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Five Things You Need to Know: Laying the Groundwork for Nationalization of GSE's


It's government-enabled expansion of Fannie Mae and Freddie Mac that led to a situation where there are "few alternative mortgage channels available today" in the first place.


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

1. Bernanke's Speech Lays Groundwork for Nationalization of Fannie Mae, Freddie Mac

Federal Reserve Chairman Ben Bernanke, in a speech this morning in Orlando, FL on "Reducing Preventable Mortgage Foreclosures," reportedly urged lenders to forgive portions of mortgages held by homeowners at risk of defaulting, according to mainstream media reports. That's one way to look at it, but it actually misses the entire point of his speech.

In the speech Bernanke outlines the grim path ahead for individuals besieged by declining home values and rising mortgage payment resets. This year about 1.5 million loans, representing more than 40 percent of the outstanding stock of subprime Adjustable Rate Mortgages, are scheduled to reset. According to the Federal Reserve, the estimated payment adjustments upon reset will result in an average monthly payment of $1,500, a 10% increase. The fear, a very real fear, is a cascade of defaults that puts additional downward pressure on home prices and forces continued risk aversion on the part of mortgage lenders.

"This situation calls for a vigorous response," Bernanke said. "With low or negative equity, as I have mentioned, a stressed borrower has less ability (because there is no home equity to tap) and less financial incentive to try to remain in the home."

Consequently, according to Bernanke, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure. In other words, adjust the mortgage principal downward to reflect the declining home value.

Wait a minute, wouldn't that put yet more pressure on home prices in areas where a significant number of homeowners seek and receive principal writedowns? It sure would. Moreover, as Bernanke notes, "Lenders tell us that they are reluctant to write down principal. They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again." And of course, on the off chance home prices rise the lender would not share in the gains.

So what is this speech about? Is it really about urging principal writedowns that even Bernanke himself admits probably won't work, or is something else going on? We're going to go out on a limb and say, "something else." The real conclusion is reached at the very end of Bernanke's speech:

"The government-sponsored enterprises (GSEs), Fannie Mae (FNM) and Freddie Mac (FRE), likewise could do a great deal to address the current problems in housing and the mortgage market," Bernanke said. "New capital-raising by the GSEs, together with congressional action to strengthen the supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they securitize."

That almost sounds like it would be a good thing. In at least one sense, it would be a good thing, but only by default. Bernanke concludes; "With few alternative mortgage channels available today, such action would be highly beneficial to the economy." That's certainly true, but only in a grimly ironic sense. It's government-enabled expansion of Fannie Mae and Freddie Mac that led to a situation where there are "few alternative mortgage channels available today" in the first place.

So Bernanke's ultimate conclusion is this: "I urge the Congress and the GSEs to take the steps necessary to allow more potential homebuyers access to mortgage credit at reasonable terms. " It takes either a massive degree of denial or a broad imagination to accept that sentence at face value. What Bernanke is really urging is the full-scale nationalization of the GSE's.

We can continue to pretend that these companies are going to be just fine, but the reality is it is impossible to fit together the pieces - raising massive amounts of new capital in the face of a yet-to-peak-wave of mortgage resets and housing price declines while simultaneously expanding their mortgage securitizations - without taking what Bernanke calls "congressional action to strengthen the supervision of these companies" to mean,essentially, nationalization of the housing market.

Fannie and Freddie stocks are down about 6% so far today. Perhaps the reality is now setting in that nationalization doesn't benefit shareholders.

2. Personal Bankruptcy Filings Jump

Meanwhile, add this to the wave of mortgage resets about to crest in 2008. Consumer bankruptcy filings jumped 15% in February compared to January, the largest monthly increase since 2005 when bankruptcy reform laws were passed, according to data from the American Bankruptcy Institute. They were also 37% higher than a year ago.

The institute is forecasting more than 1 million consumer bankruptcies in 2008, compared with about 800,000 in 2007, due mostly to heavy household debt, Reuters reported.

3. Speaking of Financial Stress...

Signs of financial stress are increasingly showing up in city budgets and financial plans as the debt crisis continues to chew away at both confidence and capital.

The city of Cleveland has been using auction rate securities to fund projects ranging from Cleveland Public Power to the city's airport. But a lack of buyers for the securities is forcing the city to pay higher rates. Cleveland has five outstanding auction-rate securities accounting for $437 million in debt.

Worst case, the city faces up to $5 million in higher rates over the next month, according to the Cleveland Plain Dealer. Best case, $1.5 million.

4. Another Kind of Staples

Staples (SPLS), the world's largest office-supplies retailer, this morning reported fourth-quarter profits lower than anticipated due to weak retail sales to North American small businesses and consumers. The company also cut its full-year forecast.

Michael Miles, President and Chief Operating Officer, said on the conference call that the poor results were driven by weaker customer traffic. At the end of the third quarter last year, the company was expecting a turnaround by mid 2008, but that has now changed. According to CFO John Mahoney It now looks like it could take a little longer. "We expect negative comps could continue well into 2008," he said.

Staples is considered a pretty good barometer for the overall health of the economy. Joe Doody, Staples President of North American Delivery noted that, "Just like I think we're an early indicator going into the recession, I believe that we're going to be an early indicator coming out of the recession. But at this point we are feeling less confident about our ability to forecast demand and that's why we revised our guidance for the short-term."

5. Socionomics of Corporate Cash

The typical American corporation has increased its savings so sharply that it probably has enough cash on hand to completely pay off its debts, the New York Times says.

According to Jason DeSena Trennert, managing partner and chief investment strategist at Strategas Research Partners, cash, as a percent of total assets on corporate balance sheets, is as high as it's been since the 1960s.

What interested us in this story was the lead in, however:

"At least someone knows how to fill a piggy bank. Unlike most American consumers, whose failure to save has exasperated economists for years, the typical American corporation has increased its savings so sharply that it probably has enough cash on hand to completely pay off its debts."

It's an interesting juxtaposition, holding up the cash-strapped American consumer next to the cash-rich corporation, and one that we can expect to see with greater frequency as social mood continues to darken. The war between haves and have-nots has many fronts and the combatants were many different uniforms.

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