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Fannie, Freddie, Moral Hazard, Housing, and the SEC


July 24

The Fannie Mae Gang (July 24 – WSJ)

So here we are this week, with the House and Senate preparing to commit taxpayer money to save Fannie and Freddie. The implicit taxpayer guarantee that Messrs. Gray and Raines and so many others said didn't exist has become explicit. Taxpayers may end up having to inject capital into the companies, in addition to guaranteeing their debt.

The abiding lesson here is what happens when you combine private profit with government power. You create political monsters that are protected both by journalists on the left and pseudo-capitalists on Wall Street, by liberal Democrats and country-club Republicans. Even now, after all of their dishonesty and failure, Fannie and Freddie could emerge from this taxpayer rescue more powerful than ever. Campaigning to spare taxpayers from that result would represent genuine "change," not that either presidential candidate seems interested.

I continue to be stunned by what is happening here to my country and, by extension, the dollar and our economy. I guess I am most stunned by how cheaply Fannie and Freddie bought their vast influence and by how ignorant Dodd, Frank and all the other archtitects of this bailout seem to be.

I've long been keenly on the lookout for the Fourth Horseman that would presage the end of the dollar, and, with the nationalization of Fannie and Freddie, it seems to be here. The four horsemen are:

  1. A rising federal deficit
  2. A better than 5% of GDP trade deficit
  3. Fed monetization of debt (the Bear Stearns deal as well as the "temporary" TAF & TASF operations qualify here)
  4. Government bailouts (purchases) of bad debt and/or direct cash injections (i.e. stimulus checks)

Each one of these operations effectively chips away at the notion of the dollar as a store of wealth and cheapens all those already in existence. Worse, the entire concept of "free market capitalism" is laid bare as a complete lie. How will we prevent even worse follies from happening in the future without accountability, without foolish investors and institutions losing a memorable amount of money? What does it mean when everybody from the middle class on down is squeezed miserably for want of a few dollars, while those in power ladle heaps of restorative wealth upon themselves and their friends?

It is long past time for you and I to stand up and start making some noise. It is simply unacceptable that our future is being frittered away by clueless, weak leaders who are more interested in remaining elected and 'getting along' than in doing what's right. In normal times we can overlook a few foibles here and there. But this nationalization of the bad debts and corporate misdeeds of Fannie and Freddie threaten to take down our entire way of life and reduce it to ashes by destroying our currency.

This is very serious stuff, folks, and I am hard pressed to express how dire these moves are.


It won't be over till housing hits bottom (July 23 – Reuters)


LONDON (Reuters) – The financial crisis won't be over until U.S. house prices stop falling, which in short means it won't be over any time soon.

Despite a long fall that has brought down several major financial institutions and taken the economy as a whole to the brink of recession, housing in the United States is still too expensive relative to incomes, rent and the availability of mortgage money with which to buy it.

And that's before you factor in rising unemployment or oil price inflation that is crimping budgets and making long commutes, and the houses built at the end of those commutes, no longer affordable.


I happen to fully agree that the housing crisis is not yet near bottom and that things will not improve until it finally does, which could be a long way off. Where I depart from this sort of analysis is in the implication that housing will be serve to "set the bottom."

Housing issues such as foreclosures and repossessions have always been lagging indicators. That is, they typically hit their worst at the tail end of a bout of economic weakness; they do not typically lead the way. The implication that this time will be exactly backwards from historical precedent is simply not very likely.

Instead, I expect that, while housing has certainly helped to kick-off a consumer credit crisis 25 years in the making, future housing woes will feed off of job losses and economic weakness and hit their worst only after the rest of the economy has already bottomed, just like they always do.


So, instead of watching housing indicators for some early signs of "the bottom," we should be looking at trends in consumer credit, retail purchases, employment, and industrial production. Here we see troubling signs that do not point to any imminent bottom, yet, and I think any predictions of when a bottom might occur should be treated with some measure of skepticism.


The Mother Of All Short Squeezes May End Badly (July 21, Investors Insight)


The rules governing short selling — borrowing shares to bet on price declines — are vastly more stringent than they were in the era of robber barons like Drew, Jay Gould and Jim Fisk, but one thing hasn't changed much: When markets decline, those who profit are seen as un-American, even evil, and the weight of the authorities is brought down against them with devastating, but usually temporary, results.

What does it all mean? Asked just hours after Cox's testimony, one dedicated short hedge fund manager had a sarcastic reply: "This means the financial crisis is over," he said, going on to clarify that nothing at all had changed fundamentally in his opinion. Of course many shorts like him suffered stinging losses and reduced capital, but the other side of the coin is that there are now far more shares to borrow at much higher prices than a few days ago. Financial stocks may well retrace at least part of their recent gains as the shock of Cox's step wears off.

The fact that the initial results were spectacular, particularly for financial stocks, shouldn't be too encouraging. Consider what happened in April 1932, at the depth of the worst-ever bear market. Upon the announcement of a cumbersome new rule that required written permission from each shareholder before a broker lent out his stock, the Dow Jones Industrials rallied 3.51%. By the time the rules were instituted weeks later, the short covering was over and the slump had resumed.


This past week, the SEC (motto: "Protecting companies from investors since 1934") suddenly changed some long-standing rules on short selling, igniting a furious short covering rally. Cynics might suggest that the SEC was merely trying to game the system to help boost the stock prices of some struggling financial companies in a bid to help them raise fresh capital from foolish investors. The cynics are probably right, especially since the SEC immediately exempted certain favored clients from these new rules almost immediately.

As this excellent article makes clear, short sellers are not to blame for any of the mess we are in, and the SEC is famous for only attempting to reverse the direction of stock prices that are heading down, never up.

Why do you care? Because the rally of the past few trading days is a false rally largely built on a sudden rule change, not a lessening of the fundamental problems affecting our financial system. It also demonstrates that the SEC is there to serve the interests of some market participants, not all of them, and certainly not you if you are a small investor.

Remember the options backdating scandal? That was huge and proved to be an enormous rip-off of shareholders by corporate insiders, but I can't recall what, if anything, was finally done about that. Probably nothing at all. And don't hold your breath for the SEC to enforce any meaningful penalties in response to the scandalous Auction Rate market failures of a few months back. Nor should you expect them to look into the numerous very odd trading anomalies that now comprise the minute by minute operations of our stock market.

As long as things seem stable (i.e. 'going up') and Wall Street is skimming off a healthy level of profits, the SEC is nowhere to be found, unless you are a tiny penny stock outfit or Martha Stewart.

At any rate, sudden, desperate rules changes make me more nervous, not less, about the true state of affairs.