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Five Things You Need to Know: Fannie Mae Inadvertently Predicts Housing Bottom


And by allowing Fannie Mae to increase its leverage, so has the OFHEO.


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

1. Fannie Mae Executives Only Ones Surprised by $2.19 Billion Quarterly Loss

Fannie Mae (FNM) this morning reported a wider loss than many analysts estimated, cut its dividend to 25 cents a share and said it will raise $6 billion in capital before it eventually burns to the ground while the Office of Federal Housing Enterprise Oversight plays a fiddle. We're paraphrasing... but only slightly.

Even as Fannie Mae reported a wider-than-expected (for Fannie Mae executives at least, the rest of us seemed to know better) $2.19 billion first quarter loss, the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator that oversees the government-sponsored mortgage giant actually lowered... yes, lowered... the amount of capital Fannie must hold.

The OFHEO said it will lower requirements for surplus capital to 15% from 20% once the $6 billion in capital is raised, and may reduce it even further to just 10% by September. The move by OFHEO to relax capital surplus requirements for Fannie Mae essentially enables the mortgage-finance company to buy more mortgages and take on even more risk.

"The lowering of the prudential cushion was appropriate in line with the company's progress and with the need to maintain safe and sound operations," OFHEO Director James Lockhart said in a statement, presumably to guard against not being able to maintain a straight face. For if there is one thing we know with absolute certainty, it is this: Fannie Mae is the antithesis of any operation that one could consider "safe and sound."

But more on that in a moment, let's take a look at Fannie Mae's 2008 housing market projections...

2. Fannie Mae Inadvertently Predicts Housing Bottom

Here is what Fannie Mae is projecting for the remainder of the year for the housing market:

First, the company said its credit loss ratio increased to 12.6 basis points in the first quarter versus 8.1 basis points last quarter, a larger increase than the company expected. Fannie Mae now expects a full-year 2008 credit loss ratio of 13 to 17 basis points.

And on what do they base that projection? This morning on the conference call, FNM President and CEO Daniel Mudd said, "In the first quarter, home prices, national average home prices, fell by about 3%. Given that decline, which was accelerated from the prior quarter, we changed our outlook for home price declines for the whole year. Instead of a 5 to 7% decline, or an ensuring 13 to 17% peak to trough, which is what we talked about the last time, we now see home prices falling about 7 to 9% for the year, which would then lead to a 15 to 19% peak-to-trough decline in the average national home prices."

But, as Minyanville Professor Scott Reamer points out, the only problem with that projection is that the Case-Shiller Home Price Index is already down 5% nationally from the beginning of the year. If we annualize that we get a 30% decline for all of 2008. Even if we keep the same slope as present for the home price index we get a 26% decline for 2008. So, for Fannie Mae to see their projected 7-9% declines we would need to have an abrupt and marked change in home prices now.

In other words, Fannie Mae has inadvertently called the bottom in the housing market. And by extension, by allowing Fannie Mae to increase its leverage, so has the OFHEO. Ah, but wait. Fannie Mae anticipated this objection...

3. Fannie Mae Says: "Not So Fast, Mr. Smarty-Pants Case-Shiller Index Lover"

Fannie Mae anticipated this objection to their projections using their own index, and said (again, paraphrasing slightly): "Not so fast, Mr. smarty-pants Case-Shiller Index lover."

Below is a chart from the investor summary slideshow that accompanied the conference call:


The fine print at the bottom of the slide is important because it speaks to the use of the case-Shiller index versus Fannie Mae's own index upon which their price projections are based. According to Fannie Mae, because the Case-Shiller index is value-weighted, it places greater weight on higher cost metropolitan areas. Fair enough.

Using the Case-Shiller index methodology, Fannie Mae says its projections would move from a 7-9% home price decline for 2008 to 10-13%, and from 15-19% peak-to-trough to 20-25%. There's just one catch with those projections increases. They strip out the impact of foreclosure sales. As Fannie Mae observes, "Foreclosure sales tend to depress the S&P/Case Shiller index relative to the Fannie Mae index."

4. Where Are We Losing Money?

It's a good question. With home prices, according to Fannie Mae, down nationally 6-9% from the second quarter of 2006, which areas are hardest hit?

The chart of the U.S. below, which Fannie presented during their conference call this morning, shows where we are losing money on our homes.


That doesn't look so bad, although the Q2 2006 start date is a little convenient. Perhaps it's true; all real estate is local. Well, hidden in that chart, what it does not show, are inventory builds nationally while overall transactions decline, mortgage lending standards tighten and consumers cut back. We'll revisit this chart next year for some different colors.

5. Socionomic Datapoint: Reduce, Reduce, Reduce

Fifteen years ago saw the introduction of the 20-ounce soda container, the king of soft drink-to-go packaging. Not long after, the 7-11 Big Gulp soda container was replaced with the porta-potty-sized Super Big Gulp checking in at a whopping 44 ounces. My how times change.

With soft-drink volume down 4.8% in the first quarter, according to Nielsen, both Coca-Cola (KO) and Pepsi (PEP) are testing 12- and 16-ounce containers at prices as low as 99 cents in hopes of reviving growth, according to USA Today.

Jeff Dahncke, a spokesperson for Pepsi, told the newspaper the new, reduced-size packaging is a way to offer "desirable prices" in a tough economy.

Economic hardship makes reduction more attractive. Social mood embraces this concept and applies it to many different aspects of life, from home size, to car size, to food and beverages. Deflation comes in many forms.

R.I.P. Super Big Gulp

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