housing prices are just now beginning to break down in price. Yes, it is true that home prices are down off the highs, the Median Home price having peaked at $262,600 in March 2007, with current prices as of May down 12.03% to a value of $231,000. However, looking at home prices from a long term point of view, a fibonacci .382 retracement of the secular advance seen during the last thirty years would suggest prices ultimately bottom out in the area near $155,000 to $170,000. Using the median for this lower target window, we arrive at downside objective of $162,500. On a percentage decline basis, that implies that the Median Home price still has approximately another 30% (29.65%) worth of substantial downside risk before important long term support is seen. At the same time, we have also plotted 10 year Bollinger Bands around the Median Home price and importantly, these will be coming in at approximately the same level looking out to the middle of 2010. In our view, the July to December 2010 time period could make a great deal of sense for a potentially more important bottom in the national housing market. Over the next few months, we will be watching to see if the Median Home price breaks below the $220,000 level as a clear cut break down below that price support (see dashed line below) would imply substantial downside acceleration in prices.
Using long term MACD on Housing prices, a break down below the important $220K level is likely as MACD is just now moving into negative territory with downside momentum still confirming downside movement in prices. Housing is nowhere close to an important bottom at the current time and as housing continues its decline, balance sheet collateral values will continue to shrink, amplifying the systemic margin call now rumbling its way through the US monetary system.
To this end, AP reported on Monday, that so far in 2008, S&P has seen 1.3 TRILLION dollars wiped out within the financial industry. What’s more, AP noted that “even more startling, is that shares of 35 companies, including bond insurers, have lost MORE than half their value so far this year.” For the US, which has been the consumer growth engine for the entire globe over the last twenty years, the rise of the Financial Economy has towered like a giant, entirely overshadowing the Mainstreet economy, especially in the last 10 years. As a result, it is difficult to describe the severity of the wound, as an implosion in the Financial Economy will ultimately translate into collapsing aggregate demand and huge job losses as one institution after another closes its doors. Just yesterday, Indymac Bank, long hailed as an innovator and poster child for intelligent lending, stopped accepting new loan submissions in its main mortgage lending division and announced plans to cut 3,800 of its 7,200 employees. I can remember personally sitting through a one hour analyst presentation on the merits of Indymac Bank not more then 2 years ago. At the time, no one, including myself, would have possibly imagined a collapse on this scope and breadth. Perhaps Mohamed El-Erian, co-chief executive officer of PIMCO and former CIO of the Havard endowment said it best with a quote last week, “we are living through the unthinkable.”
Above: IndyMac Bank (IMB) under $1.00… downsizing.
At the close, the DJIA rallied sharply as Oil prices tumbled, with the Dow gaining 152.25 index points to close at 11,384.21, the S&P gaining 21.39 to finish at 1273.70, and the NASDAQ gaining 50.41 to finish at 2293.73. For the DJIA, Tuesday produced a gain of 1.36%, for the S&P 500 a gain of 1.71% and for the NASDAQ, a gain of 2.25%. The 10 Year Bond Yield ended at 3.88 down .05 basis points, while nearby Gold ended lower at $923.30, down 5.50 the ounce.
That’s all for now,
© 2008 Frank Barbera