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Let's Be Frank About Fannie and Freddie


Barney Frank's idea to ensure government backing only on certain debt and mortgages will dislocate many investors and markets.

Editor's Note: This article was written by Richard Suttmeier, chief market strategist at, which is a fundamentally-based quant research firm in Princeton, New Jersey, that covers more than 5,000 stocks every day.

You Can't Have a Two-Tiered Guarantee for Fannie and Freddie

Barney Frank wants to "clarify" the government backing of Fannie Mae (FNM) and Freddie Mac (FRE) under Conservatorship. He only wants to have issuance since Conservatorship to be backed by the United States of America. What this means is that debt and mortgages dated prior to September 7, 2008, wouldn't have government backing, while those dated on September 7, 2008, and later would be backed by the full faith and credit of the US government.

You can't have a two-tiered Fannie and Freddie guarantee! I actively traded Fannie Mae and Freddie Mac debt and mortgage-backed securities off and on throughout my career in the US capital markets since 1972. If Frank gets his way, the market dislocations would be ridiculous. Investors who bought pre-dated GSE securities and mortgages because of Conservatorship will get screwed as spreads widen. GSE traders will have to check dated dates when making markets. If this idea is implemented, mortgage rates will likely spike higher.

I have often pointed to the Fannie Mae website citing that its debt isn't US-backed under Conservatorship. Here's the post as of March 3, 2010:

Fannie Mae debt securities, together with interest thereon, are not guaranteed by the United States and do not constitute a debt or obligation of the United States or of any agency or instrumentality thereof other than Fannie Mae.

Here's what it states in a CRS Report for Congress dated September 15, 2008:

On September 7, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac in Conservatorship. This means that the US Taxpayer now stands behind $5 trillion of GSE debt.

So which is it as you can't have it both ways? If GSE debt and mortgage securities are government-backed they should be under our nation's debt ceiling, not off balance sheet. Frank's idea could create a cascade of global selling of Fannie Mae and Freddie Mac debt and mortgages, which could push the housing market and banking system right back on the edge of the abyss.

Wasn't it about a month ago when Frank wanted to abolish Fannie and Freddie?

Back in May 2008 on Fox Business I favored the liquidation of Fannie and Freddie months before the US Treasury took them over in Conservatorship. I suggested beefing up the government-backed Ginnie Mae mortgage program, while gradually liquidating Fannie and Freddie. Instead US taxpayers are on the hook for $126 billion and counting and will be covering all losses through 2012, leaving a lifeline that could be double the current $400 billion.

By expanding the role of Fannie and Freddie the implicit guarantee has become explicit, making all GSE mortgages and debt the obligations of the US government and hence taxpayers. Wall Street and investors would have been on the hook under liquidation, not taxpayers on Main Street. It was Wall Street that sold GSE debt and mortgages to global investors stating that they were government-back, when they weren't. Exotic mortgage-backed securities and related derivatives spread around the world was described and indorsed by Fed Chairman Alan Greenspan as the way to spread the risk.

Because of Wall Street Greed US citizens are backing $5.5 trillion in GSE mortgages, and around $1.5 trillion to $2 trillion in GSE debt under Conservatorship. This must be added to the more than $14.2 trillion US debt ceiling.

The Dow on the Rise, but Can Strength be Sustained?

The Dow ended last week above my annual pivot at 10,379, so this sets up a test of the January high of 10,730. The low end of the range was the February low of 9.835. Keep in mind that the NASDAQ and Russell 2000 set new year-to-date highs on Friday.

Source: Thomson / Reuters

Wouldn't it be interestingly devilish if the high of 666 for the Russell 2000 followed by one year the low of 666 for the S&P 500?

Source: Thomson / Reuters

Friday's Employment Report for February

Shedding 36,000 jobs and having an unemployment rate of 9.7% isn't bullish for stocks. The impact of the snowstorms during the survey was likely not a factor as all an employee has to do is work one hour during that week to be considered employed.

Job creation and increases in payrolls by at least 150,000 per month are required just to stabilize the labor market. The jobs picture isn't brightening when discouraged Americans continue to leave the labor force. The underemployment rate rose to 16.8% from 16.5%.

The key labor component to the market in my judgment is the construction industry, which lost 64,000 jobs. How can that improve with those troubled C&D and CRE loans on the books of our nation's banks? Where are those "shovel ready" projects? That's where the jobs created or saved are supposed to come from. The average workweek is a key component and it dropped to 33.8 hours from 33.9 hours in February. Now that holiday shopping is over, many stores are cutting back hours worked.

Bank Failure Friday

The FDIC closed four community banks on Friday with one publicly traded Sun American Bank, which is on the ValuEngine List of Problem Banks.

The 26 bank failures so far in 2010 have cost the Deposit Insurance Fund $4.7 billion, bringing the DIF Deficit to $25.6 billion. The FDIC has $46 billion in prepaid DIF fees for 2010 through 2012 that are earmarked for the DIF when scheduled.

The FDIC is having a tougher time finding a bank to take over a failed institution as one was set up as an FDIC Bridge Bank, and another bank just had its deposits moved to Zions Bancorp.

Three of the four banks had heavy overexposures to C&D and CRE loans with pipeline ratios between 87.9% and 100%, which was the case for the bank within regulatory guidelines for C&D and CRE exposures.

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No positions in stocks mentioned.
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