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Five Things You Need to Know: More People, More Risk


Expanding the GSE loan limits opens up the door for more people to be covered; and more people, more risk.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. More People, More Risk

Congress gave final approval Thursday night to an economic stimulus package that would send government payments to more than 130 million households, grant tax incentives for business investment and temporarily permit Fannie Mae (FNM) and Freddie Mac (FRE) to buy or guarantee mortgages 75% higher than the current limit of $417,000.

The measure now goes to President Bush for his signature, which will reportedly come next week. We already know what the average $600 per individual tax rebate will do (see today's Number Three), but let's look at a bit closer at the temporary lifting of Fannie Mae's and Freddie Mac's loan limit. What does this really mean?

Lifting the loan limit will put Fannie Mae and Freddie Mac in the market for so-called "jumbo mortgages." The first problem right off the bat is that the mission of the Government-Sponsored Enterprises (GSEs) is to "expand affordable housing." Jumbo mortgages, almost by definition, target unaffordable housing.

"Fannie Mae is a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market." From the Fannie Mae Web site.

Ironically, as James Lockhart III, head of the Office of Federal Housing Enterprise Oversight, the agency that oversees the federally chartered mortgage companies, told the Senate Banking Committee on Thursday, taking on jumbo mortgages could actually divert money away from less expensive housing. After all, Lockhart pointed out, funding one $600,000 mortgage takes as much capital as three $200,000 mortgages.

But there's more to the issue. There's also the risk involved. As Lockhart noted, "during 2007, the housing GSE debt and guaranteed Mortgage Backed Securities outstanding grew 16% to $6.3 trillion." To put that in perspective, the debt of the United States was $5.4 trillion, including that held by the Fed. "The whole debt of Fannie and Freddie and the MBS equals that, and if you add on the Federal Home Loan's debt of $1.2 trillion, you get $6.3 trillion of debt."

"[Fannie Mae and Freddie Mac] are effectively, combined with the Federal Home Loan Bank, the mortgage market," Lockhart said. And with credit losses in the Fannie and Freddie portfolios growing, so too are the risks. In the fourth quarter, they cut their dividends and raised almost $14 billion in preferred stock, a necessary step to shore up reserves against what both CEOs have said are going to be tough fourth quarters in 2008.

Now, at precisely the wrong time, with risk growing, the answer from Congress is to allow the GSEs to take on still more risk. Many of the jumbo mortgages originated over the past few years were relatively risky, involving borrowers reaching to get into houses, a disproportionate percentage written under adjustable-rate terms as opposed to fixed rates. But those facts aside, expanding the loan limits opens up the door for more people to be covered by the GSE's. And as Lockhart put it, "More people, more risk."

2. Consumer Credit Slowing

Yesterday, the Federal Reserve reported a sharp slowdown in consumer credit. Consumer credit outstanding still expanded in December, by $4.5 billion, but compare that to the upwardly revised $17.1 billion of expansion in November. Yesterday's increase, the slowest in eight months, took the seasonally adjusted annualized growth rate down to 2.7%, compared to 13.7% in November and 11.1% in October.

Why does the slowing of consumer credit matter? In a finance-based economy, the most important growth variable is velocity of money. This ratchets down further the velocity of money coming from the consumer side.

It's not exactly rocket science why this is bad. The consumer makes up more than 70% of the U.S. economy. As we noted in Five Things, consumer lending standards are tightening, while consumer loan demand is contracting, while home prices are deflating at a record pace.

Add those pieces together and we can see why congress is risking it all, literally, by expanding the GSE loan limits. Anything to increase the velocity of money.

3. Credit Card Staples

But OK, fair enough, although slowing, credit is still expanding, and don't forget that $600 check in the mail from the Federal government. The only catch is, what is credit expanding toward? Increasingly, it seems, consumer staples.

Last week MasterCard (MA) noted that it has seen consumers card use trending away from consumer discretionary purchases and toward every day purchases for items such as gasoline and groceries.

And in Thursday in their sales call Wal-Mart (WMT) noted that gift card redemptions were below expectations and, even more ominous, "customers appear to be holding gift cards longer and sometimes using them more often for food and consumables than discretionary purchases."

4. Hedge Fund Managers, They're Just Like Us!

How many times has this happened to you? You do your macro research, narrow down your sector choices, then buy the individual stock... and it plummets. Well, don't worry, according to Bloomberg the same thing happens to hedge fund managers, or at least it did last month.

Hedge-fund managers who focus on stock selection lost an average of 4.1% in January, the biggest monthly decline in more than seven years, a Hedge Fund Research Inc. report showed.

5. Fisher Says Monetary Policy Just Like Scotch, Tequila

Scotch and tequila are just like monetary policy. Wait, what kind of weird gibberish is that? How are scotch and tequila like monetary policy? Let's ask Dallas Federal Reserve President Richard Fisher.

"Monetary policy act with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect," Fisher said yesterday in a speech in Mexico City. Fisher then went on in his speech to say something about inflation and economic stuff, but we can't remember exactly what because of the lag in all that "monetary policy" we had at lunch. [Word of caution: After having 125 "basis points" of "monetary policy," do not start in on the "fiscal stimulus" or you will be very sorry in the morning.]

Like most Americans, we are not economists or central bankers. But, like many Americans, we do know a thing or two about scotch and tequila... and they are nothing like monetary policy! At all!

To us, a good single malt scotch is like the warm hug of a celtic sweater, while a good tequila makes us want to peel off that hot wool sweater. Also our pants, but that is a different story.

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