Mortgage Spreads: Fannie Mae 30 Year versus 10 Year Treasury Notes

I took a look today at the current mortgage spread, comparing the Fannie Mae 30 Year Net Required Yield versus the Treasury's 10 Year Note Yield.


What is interesting is that spreads have actually been coming down. I had made some comments to clients during the week, before looking at the data, that spreads were being stubborn, and not really coming down. I was wrong, based on the data from Fannie Mae.

The data is daily data from December 3, 2007 to December 17, 2008.



Spread Data: (Fannie Mae 30 Year Net Required Yield - 10 Year Treasury Note)
December 3, 2007 to December 17,2008

Average Spread: 2.099%

+ 2 Standard Deviations: 2.551%

- 2 Standard Deviations: 1.647%

Maximum Spread: 2.73947% - 11/20/08

Minimum Spread: 1.57615% - 01/23/08

Mortgage Meltdow Deux - CNBC Interview with Whitney Tilson

Date: December 18, 2008

CNBC Interview with Whitney Tilson, T2 Partners Managing Partner

Carl Quintanilla: Our next guest warned that the subprime crisis was only the beginning. That was a year ago. Is a second meltdown now on the horizon? Joining us this morning, on set hedge fund manager Whitney Tilson, of T2 Partners, Managing Partner and manager of Tilson mutual funds.

We saw you on 60 Minutes over the weekend, and it’s good to talk to you live. We’ve been talking about the second wave for a long time. But here it is, we’re close to the turn of the year, and you still think next year will be about Prime loans, helocs, things we haven’t had to deal with yet?

Whitney Tilson: Right, I sort of hate say everything that I’ve predicted the multiple times that I’ve been with you over the past year have come to pass. The subprime bubble has been just as bad as we thought. The wave of resets, though, is coming to an end. So, these were mostly two year resets. So the peak of the bubble in writing these bad mortgages was ’05 and ’06, two years later, ’07/’08 was when they all defaulted, upon the resets. The problem is, subprime was only 13.6% of mortgage volume at the very peak of the bubble. And the crazy behavior, and crazy lending, extended far beyond subprime; up into Alt-A, a little bit better than subprime, and then, even into prime loans, these things called option arms especially. Those tended to have three and mostly five year reset, which means those resets are still coming up in the next three years. And it’s even larger volume than the subprime.

Carl Quintanilla: So, as an aftershock, this will be, ten years from now, we’ll be talking about the wave to come, or the wave that just passed. Which is the stronger element?

Whitney Tilson: They’re roughly equally sized. And, unfortunately, the default data that we are seeing looking at pools of bubble-era mortgages… I just looked at an Alt-A pool written, one of the last one’s to get out, in July of ’07, this is only a year and a half ago, Lehman put a billion dollar pool out, and already, seventeen months in, 43%, of these Alt-A loans, these are supposed to be better than subprime, 43% have defaulted. So, uh, so we’re going to see, we’re seeing, the same trend lines and trajectories of defaults and delinquencies on Alt-A and Option Arms as we’re seeing on Subprime at the same stage.

Rebecca Quick: Whitney, everything the Fed’s doing, the Treasury’s doing, has been bringing mortgage rates down. There’s all this talk of additional measures that will help some of these people out. Will that stem this crush before it makes shore?

Whitney Tilson: Yes. Um. It will to some extent. The problem is, for example, this Alt-A pool was written at 96% loan to value, it was 25% in California where home prices are down, in these areas, 30 to 40%. So people are so far underwater that a 100 bip drop in the mortgage rate might help some people at the margin. So, Credit Suisse has predicted six million foreclosures at current trend line over the next four years. I think if you drop interest rates a hundred bips, which I hope the government does, I think that will help a lot. My guess would be is that it might help about a third of those people refinance into fixed rate mortgage. But there’s not a lot you can do when someone is almost 50% underwater.

Carl Quintanilla: Wilbur, you know all about all this stuff. Do you take any issue with any of it?

Wilbur Ross: Well, I think that default rates are going up. And the toxic thing about the Option Arms is they kept building up the size of the mortgage. Instead of paying the interest, the accrued it. So what that means, is you have house value going down, the face amount of the mortgage going up. That’s a real collision. And people who are underwater don’t pay mortgages.

Rebecca Quick: Whitney, we want to thank you very much for coming in. We hope to see you again soon. Appreciate it.

End of interview

CNBC's Jim Cramer Recommends Real Estate

Date: December 16, 2008

On tonight's episode of Mad Money on CNBC, at 7:13 in this clip, Jim takes a question from Rosanna In New York.

In answering Rosanna's question, Jim makes the first agressive recommendation of buying real estate that I've heard him make.

Click on picture to go to video.

From Jim, at the 8:07 mark of the clip:

"I know this is going to be antithetical, but I really think this is the time, if you live in Brooklyn there’s tons of places for sale I think you buy some real estate. Why do I say that, because the Fed’s going to reduce mortgage rates so low, that you’re going to want to buy something. You’re going to want to refinance, you’re going to take out a home equity loan, or you’re going to want to buy real estate, because it’s going to be a once in a lifetime reduced mortgage environment. So rather than be cautious on this I’m going to urge you to buy some real estate..."

Fed Cuts Rates To Lowest Level On Record

The Federal Reserve brought out the howitzers today, and cut the Fed Funds rate to 0.25%.

http://www.bloomberg.com/apps/news?pid=20601087&sid=atjRtu5oBDX0&refer=worldwide

“A big, widespread, explosive, incendiary shell has come out of the Fed’s cannon,” said Frederic Dickson, who helps oversee about $19 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. “It’s a bloody big deal. This is the kick-it-up-a-notch moment.”

http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm

FED STATEMENT

Release Date: December 16, 2008

For immediate release

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

Local News Feature Of Bill Fleckenstein

Here is a recent video featuring Mr. Fleckenstein from local Seattle station King 5 TV.

For those that are not familiar with Bill Fleckenstein, you should become familiar with his work. He's a hedge fund manager that has gained quite a reputation as one of the earliest individuals warning about the financial bubble that has now burst.

His book, Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve , (link to Amazon.com) is a serious indictment of the former Federal Reserve Chairman.

Mortgage Delinquencies Skyrocket

Not a major surprise, given the state of the economy and the real estate market, but mortgage delinquences are skyrocketing. The latest deliquency report from the Mortgage Bankers Association show deliquencies on 1 to 4 unit properties at 6.99% for the 3Q 2008, an increase of 140 basis points on a year over year basis.

Diana Olick On Mortgage Delinquencies

Non-Farm Payrolls Slashed by 533,000

The employment picture has been progressively worsening as the current recession deepens. The latest non-farm payroll numbers announced this morning were downright ugly. Down 533,000 jobs, the worst monthly job loss since December 1974. The problem is that the job losses are accelerating. It would not be surprising at this point to see a monthly job loss total that exceeds 600,000 jobs in January.

CNBC's Steve Liesman on the Non-farm payrolls report

http://www.haver.com/

U.S. Payrolls Slashed 533,000; 6.7% Jobless Rate Highest Since 1993

· Nonfarm payrolls were slashed during November by the most during any one month since December 1974. The 533,000 decline followed shortfalls of 320,000 and 403,000 during October and September, both of which were larger than reported earlier by the Bureau of Labor Statistics. Also, the latest exceeded Consensus expectations for a 323,000 drop. So far in 2008, nonfarm payrolls are down 1.9 mil., or 1.4%.

· During the last three months, payrolls fell at a 3.6% annual rate. That is the quickest rate of decline since during the recession of 1980.

· The unemployment rate rose further to 6.7% last month, the highest level since October 1993. The increase fell short of Consensus expectations for a rise to 6.8%. The jump owed to a 673,000 drop in employment (-1.6% y/y), as measured in the household survey, and the latest monthly decline in household sector employment was the ninth this year. It was the largest since the recession of 2001.
















Report Link To Bureau Of Labor Statistics

Mega Bear Markets

Doug Short had a fascinating chart comparing the current bear market (using the S&P 500 as proxy), the Dow 1929 Bear Market, the Nikkei Bear market beginning in 1989, and the Nasdaq bear market beginning in 2000. http://dshort.com/charts/mega-bear-comparisons.html?mega-bear-duet

What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup

I'm putting this blog post from Christopher Whalen up simply because I don't want to lose it. It's a terrific piece of writing from Mr. Whalen. Courtesy of Barry Ritzhold's Big Picture blog.

http://www.ritholtz.com/blog/2008/11/what-obama-geithner-aig-fiasco/

What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup

Christopher Whalen is Managing Director of IRA. Chris has worked as an investment banker, research analyst and journalist for more than two decades. After graduating from Villanova University in 1981, Chris worked for the U.S. House of Representatives and then as a management trainee at the Federal Reserve Bank of New York, where he worked in the bank supervision and foreign exchange departments. Chris subsequently worked in the fixed income department of Bear, Stearns & Co, in London. After moving back to the U.S. in 1988, Chris spent a decade providing risk management and loan workout services to multinational companies and government agencies. In 1997, Chris worked as an investment banker in the M&A Group of Bear, Stearns & Co.
~~~>

On Friday, the FDIC closed and facilitated the sale of two CA savings banks, Downey Savings and Loan, the bank unit of Downey Financial Corp (NYSE:DSL) and PFF Bank and Trust, Pomona, CA. All deposit accounts and all loans of both banks have been transferred to U.S. Bank, NA, lead bank unit of US Bancorp (NYSE:USB). All former Downey and PFF Bank branches reopen for business today as branches of U.S. Bank.

Earlier this year we wrote positively about Downey and the funding advantages it had over larger thrifts such as Washington Mutual due to the solid deposit base and strong capital. Indeed, as of Q3 2008, the bank’s Tier One leverage ratio was over 7.5%, more than two points over the minimum, and its charge offs had actually fallen compared with the gruesome 400 basis points of default reported in the previous period.

But since the September resolution of WaMu and Wachovia, the FDIC, it seems, is not willing to wait to resolve institutions, even banks that are apparently solvent and not below any of the traditional regulatory triggers for closure. The visible public metrics indicating soundness did not dissuade the Office of Thrift Supervision and FDIC from seizing both banks and selling them to USB.

The purchase of Downey and PFF is good news for the depositors and borrowers, who will all be offered the FDIC’s prepackaged IndyMac mortgage modification program as a condition of the USB acquisition. Bad news for the investors and creditors, who now see their already impaired investments wiped out.

The resolution of Downey illustrates both the best and the worst aspects of the government’s remediation efforts. On the one hand, we have argued that the government should be pushing bad banks into the arms of stronger banks to improve the overall condition of the system. The good people at the FDIC do that very well - when politics does not intervene.

In the case of Downey and PFF, it appears that the OTS and FDIC projected forward from the current above-peer loss rates and concluded that a prompt resolution was required. Reasonable people can argue whether this is the right call. But when we see the equity and debt holders of DSL, Washington Mutual or Lehman Brothers taking a total loss, we have to ask a basic question: why is it that the debt holders of Bear Stearns and AIG (NYSE:AIG) are granted salvation by the Federal Reserve Board and the US Treasury, but other investors are not?

If the rule of driving money to the strong banks (see “View from the Top: A Prime Solution to the US Banking Crisis”) safety and soundness is to be effective, it must be applied to all. And now you know why we have questions about the nomination of Tim Geithner to be the next Treasury Secretary. If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat. Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation. Thus Lehman, WaMu, Wachovia and Downey shareholders and creditors get the axe, but the bondholders and institutional counterparties of Bear and AIG do not.

Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or “CDS,” insurance written by AIG against senior traunches of collateralized debt obligations or “CDOs.” The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG’s CDS book.

The Paulson/Geithner bailout model as manifest by the AIG situation is untenable and illustrates why President-elect Obama badly needs a new face at Treasury. A face with real financial credentials, somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced - CDS.

Last Thursday, we gave a presentation to the New York Chapter of the Risk Management Association regarding the US banking sector and the long-term issues facing same. You can read a copy of the slides by clicking here.

As part of the presentation (Page 17-21), IRA co-founder Chris Whalen argued the case made by a reader of The IRA a week before (see “New Hope for Financial Economics: Interview with Bill Janeway,”) that until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions. Here is how we presented the situation to about 200 finance and risk professionals in the auditorium of JPM last week. Of note, nobody in the audience argued.

1) Start with the $50 trillion or so in extant CDS.

2) Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.

3) Now assume a 25% recovery rate against that portion of all CDS that goes into the money.

4) That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.

Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.

Our answer to this cowardly view is that AIG needs to be put into bankruptcy. As we wrote on TheBigPicture over the weekend, we’ll take our queue from NY State Insurance Commissioner Eric Dinalo and stipulate that we pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.

President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation.

And, yes, we can put AIG and the other providers of protection through a bankruptcy and force the CDS market into a quick and final extinction. Remember, when AIG goes bankrupt the insurance units are taken over by NY, WI and put into statutory receiverships. Only the rancid CDS positions and financial engineering unit of AIG end up in bankruptcy. And fortunately we have a fine example of just how to do it in the bankruptcy of Lehman Brothers.

Our friends at Katten Muchin Rosenman in Chicago wrote last week in their excellent Client Advisory: “On November 13, 2008, Lehman Brothers Holdings Inc. and its U.S. affiliates in bankruptcy, including Lehman Brothers Special Financing and Lehman Brothers Commercial Paper (collectively, “Lehman”) filed a motion asking that certain expedited procedures be put in place to allow Lehman to assume, assign or terminate the thousands of executory derivative contracts to which they are a party. If Lehman’s motion is granted, counterparties to transactions that have not been terminated will have very little time to react and will likely find themselves with new counterparties and no further recourse to Lehman because, by assigning contracts to third parties, Lehman will effectively receive, by normal operation of the Bankruptcy Code, a novation.”

The bankruptcy court process also allows for parties to terminate or “rip up” CDS contracts, something that has also been fully enabled by the DTCC. The bankruptcy can dispose and the DTCC will confirm.

BTW, while you folks in the Big Media churned out hundreds of thousands of words last week waxing euphoric about the prospect for enhanced back office clearing of CDS contracts, the real issue is the festering credit situation in the front office. Truth is that the DTCC and the other dealers, working at the behest of Mr. Geithner, Gerry Corrigan and many others, have largely fixed the operational issues dogging the CDS markets. The danger of CDS is not a systemic blowup - though that will come soon enough. It is the normal operation of the now electronically enabled CDS market wherein lies the threat to the entire global financial system, this via the huge drain in liquidity illustrated above as CDS contracts are triggered by default events.

The only way to deal with this ridiculous Ponzi scheme is bankruptcy. The way to start that healing process, in our view, is by the Fed emulating the FDIC’s treatment of DSL, withdrawing financial support for AIG and pushing the company into the arms of the bankruptcy court. The eager buyers for the AIG insurance units, cleansed of liability via a receivership, will stretch around the block.

By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG’s resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.

The bailout of AIG represents the last desperate rearguard action by the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering. Hopefully somebody will pull President-elect Obama aside and give him the facts on this mess before reality bites us all in the collective arse with, say, a bankruptcy filing by GM (NYSE:GM).

You see, there are trillions of dollars in outstanding CDS contracts for the Big Three automakers, their suppliers and financing vehicles. A filing by GM is not only going to put the real economy into cardiac arrest but will also start a chain reaction meltdown in the CDS markets as other automakers, vendors and finance units like GMAC are also sucked into the quicksand of bankruptcy. You knew when the vendor insurers pulled back from GM a few weeks ago that the jig was up.

And many of these CDS contracts were written two, three and four years ago, at annual spreads and upfront fees far smaller than the 90 plus percent payouts that will likely be required upon a GM default. That’s the dirty little secret we peripherally discussed in our interview last week with Bill Janeway, namely that most of these CDS contracts were never priced correctly to reflect the true probability of default. In a true insurance market with capital and reserve requirements, the spreads on CDS would be multiples of those demanded today for such highly correlated risks. Or to put it in fair value accounting terms, pricing CDS vs. the current yield on the underlying basis is a fool’s game. Truth is not beauty, price is not value.

If you assume a recovery value of say 20% against all of the CDS tied to the auto industry, directly and indirectly, that is a really big number. The spreads on GM today suggest recovery rates in single digits, making the potential cash payout on the CDS even larger.

As Bloomberg News reported in August: “A default by one of the automakers would trigger writedowns and losses in the $1.2 trillion market for collateralized debt obligations that pool derivatives linked to corporate debt… Credit-default swaps on GM and Ford were included in more than 80 percent of CDOs created before they lost their investment-grade debt rankings in 2005, according to data compiled by Standard & Poor’s.”

At some point, Washington is going to be forced to accept that bankruptcy and liquidation, the harsh medicine used with other financial insolvencies, are the best ways to deal with the last, greatest bubble, namely the CDS market. When the end comes, it will effect some of the largest financial institutions in the world, chief among them Citigroup (NYSE:C), JPMorganChase (NYSE:JPM), GS and MS, as well as some large Euroland banks.

The impending blowback from a CDS unwind at less than face amount is one of the reasons that the financial markets have been pummeling the equity values of the larger banks last week. Any bank with a large derivatives trading book is likely to be mortally wounded as the CDS markets finally collapse. We don’t see problems with interest rate or currency contracts, by the way, only the great CDS Ponzi scheme is at issue - hopefully, if authorities around the world act with purpose on rendering extinct CDS contracts as they exist today. Call it a Christmas present to the entire world.

Indeed, as this issue of The IRA goes to press, news reports indicate that C is in talks with the Treasury for further financial support under the TARP, including a “bad bank” option to offload assets. [EDITOR: Already approved by Treasury and the Fed]. A bad bank approach may be a good model for applying the principle of receivership to the too-big-too fail mega institutions, but the cost is government control of these banks.

Q: Does a “bad bank” bailout for C by Treasury and FDIC qualify as a default under the ISDA protocols!?

We’ve been predicting that Treasury will eventually be in charge of C. On the day the government formally takes control, we say that Treasury should and hire FDIC to start selling branches and assets. Thus does the liquidation continue and we get closer to the bottom of the great unwind. Stay tuned.

Case-Shiller Home Price Index Fell Further Through September

The Case-Shiller Home Price Index fell further - the September 2008 data, released on Tuesday, shows a year over year drop of 17.4% for the national index.

The most alarming aspect of these numbers is that they go through September, given what we know about sudden and dramatic slowdown in the economy in October and November, there is virtually no doubt that the housing price free-fall is going to continue for at least the next two reports.

David Blitzer Discusses Case-Shiller Index

Seattle Market Not As Bad - Down 9.8% Year over Year, Down 10.1% From Peak

Happy Thanksgiving 2008

Happy Thanksgiving to all.

In the midst of this unprecidented financial turmoil, we have much to be thankful for.

Fast Money Interview With Laura D'Andrea Tyson November 24, 2008

Transcripts:

Fast Money Interview: Laura D’Andrea Tyson
Date: November 24, 2008

Dylan Radigan: We are joined now by a member of his (Obama) advisory community, Laura Tyson, former member of the Clinton Administration, joins us now from Berkeley California, where she is a professor at their school of business. And professor, we welcome you to the program.

Laura D’Andrea Tyson: Thanks a lot.

Dylan Radigan: What justifies in your mind the treatment of Citigroup today? In other words…maybe I shouldn’t ask the question that way. What is your opinion of the Citigroup deal today, knowing that, again, this is not your world, necessarily, that you’re not in charge of policy at this point, but you’re obviously an observer.

Laura D’Andrea Tyson: Right, right… Well, as an observer of policy, I think it’s very important to say that we are in an unprecedented, historic capital market crisis. That in such a crisis, and I heard some of the conversation just preceding on your program, uh, it’s not clear at all that market fundamentals are at play, there’s a lot of fear and panic at play. When there’s fear and panic at play, one of the things that must happen is that the large government balance sheet must be used to save institutions at risk, if those institutions are important to the system’s functioning. Citigroup is important to the system’s functioning, both in the United States and around the world. And we have to do whatever is necessary to bring the capital market system back into some normalcy of functioning. And that’s how I interpret what was done, announced over the weekend.

Dylan Radigan: If you look at the sidebar to it, however, which is the cost of capital being attractive to them, and in effect a subsidy many would argue for them, and that many executives including Bob Rubin, who’s one of your colleagues advising Barrack Obama, have managed to make hundreds of millions if not billions of dollars benefitting from this system of credit creation that now is coming out of the taxpayer’s hide. What is your view of that aspect of it?

Laura D’Andrea Tyson: I don’t think it’s appropriate to think about this as coming out of the taxpayer’s hide. I think what we have to say here, and this was said by President-elect Obama this morning. The interests of Wall Street and Main Street are one in this kind of crisis situation. Homeowners can’t get mortgages, students can’t get loans, people can’t get car loans, businesses can’t get loans to run. We need a Wall Street that is functioning…

Dylan Radigan: No one disputes that…

Laura D’Andrea Tyson: We need to look at…we need to look at this as a systemic bailout, I don’t even like the term bailout, an effort to restore normalcy to the system. When we look around the world at previous economic crisis, capital market crisis of this significance, and there are very few, it is normally the case that at some point the government balance sheet has to come in to back up the balance sheets of private institutions, and that’s how we should see this…


Dylan Radigan: Right, and but…my question, understood, and I don’t think…and I don’t contest any of that. What I was asking though, is that the individuals that helped create the structure that created the crisis paid themselves hundreds of millions of dollars, and now have come to the taxpayer for capital.

Laura D’Andrea Tyson: The point is, they haven’t come to the taxpayers for capital.


Dylan Radigan: No, they just created a system that forced their successors to do so.


Laura D’Andrea Tyson: The system… Look, there was a system in which everyone believed that housing prices would never go down. There was a system which allowed people to hedge their risk so that no one believed they had any risk. So you had a system creating an outcome. And I think it’s a mistake, I really think it’s a mistake, to look at individuals or individual institutions and say “there, that’s where the blame lies.”

Dylan Radigan: It’s not about the blame.


Laura D’Andrea Tyson: There is a systemic failure…


Dylan Radigan: no, it’s not about blame. Let me be clear though. It’s not about blame. Just the same as if I buy a house that I can’t afford inside of the system that you describe, the system is set up to remove that house from me because I actually never could afford that house, probably didn’t belong in it…

Laura D’Andrea Tyson: {interrupts} but you see

Dylan Radigan: let me finish, please. The same system allowed me to bonus myself a few hundred million dollars creating 40 Trillion dollars worth of credit for every Trillion that I had, and I really didn’t make that money either.

Laura D’Andrea Tyson: Here’s what I would say, here’s what I would say…It is very important right now, for the United States of America, for the President-elect, for the new Congress, for everyone on Main Street, to solve the problem we face. There is plenty of time in the future to try to un…to piece together how we got here… If we start focusing on that now, and take our eye off the ball of the stimulus package that needs to be passed..

Dylan Radigan: agreed…no contest

Laura D’Andrea Tyson: or of other possible…so…I don’t think the focus should be on individuals and their past compensation, I just don’t think that’s the focus…

Karen Finerman: Miss Tyson, it’s Karen Finerman…

Laura D’Andrea Tyson: I think the focus is the stimulus. Let’s talk about the stimulus, I mean how big should it be?

Karen Finerman: I’d like to talk about the stimulus…Can you tell me about…I’ve seen a bunch of different numbers, about whether it’s $500 Billion, $700 Billion. Can you give me a little more clarity, on what kind of stimulus, whether it’ll be a check right away like they did in May which seemed to have very short-lived results, will it be more of a long-term infrastructure type stimulus that requires a lot of planning to sort of, gear-up, some of both, is it a one-year or two-year package. What are you thinking?

Laura D’Andrea Tyson: Well I think, first of all, as we know the depth of the crisis and challenge we face, uh, is becoming more apparent. So that whereas just a few weeks ago, forecasters may have been predicting a first quarter where GDP, private demand, was down by 2%, now they’re predicting things like private demand is down by 4%. So what’s happening is the estimates of the size of a stimulus that could really make up for the absolute dramatic decline in private demand, the size of the stimulus is rising. People have been marking up the estimates from two to three to four; uh, I saw a recent report by a Goldman Sachs economist saying we should get up to six.

Dylan Radigan: no, and we understand…sorry to interrupt you, but we’re running a clock here. But I think the question everybody wants answered…on the stimulus…we know that there are many variables, and lots of things we do not know. These traders live it every day; we all live it every day.

Laura D’Andrea Tyson: Yes they do.

Dylan Radigan: So, we don’t need that information, quite honestly.

Laura D’Andrea Tyson: Ok, what information would you like?

Dylan Radigan: We would like the mathematical formula or set of principles you are utilizing to try to determine how much money you want to spend on our economy, understanding that it is changeable based on the dynamic nature of the data set.

Laura D’Andrea Tyson: I think we want to, I think my advice would be, we want a size in stimulus, uh, that basically is making up for the shortfall in domestic demand. So between two and four percent, between 300 and 600 billion dollars, would be my personal advice.

Now, what should it be?

President-elect Obama, who was one of the first to call for a second economic stimulus during the campaign, made it very clear what his priorities are, and he said them today. We need to make sure that we can invest in infrastructure. I disagree with the point made that we cannot roll out significant spending on infrastructure quickly. Look around at every local and state government in the country that is being forced to close down projects that are underway. You can keep those projects going, keep people employed.
So, that’s number one.

Number two, is energy, alternative energy. We really can do a lot with households, with businesses, to improve energy efficiency. There’s lots of things one can do with refurbishing buildings, refurbishing households, that cost money, it keeps people employed…

Fed Unveils Plan to Support Mortgages, Consumer Credit
Reuters and CNBC.com 25 Nov 2008 08:27 AM ET

The U.S. Federal Reserve, in another massive life-support intervention for the U.S. financial system, Tuesday announced a $600 billion program to buy mortgage-related debt and securities and a $200 billion facility to buy consumer debt securities.

The U.S. central bank said it would buy up to $100 billion in debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, the government-sponsored mortgage finance enterprises.

The Fed also said it would buy up to $500 billion in mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

The move is intended to strike at the heart of U.S. economic woes, the collapsed housing market.

"This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved financial conditions more generally," the Fed said in a statement.

http://www.cnbc.com/id/27906891

FOMC Minutes From October 28-29

Big revisions coming from the FOMC regarding economic projections.

The Fed moves incrementally most of the time, so the real news isn't necessarily the projections they're making, as there are probably more revisions to their projections upcoming, but the size of this revision is very large. The Fed essentially shaved 1 to 1.3% off of GDP projections for 2008, and anywhere from 1.7% to 2.2% off of 2009 GDP projections from the June 2008 projection. That is a huge miss. Huge.

http://www.federalreserve.gov/monetarypolicy/fomcminutes20081029ep.htm

Obama's First 100 Days

Interesting video from CNBC's Fast Money

Transcript of Introduction: Voiceover by Dylan Radigan

1:50 Introduction:
January 20th, 2009. It’s your first day as President of the United States of America. And the briefing from your economic advisors sounds something like this:

The economy is contracting, both at home and abroad
People are losing their homes, at a record rate
The deficit stands at about a trillion dollars
And the capitalist system still in it’s worse shape since the Great Depression

And, by the way, there are two wars going on.

The expectations for President Obama’s solutions are as high as the challenges themselves. The first task will be what he does in the first hundred days. Many expect a speedy FDR-type game plan, in which Roosevelt passed fifteen major bills right off the bat aimed at jump starting the economy, regulating Wall Street, and creating jobs.

But Obama’s first moves may not be so sweeping, as spending will be hamstrung by a ballooning deficit. From Wall Street to Main Street, the eyes of the world are on Washington, D.C. right now. Fast Money has come here to find out what we can expect in Obama’s first hundred days.

3:06 Dylan Radigan: And joining us now, fresh out of that meeting in Chicago with Obama’s transition team, William Daley, former Secretary of Commerce, a long list of accomplishments for you Mr. Daley. I’m curious from an advisory standpoint how you are counseling the President elect. In other words, are you advising him to focus on stimulating infrastructure? Are you advising him to stimulate directly as the Bush Administration has? And what is your view on deficit spending as a mechanism to accomplish it?

3:41 William Daley: I think what you heard today at the meeting, what you heard from President elect Obama, is a commitment, only after only 72 hours of being President-elect, to making sure that this transition goes smoothly. Obviously, we have one Administration, we have one President until January 20th, and what President-elect Obama’s statement today indicates is a desire to make sure that the markets know, and the world knows, that the American economy will come back. He is strongly believing that we need a stimulus, as he said, sooner rather than later. If it doesn’t get done in lame-duck, it will get done first thing after he’s President, January 20th.

4:21 Dylan Radigan: Yeah, understood. But philosophically, as a member of that team, where do you come down on a view on stimulus, and a view on deficit spending.

4:33 William Daley: There’s no question that you’ve got to get stimulus moving, that’s a combination of short term and long term. If you believe that we are early in this recession, infrastructure stimulus is a good thing to do.

We listened to Mayor Villaraigosa today talk about the need for infrastructures, both cities and states are talking about. That’s longer term. But, short term, we’re going to need to do something about unemployment and other items, and I think the President elect is going to be very specific over not just during the transition, but more importantly as he prepares for the Presidency on January 20th.

5:08 Dylan Radigan: Yeah. Specifically, what is your view on tax policy, and how would you counsel the President-elect to view the use of taxes in the first hundred days.

5:20 William Daley: As the President elect said today, the tax cut for the middle class, and a very broad one, is an important part of his agenda, and an important part of stimulating the economy next year. Ah, he’s committed to it, and he’s prepared to make sure that that happens for the vast majority of people next year.

5:40 Dylan Radigan: What about taxes on capital. Both capital gains and otherwise. In other words, taxes on businesses, things that affect the flow of capital in the economy; capital that could indeed flow into alternative energy, flow into healthcare, all those sorts of things.

5:55 William Daley: Everyone wants to know the specifics for his Administration that starts in January. They’re not going to be laid out until he’s President. He’s been strong about the need to stimulate the economy, do that now; and prepare for an Administration, prepare for a program that begins to change these difficult…it took us a long time to get into these difficult times, and I think it will take us a while to get out. We all know it. We all know we have to go through a recession. The government’s got to be committed to making sure that this recession is not as deep as some predict it may be; but, no one can stop the difficulties that are coming. It’s just trying to slow them down, make ‘em not as deep, and shorten it. And those are steps that will be taken after January 20th.

6:39 Dylan Radigan: Understood, do you have a view as to how many jobs you think are at risk in this country?

6:44 William Daley: I think we’re going to continue as most of the people probably today predicting after today’s numbers, that this, that the numbers for the last month may not be the high point by any stretch. So I think we’re going to continue to see difficulties. But, this economy as we know, has gone through difficulties before; we will come out of this. The President-elect was very optimistic not only in the meeting today, about the American economy, and the opportunities that will present themselves; but we will go through some difficult times, no doubt about it. The numbers that we heard today, and the re-adjustment for last month, which may be as upsetting as the actual numbers this month, probably are not the low point for a while.

7:26 Dylan Radigan: And my last question for you: What is your view on how the U.S. Government should deal with the automakers?

7:31 William Daley: Well, I think the President-elect was very, also, very sympathetic today, to the difficulties of the auto companies. He has stated before, that he wants to see the auto companies and the autos of the future help us break the dependency on the oil that we’ve been on for all these years. And so he has been also very emphatic about the need to retool Detroit and make sure that the industry not only survives, but grows, and grows with the new energy needs of the country, not the old ones. So, I, I think you will see action by Congress, whether it passes or not, it remains to be seen.
8:12 Dylan Radigan: Alright, Mr. Secretary. I understand that you used to work out with Pete Najarian, so you must be a rather strong man. Ah, we appreciate your time with us today…

Home Prices Case-Shiller

New home price data out today, in the form of the Case-Shiller Index.

CNBC Interview with Standard And Poor's David Blitzer regarding the Case-Shiller index.

Transciption of Interview:

CNBC Interview with David Blitzer, S&P 500 Index Committee Standard & Poor's managing director/chairman
Date: 10-27-2008
Interviewers: Erin Burnett, Mark Haynes, CNBC Squawk On The Street

Erin Burnett: We want to talk about the latest housing data to come out. S&P/Case-Shiller’s new report says the downturn in residential real estate, continues, no surprise. There are not many bright spots, but here are the overall numbers. Prices down 16.6% in August from a year ago. Joining us first on CNBC to dissect the data, Standard and Poors’ David Blitzer, chairman of the S&P 500 Index Committee.

Now David, I just have to be blunt, my main question sir, on this data, is that it’s August [August data]. And that appears to be ions ago, because it was before sort of the world fell apart. So can you give us an honest assessment of the relevance of this data, whether things have dramatically accelerated from here?

David Blitzer: I think what we’re beginning to see, what we see the beginnings of in this data, and what we’ll see as we roll forward over the next several months, are the impact of foreclosures more than anything else.

Based on discussions we had yesterday, we’re definitely seeing foreclosures begin to show up here. And the initial impact will be to continue the price fall, probably accelerate the price decline, throughout the Sunbelt cities that we’ve been worried about so much over the last year or more, and so on. That’s where the foreclosures are likely to be concentrated, that’s where the price impact will be. What it means for the overall index, is we’re going to see increasingly a split. The Sunbelt, Miami, Tampa, on the East Coast. Phoenix, San Diego, Las Vegas, Los Angeles, and rolling in San Francisco, even though it may not be sunny, on the West Coast. Those areas will continue to go down.

Other parts of the country are beginning to show some stability. And my guess is, by the end of this year, when we’ve had a lot more data about housing in the recent turmoil, we will see a clearer split in the division. We’ll see signs of recovery in parts of the Northeast, and in some other spots around the country. But the Sunbelt, unfortunately, is going to have a long, long way to go.

Mark Haynes: So that, kind of that, crescent from Florida, across the South up to California is the problem area. The Northeast…we had some pretty good property appreciation in the Northeast; ah, ah, ah, what I mean is, during the bubble, so…

David Blitzer: yeah, [nervous laughter] we don’t have any recent good property appreciation at any price unfortunately.

David Blitzer: That’s true, but…Northeast, I mean if you look at Boston for a moment. Boston was the first city to peak way back in September in 2005. So that’s 3 years back, you know, which is a long time for half of the housing cycle, which is what we’re going through.

So I think between time, and the fact that you didn’t have the kind of rampant development in sections of the Northeast; because there wasn’t that much empty land to rampantly develop. That’s going to mean a little bit more stability, and that’s where you’ll begin to see some more improvement.

New York is a bit of a wild card because of financial services; and, you know, we all, unfortunately, know that story. But, I think we’re going to see this, sort of, splitting off. The Sunbelt continuing to sink, or sink even more quickly over the next few months because of foreclosures. The rest of the country, beginning to get toward stability.

No place, or price, is about to go sky high, or straight up. That’s a 2009 or 2010 story, according to most of the people we hear from.

Erin Burnett: David, thank you, as always, for being with us, we appreciate it. David Blitzer with Standard and Poors’ on that latest data on the housing market.

Washington Mutual - RIP

The shutting down of WAMU no doubt is hastening the takeover of Wachovia. Talk about denial, insiders disputing how close it was to failing...That is simply incredible. WAMU had a portfolio of Option Arms, by far the most toxic mortgage instrument on the market today. They simply couldn't unload these assets on the open market for a price that would've allowed them to stay in business.


WaMu's desperate last days

http://seattletimes.nwsource.com/html/businesstechnology/2008210320_wamu28.html

Regulators and insiders paint a picture of a deeply troubled bank that only reluctantly put itself up for sale, though they dispute how close it was to failing.

Why Now?

So what caused Secretary Paulson and Fed Chairman Bernanke to act now, as opposed to next week, next month, after the election?

I believe you'll find the answer in these charts.

A Week For The History Books

Collapse and Capitulation

On September 2, see blog entry below, we warned that "we are directly in front of a major financial hurricane". Obviously, this is exactly what has occurred. Today, we are in the front end of the hurricane. This market has the potential for a full-fledged meltdown.


After the government bridge loan of $85 Billion to AIG, a loan the government tried desperately to avoid making, you've really got to ask: "Are we out of money." My guess is, there are no further bailouts coming, simply because the government cannot afford any more bailouts. Heck, I don't think they could afford this AIG bailout. They were damned if they did, and damned if they didn't.


And today's market selloff, the Nasdaq is currently -3.26%, certainly has the potential to continue to accelerate down.


Critical Long Term Support


Below is a chart illustrating an absolutely critical long term support line for the Nasdaq, connecting the October 1990 lows with the October 2002 lows. This critical support line is currently at 2037, roughly 90 points away from the current level of 2122.

Interest Rates
Interest rates for the safest governement bonds are coming down rapidly. The rate on the government 10 Yr. Note hit 3.25% early in the trading session before climbing significantly higher, with a closing high at 3.496%. Tremendous volatility. Yesterday's low at 3.25% actually was below the January low for rates which was at 3.28%.

Today, interest rates are headed lower again, current at 3.368%.

Below is a one year chart of the 10 yr bond index.

Mortgage rates are very grudglingly following Treasury rates lower. For example, at the low in the 10 Yr in January, the 30 yr mortgage rates were actually at 4.875% at par for a brief moment (approx. 4 hours) in January. Today, they sit at 5.50%. Spreads have widened.

I am strongly recommending that those looking to refinance into a 30 year fixed rate, anything at 5.50% or lower looks extremely attractive historically. This is no time to play footsy with interest rates, there is far too much volatility in the interest rate market, and far too much uncertainty in the markets in general.

Lessons of Bear Stearns

Terrific blog entry by Barry Ritholtz at The Big Picture:

The Terrible Lessons of Bear Stearns

As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies -- we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.

The lesson from the Bear Stearns' bailout -- $29 Billion in Federal Reserve bad paper guarantees -- are quite stark:

• Go Big: Don't just risk your company, risk the entire world of Finance. Modest incompetence is insufficient -- if you merely destroy your own company, you won't get rescued. You have to threaten to bring down the entire global financial system. The fear and disruption caused by a Bear collapse is why it was saved. (AIG has the right idea on this)

• If you cant Go Big, Go First: Had Lehman collapsed before Bear, then the same fear and loathing of the impact to the system might have worked to their advantage. But having been through this once before, the sting is somewhat lessened -- especially for a smaller, lets interconnected firm like LEH. (First mover advantage!)

• Threaten your counter-parties: Bear Stearns had about 9 trillion in its derivatives book, of which 40% was held by JPMorgan (JPM). Some people have argued that the Bear bailout was actually a preventative rescue of JPMorgan. Its a good strategy if your goal is a bailout -- risk bringing down someone much bigger than yourself.

• Risk an important part of the economy: If your book of derivatives is limited to some obscure and irrelevant portion of the economy, you will not get saved. On the other hand, if Mortgages are important, credit cards and auto loans are too. Securitized widget inventory is not. To use a dirty word, Lehman's exposure is "contained."

• Balance Sheets Matter: Focus on the media, complain about short sellers, obsess about PR. These are the hallmarks of a failing strategy -- and a grand waste of time. Why? Its call insolvency. ALL THAT MATTERS IS THE FIRMS' BALANCE SHEET. Lehman's liabilities exceed its assets, and they are now toast. Merrill Lynch got a lot of the junk off of its books, and got a takeover at 70% premium to its closing price. And Credit Suisse, who dumped much of its bad paper many quarters ago, is in a better tactical position than most of its peers.

• Unintended Consequences lurk everywhere: When the Fed opened up the liquidity spigots via its alphabet soup of lending facilities, the fear was of the inflationary impacts. But the bigger issue should have been Complacency. The Dick Fulds of the world said after Bear, these new facilities "put the liquidity issue to rest." Lehman got complacent once liquidity was no longer an issue -- perhaps they acted to slowly to resolve their insolvency issue in time.

Unfortunately, Moral Hazard has created terrible lessons in 2008 -- via Bear Stearns (BSC), Lehman (LEH), Fannie Mae (FNM) and Freddie Mac (FRE).

Lehman Brothers - RIP 2008?

It certainly looks like Lehman Brothers is going under...The govt is drawing a line in the sand, no backstopping of Lehman debt.

Barclays Walks from Lehman Deal
In Frantic Day, Wall Street Teeters

Special Resk Reduction Trading Session Called by ISDA Re Lehman Bankruptcy
ISDA confirms a risk reduction trading session is taking place between 2 pm and 4 pm New York time today (September 14) for OTC derivatives. Product classes involved are credit, equity, rates, FX and commodity derivatives. The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy filing. Trades are contingent on a bankruptcy filing at or before 11:59 pm New York time, Sunday, September 14, 2008. If there is no filing, the trades cease to exist. These trades are subject to a protocol which is being distributed by ISDA (International Swaps and Derivatives Association). Traders should execute the protocol and email a copy of the signature page to Mark New at ISDA (mnew@isda.org) with LEHMAN PROTOCOL in the subject line. Click here for Protocol Text. An explanatory statement regarding the Protocol can be found here.
MARKET PARTICIPANTS HAVE INDICATED THAT THEY ARE WILLING TO TRADE UNTIL AT LEAST 6:00 NEW YORK TIME. PARTIES SHOULD COMMUNICATE WITH EACH OTHER AS TO THEIR WILLINGNESS TO TRADE LATER THAN 6:00.
International Swaps and Derivatives Association - Lehman Risk Reduction Trading Session Protocol

Bank of America walked away from Lehman, and is in talks with Merrill Lynch.
Bank of America In Talks To Buy Merrill Lynch

This news is going to hit all markets.

In my opinion, the reason that the stock market has not gone down more, until now, has been the belief that the government was going to backstop nearly every financial failure. That assumption has been taken away. First with the Fannie/Freddie deal, and now with the apparent Lehman failure, the government safety net for equity holders is gone.

We spoke a couple of weeks ago about the Elliot Wave formation calling for an upcoming stock market collapse. The last two weeks we've seen some deterioration, but, imo, the collapse begins in earnest this week (tomorrow). It could get very, very ugly.

A First Look Inside the Fannie / Freddie Bailout Plan

A First Look Inside the Fannie / Freddie Bailout Plan
http://seekingalpha.com/article/94304-a-first-look-inside-the-fannie-freddie-bailout-plan
Paul Kedrosky
posted on: September 07, 2008

Details on the just-announced Fannie/Freddie bailout plans were initially scant, but the OFHEO and Treasury websites now have most of what you're looking for.

Here is the gist:
1. The two mortgage giants will open Monday under Treasury control
2. New CEOs and boards are inbound
3. Common shareholders are being massively diluted as preferred of a preferred/warrant deal that is being held out as offering taxpayers upside.
4. The U.S. is now buying MBS securities direct from GSEs in the open market, and there is no explicit limit specified.
5. The U.S. just added a planet-sized new (red) line item on its national balance sheet.

For those of you who like more words, here is OFHEO's description of the bailout's key elements:

There are several key components of this
conservatorship:

First,Monday morning the businesses will open as normal,
only with stronger backing for the holders of MBS, senior debt and subordinated debt.

Second, the Enterprises will be allowed to grow their guarantee MBS books without limits and continue to purchase replacement securities for their portfolios, about $20 billion per
month without capital constraints.

Third, as the conservator, FHFA will assume the power of the Board and management.

Fourth, the present CEOs will be leaving, but we have asked them to stay on to help with the transition.

Fifth, I am announcing today I have selected Herb Allison to be the new CEO of Fannie Mae and David Moffett the CEO of Freddie Mac. Herb has been the Vice Chairman of Merrill Lynch and for the last eight years chairman of TIAA-CREF. David was the Vice Chairman and CFO of US Bancorp. I appreciate the willingness of these two men to take on these tough jobs during these challenging times. Their compensation will be significantly lower than the outgoing CEOs. They will be joined by equally
strong non-executive chairmen.

Sixth, at this time any other management action will be very limited. In fact, the new CEOs have agreed with me that it is very important to work with the current management teams and employees to encourage them to stay and to continue to make important improvements to the Enterprises.

Seventh, in order to conserve over $2 billion in capital every year, the common stock and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. Subordinated debt interest and principal payments will continue to be made.

Eighth, all political activities -- including all lobbying -- will be halted immediately. We will review the charitable activities.

Lastly and very importantly, there will be the financing and investing relationship with the U.S. Treasury, which Secretary Paulson will be discussing. We believe that these facilities will provide the critically needed support to Freddie Mac and Fannie Mae and importantly the liquidity of the mortgage market.

One of the three facilities he will be mentioning is a secured liquidity facility which will be not only for Fannie Mae and Freddie Mac, but also for the 12 Federal Home Loan Banks
that FHFA also regulates. The Federal Home Loan Banks have performed remarkably well over the last year as they have a different business model than Fannie Mae and Freddie
Mac and a different capital structure that grows as their lending activity grows. They are joint and severally liable for the Bank System’s debt obligations and all but one of the 12 are profitable. Therefore, it is very unlikely that they will use the facility.

And more here from the WSJ, straight from Treasury's description of the shareholder-diluting PSPA:

The Treasury said its senior preferred stock purchase agreement includes and
upfront $1 billion issuance of senior preferred stock with a 10% coupon from
each GSE, quarterly dividend payments, warrants representing an ownership stake
of 79.9% in each firm going forward, and a quarterly fee starting in 2010.

Lots more details to come, I have to think. The market is going to initially swoon for this, but Tuesday will be interesting as the ripple effects hit.

Fannie, Freddie Capital Concerns Prompt Paulson Plan

Fannie, Freddie Capital Concerns Prompt Paulson Plan

http://www.bloomberg.com/apps/news?pid=20601087&sid=aMX336c2lWGQ&refer=worldwide
By Dawn Kopecki and Alison Vekshin

Sept. 7 (Bloomberg) -- Treasury Secretary Henry Paulson decided to take control of Fannie Mae and Freddie Mac after a review found the beleaguered mortgage-finance companies used accounting methods that inflated their capital, according to people with knowledge of the decision.

Paulson will hold a press conference at 11 a.m. today in Washington, according to a statement. Morgan Stanley, hired by the Treasury to probe the companies' finances, concluded the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings are confidential.

The Treasury plans to put Fannie and Freddie into a so- called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview yesterday. The government would make periodic capital injections by buying convertible preferred shares or warrants, according to a person briefed on the plan. Paulson is seeking to end a crisis of confidence in the companies sparked by concern the companies didn't have enough capital to weather the biggest housing slump since the Great Depression.

The Treasury was ``convinced that the markets simply wouldn't respond until after something like this,'' said Frank, who was brief by Paulson. ``I think it's an important combination.''
Debt Holders Protected

Paulson gathered Federal Reserve Chairman Ben S. Bernanke, Federal Housing Finance Agency Director James Lockhart, Fannie Chief Executive Officer Daniel Mudd and Freddie CEO Richard Syron to discuss the plan to take control of the government- sponsored enterprises, which have operated as private shareholder-owned corporations for almost 40 years. Lockhart will also speak at today's press conference, the statement said.

Holders of the companies' common and preferred stock are ``very unlikely to come out of this at all happy,'' and the chief executive officers will be forced out, Frank said. Senior and subordinated debt holders will likely be protected, said other people who were briefed on the plan.

Fannie and Freddie own or guarantee almost half of the $12 trillion in U.S. home loans and the government had been leaning on the companies to help pull the economy out of the housing crisis. Instead, they got caught in the same slump that left the world's banks with more than $500 billion of losses since the collapse of the subprime-mortgage market last year.

Rising Costs

Concern over the companies' capital pushed their borrowing costs to record levels over U.S. Treasuries, sent their common and preferred stocks tumbling and boosted mortgage rates. Washington-based Fannie is down about 66 percent in New York Stock Exchange trading since the end of June. McLean, Virginia- based Freddie has fallen about 69 percent.

Paulson met with Mudd, 50, and Syron, 64, Sept. 5 to tell them of the decision to remove the executives from their jobs, according to two people briefed on the discussions. Mudd, who replaced three top executives almost two weeks ago, is negotiating with regulators to stay on in a consultative role for several months, according to people with knowledge of the talks.

A government takeover would be the latest attempt to blunt the impact of the yearlong credit crisis, after the Fed provided financing for Bear Stearns Cos.'s takeover by JPMorgan Chase & Co.

``They have to open their wallet,'' Bill Gross, manager of the world's biggest bond fund at Newport Beach, California-based Pacific Investment Management Co. About 61 percent of Gross's holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or government agency Ginnie Mae, according to data on Pimco's Web site.

Obama, McCain Briefed

Pimco and other large investors may put in their own money once the Treasury decides to inject government funds, Gross said Sept. 5 in a Bloomberg Television interview.
Paulson hired Morgan Stanley a month ago to advise on Fannie and Freddie. Mark Lake, a spokesman for Morgan Stanley, declined to comment. Paulson also consulted with Bank of America Corp. Chief Executive Officer Kenneth Lewis on his plan, according to people with knowledge of the talks. Bank of America spokesman Scott Silvestri declined to comment.

The Treasury briefed Democratic presidential candidate Barack Obama yesterday and has contacted Republican contender John McCain's staff. Officials also discussed the plans with House Speaker Nancy Pelosi, Senate Majority Leader Harry Reid and Senate Banking Committee Chairman Christopher Dodd.

``We are making progress on our work with Morgan Stanley, FHFA and the Fed,'' Treasury spokeswoman Brookly Mclaughlin said Sept. 5 in Washington, declining to comment on any specific plans. FHFA spokeswoman Stefanie Mullin declined to comment.

Losses Grow

Fannie was created by the government in 1938 as part of President Franklin D. Roosevelt's New Deal. Freddie was chartered in 1970 to compete with Fannie.

As losses on the mortgages grew late last year, the companies recorded $14.9 billion in combined net losses, eating into their capital. Fannie raised $14.4 billion since November and Freddie sold $6 billion of preferred securities. Plans for a $5.5 billion sale were delayed as the company's fortunes sank.

Fannie had $47 billion of capital as of June 30, according to company filings. The company is required by its regulator to hold $37.5 billion. Freddie's capital stood at $37.1 billion, compared with a requirement of $34.5 billion, filings show.

Critics including former Federal Reserve Chairman Alan Greenspan and Richmond Federal Reserve Bank President Jeffrey Lacker have called for the companies to be nationalized. William Poole, the former head of the St. Louis Fed said in July that Freddie Mac is technically insolvent and Fannie Mae's fair value may be negative next quarter.
Fed Involvement

Fannie and Freddie dropped in after-hours trading on Sept. 5. Fannie fell $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70. The market value of Fannie's $21.7 billion in preferreds had dropped 64 percent to $7.87 billion late last month, according to Friedman Billings & Ramsey & Co. The market value of Freddie's $14.1 billion in preferreds has fallen 61 percent to $5.44 billion.

Fannie's market capitalization is now $7.6 billion, down from $38.9 billion at the end of last year. Freddie's has fallen to $3.3 billion, from $22 billion over the same period.

Bernanke participated in the meetings because the central bank was given a consultative role in overseeing Fannie's and Freddie's capital under legislation approved in July. Paulson's decision won the approval of Bernanke and Lockhart, the person briefed on the discussions said.
Conservatorship

The FHFA has the authority to place Fannie or Freddie into conservatorships or receiverships under the law. The legislation that President George W. Bush signed July 30 also gave the Treasury the power through the end of next year to extend unlimited credit to or make equity purchases in the firms.

Under a conservatorship, the authorities would aim to preserve Fannie and Freddie assets, rather than dispose of them, the law says.

The FHFA was scheduled to release its assessment of the companies' capital levels as early as last week as part of a quarterly appraisal of their finances.

Analysts have speculated that the Treasury would wipe out common shareholders, while seeking to shield preferred stockowners from total loss. Fannie and Freddie preferred shares are typically owned by banks and insurance companies. Their $5.2 trillion of debt outstanding is held by investors including Asian central banks, and would probably be guaranteed, analysts said.

Senior Position

Frank said the federal government will take a senior repayment position to ``all shareholders, preferred and common.''

The Treasury is ``going beyond no dividends, I believe, in terms of what's going to happen to the shareholders,'' Frank said. ``I think shareholders are going to find themselves in a very subordinate position.''

``Treasury's main concern is the debt markets, and if it was to say that it will do whatever is necessary to keep Fannie and Freddie running, the better it is for their funding,'' said Alex Pollock, fellow at the American Enterprise Institute in Washington and former president of the Chicago Federal Home Loan Bank.

Fannie and Freddie sell billions of dollars of bonds each month to pay maturing debt. As of mid-August the companies had $223 billion of debt to refinance by the end of the quarter.

While they have continued to issue securities, Fannie and Freddie have paid record yields over U.S. Treasuries to attract investors reluctant to take on the debt even with its implicit backing from the government.

Freddie sold $3 billion of two-year reference notes this week at 3.229 percent, or 97.5 basis points more than Treasuries of similar maturity, the highest since at least 1998, based on company and market data compiled by Bloomberg.