A Sudden Turn for the Worse

Freddie Mac posted a loss of $354 million this quarter, versus a $2.16 billion gain the previous quarter.  Fannie Mae did slightly better with net earnings of $1.1 billion, which were still substantially down from $2.5 billion the previous quarter though.

 

10621303-freddie-mac-hqFreddie Mac HQ – a strange time for posting losses

Photo via nytstyle.com

 

Instead of delving into the entrails of the financial statements, I would like to ask a broader question:  Why is Freddie reporting a loss at all (and why is Fannie  barely profitable)?

Using September 2008 as a starting point, what kind of business climate have they been operating under since the Treasury took over as conservator?

Monopolistic Dominance.  The agencies are now over 70% of the residential mortgage market, and increasing, with no competition in sight.

Price Appreciation.  Per Case Shiller, housing price has been appreciating steadily for the last 4-5 years.  In other words, loan to value ratios should be decreasing, reducing the risk of loan losses in the event of a default.

1-case-shillerHistorical performance of Case-Shiller US Home Price Indexes – click to enlarge.

 

Defaults, foreclosures and REO inventory.  Borrowing a chart from my cyber-friend Bill of Calculated Risk (who really has great simple and to the point charts), it is obvious that the worst time was over five years ago and that loan losses should be continuously improving.

 

2-REO InventoryREO (real estate owned) inventory of Fannie and Freddie – declining since Q3 2010 – click to enlarge.

 

Accommodative Interest Rates.  Aside from a minor bump in 2013, mortgage rates have been steadily declining (see chart from Mortgage News Daily below). Theoretically, payments are easier for borrowers to service.  In addition, if held in a portfolio, these loans should be gaining in value inversely proportional to the drop in rates.

 

3-30 year fixed rates30 year fixed mortgage rates (MBA, Freddie Mac, MND) –  a steady downtrend – click to enlarge.

 

Easy Money?

There is no need to go any further.  As global economies struggle, the agencies cannot be offered a better environment to make easy profits. So once again, why is Freddie Mac reporting a loss?  In order to answer that question, we need to determine what type of businesses Freddie and Fannie are engaged in.

If they are a secondary market mortgage companies, conditions couldn’t be any better. First one buys up a bunch of loans, secured by “highly qualified” borrowers with residential real estate as collateral, collecting fees in the process.  Then one securitizes them and sells them via Wall Street, with the Federal Reserve as an ultimate buyer to guarantee the success of these bond issues, collecting more fees in the process.

If this business model is sound, then why has not a single competitor emerged?  During the sub-prime era, private label MBS were issued by every Tom, Dick and Harry.  You may remember these as Fremont, Countrywide, Indymac, Long Beach, New Century, Novastar, in addition to a few names that are still around today.

When was the last time we heard of a WFC, or JPM, or BofA MBS issue? Do you suppose Jamie Dimon (JPM) or Lloyd Blankfein (Goldman) have made too much money already and have decided not to participate in the lucrative secondary market, if there is easy money to be had?

 

4-Freddie MacFreddie Mac’s share price weekly, over the past 5 years  – click to enlarge.

 

The truth is no one in the private sector can compete with the government-subsidized price and terms of the agencies. The agencies are essentially running money-losing operations.

What if the agencies were to operate as insurance companies?  In other words, they would buy mortgages from originators using pre-determined guidelines,  then resell the bundles with the stamp of an agency guarantee, collecting a guarantee fee in the process.

Based on the recent decline in loan losses, the agencies should be making a fortune.  Just imagine them as selling flood insurance policies during a prolonged drought.  It is all premiums coming in and no claims to pay out.

 

Stress Testing

The agencies are actually both of the above, and more.  If this is such a lucrative business, why are there no competitors?  Wall Street is so desperate for ideas that it is willing to throw billions behind little cameras strapped on your forehead, or wristbands that tell you how many times you bounced around, or software that allows users to send naked photos of themselves instantly to the world using their phones.  Why wouldn’t Wall Street be salivating over a proven trillion dollars industry that provides the financing backbone to the real estate market?

Wall Street is desperate for IPOs or M&A deals.  Can you imagine how much  FRE and FNM can generate in underwriting fees?  Yet, there is not a single proposal from Wall Street’s usual suspects.  Instead, we only hear from shysters who try to suck all cash flow from operations, while leaving all future liabilities to the government (aka taxpayers).

Here is a misguided article by Matt Taibbi, demonizing the government for not letting these so called “activist investors” steal the operating cash flow from the agencies. I believe the government does have something to hide.  If it actually disclosed the liability the agencies have incurred by their guarantees, it may not only shock the bond/real estate market, it may destabilize the entire economy.

 

5-FNMAFannie Mae share price weekly –  a similar picture. At a time when the agencies should be making money hand over fist, the markets appear quite skeptical – click to enlarge.

 

The Federal Reserve performs these so called bogus stress tests on the banks, somehow determining they are all safe.  They have a proven record.  Greenspan said the banks understand risk better than him and they can take care of themselves.  Bernanke said he did not see it coming, and so did Yellen.  Now they think the too gigantic to fail banks are safe?

Instead of stress testing the banks, the Federal Reserve and the Treasury should stress test borrowers.  The test is simple.  Take a sample and assume that borrowers suffer a 10% or 20% or 30% loss of household income.  How long would it take before such a household defaults?  It is an easy and accurate test, because all the required information is in the loan application, fully documented.

If these two mortgage giants (which should have been consolidated long ago) post combined income of only $746 million last quarter under ideal conditions, what happens if the market turns sour?  Can they handle a reversal in home price trends?  What if defaults tick back up?  How about an increase in mortgage rates by 50 basis points?  Have they reserved anything for potential losses, or is the Treasury’s line of credit what they are counting on as their safety net?

 

Conclusion

In conclusion, I believe that just one hiccup would send these agencies down the same path that forced them into conservatorship in 2008, only it will be worse this time around.  They are now the market.  There is no chance that the real estate market can survive without these two giants.  Maybe we should all vote for Donald Trump.  He would be best suited to handle the bankruptcies.

 

trump-bankruptcy-540x304It may be a good time to hire a bankruptcy specialist…

Image credit: CNN Money

 

Charts by: S&P / Case-Shiller, Calculated Risk, Mortgage News Daily, BigCharts

 

Chart and image captions by PT

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • As the Madness Turns
      A Growing Gap The first quarter of 2019 is over and done.  But before we say good riddance.  Some reflection is in order.  To this we offer two discrete metrics.  Gross domestic product and government debt.   US nominal GDP vs total federal debt (in millions of USD) – government debt has exceeded  total economic output for the first time in Q4 2012 and since then its relative growth trajectory has increased – and it seems the gap is set to widen further....
  • Bitcoin Jumps as Ordered -  Precious Metals Supply and Demand
      Digital Asset Rush The only part of our April Fools article yesterday that was not said with tongue firmly planted in cheek was the gold and silver price action (though framed it in the common dollar-centric parlance, being April Fools):   “Gold went down $21, while silver dropped about 1/3 of a dollar. Not quite a heavy metal brick in free fall, but close enough.”   Bitcoin, hourly – a sudden yen for BTC breaks out among the punters. [PT]   It also...
  • A Trip Down Memory Lane – 1928-1929 vs. 2018-2019
      Boom Times Compared It has become abundantly clear by now that the late 2018 swoon was not yet the beginning of the end of the stock market bubble – at least not right away. While money supply growth continues to decelerate, the technical underpinnings of the rally from the late December low were actually quite strong – in particular, new highs in the cumulative NYSE A/D line indicate that it was broad-based.   Cumulative NYSE A/D line vs. SPX – normally the A/D line...
  • Debt Growth and Capital Consumption - Precious Metals Supply and Demand
      A Worrisome Trend If you read gold analysis much, you will come across two ideas. One, inflation so-called (rising consumer prices) is not only running much higher than the official statistic, but is about to really start skyrocketing. Two, buy gold because gold will hedge it. That is, the price of gold will go up as fast, or faster, than the price of gold.   CPI monthly since 1914, annualized rate of change. In recent years CPI was relatively tame despite a vast increase in the...
  • Unsolicited Advice to Fed Chair Powell
      Unsolicited Advice to Fed Chair Powell American businesses over the past decade have taken a most unsettling turn.  According to research from the Securities Industry and Financial Markets Association, as of November 2018, non-financial corporate debt has grown to more than $9.1 trillion [ed note: this number refers to securitized debt and business loans, other corporate liabilities would add an additional $11 trillion for a total of $20.5 trillion].   US non-financial corporate...
  • Long Term Stock Market Sentiment Remains as Lopsided as Ever 
      Investors are Oblivious to the Market's Downside Potential This is a brief update on a number of sentiment/positioning indicators we have frequently discussed in these pages in the past. In this missive our focus is exclusively on indicators that are of medium to long-term relevance to prospective stock market returns. Such indicators are not really useful for the purpose of market timing -  instead they are telling us something about the likely duration and severity of the bust that...
  • The Effect of Earnings Season on Seasonal Price Patterns
      Earnings Lottery Shareholders are are probably asking themselves every quarter how the earnings of companies in their portfolios will turn out. Whether they will beat or miss analyst expectations often seems akin to a lottery.   The beatings will continue until morale improves... [PT]   However, what is not akin to a lottery are the seasonal trends of corporate earnings and stock prices. Thus breweries will usually report stronger quarterly earnings after the...
  • The Liquidity Drought Gets Worse
      Money Supply Growth Continues to Falter Ostensibly the stock market has rallied because the Fed promised to maintain an easy monetary policy. To be sure, interest rate hikes have been put on hold for the time being and the balance sheet contraction (a.k.a.“quantitative tightening”) will be terminated much earlier than originally envisaged. And yet, the year-on-year growth rate of the true broad money supply keeps declining noticeably.   The year-on-year growth rates of...
  • The Gold-Silver Ratio Continues to Rise - Precious Metals Supply and Demand
      Is Silver Hard of Hearing? The price of gold inched down, but the price of silver footed down (if we may be permitted a little humor that may not make sense to metric system people). For the gold-silver ratio to be this high, it means one of two things. It could be that speculators are avoiding the monetary metals and metal stackers are depressed. Or that something is going on in the economy, to drive demand for the metals in different directions.   As a rule the gold silver...
  • What Were They Thinking?
      Learning From Other People's Mistakes is Cheaper One benefit of hindsight is that it imparts a cheap superiority over the past blunders of others.  We certainly make more mistakes than we’d care to admit.  Why not look down our nose and acquire some lessons learned from the mistakes of others?   Bitcoin, weekly. The late 2017 peak is completely obvious in hindsight... [PT]   A simple record of the collective delusions from the past can be quickly garnered from...

Support Acting Man

Item Guides

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!