Archive for July, 2008

FNMA and FHLMC: Guidance from the Hitchhiker’s Guide to the Galaxy

Sunday, July 13th, 2008

Don’t Panic is a phrase used in the book The Hitchhiker’s Guide to the Galaxy by Douglas Adams. It comes from the fictional intergalactic travel guide The Hitchhiker’s Guide To the Galaxy, that theoretically served to show planet-hoppers how to see the Universe on less than thirty Altairian dollars a day.

Now to FNMA and FHLMC – both insolvent from a mark to market perspective, and both deeply strugglling (depending upon your definition of capital) with the problems in the mortgage markets.   The Bush administration just opened a new chapter in their figurative Hitchhiker’s Guide by announcing a plan to save these GSE’s by extending a $300 billion line of credit. Since this will require an act of Congress, it is expected that the Fed will provide the financing in the interim.

But wait, the Fed already has about 1/2 of its assets (about $400 out of $878 billion) tied up in non-US Treasuries and their existing ‘short term’ credit facilities for banks and brokers.  The Fed reports its balance sheet weekly.  Click here for the most recent numbers.  No wonder the old saying is "If you owe the bank $1 million and can’t pay, you’re in trouble, but if you owe the bank $1 billion and can’t pay, the bank’s in trouble."  Just add a few zeros (in the contingent liability column) in this case.

It has always been my impression that FNMA and FHLMC underwriting standards were superior and tighter as compared to other lenders, especially many of those in the private label securitization game.  Thus, we will probably learn that the market’s latest concerns are overblown.  In fact, this may get back to the value of the mortgages held by the GSE’s.

With Friday’s FDIC takeover of the very aggressive lender – IndyMac Bank – there should be no worries for depositors with less than $100,000 at the bank.  However, the real worry will be what the FDIC will be able to receive when it goes to liquidate IndyMac’s assets in an already tight mortgage market. 

Thankfully, one would assume that:

(1) Most mortgages held by these GSE’s are better underwritten than those held by IndyMac, or Countrywide, or Washington Mutual, or…

(2) The U.S. government will continue to make good on any of these GSE’s problems, since debt and MBS issued by them are held not just by domestic investors, but foreign investors consider them to be as good as US government debt.  And, those investors hold trillions of dollars of US securities.

(3) FNMA and FHLMC now make up a large majority of mortgages being originated today.  Thus, they must continue in business in order for the mortgage market to begin to recover and, with it, the valuation of residential properites.  An interesting article in Barron’s this week has Chip Case, of Case/Shiller Index fame, making a case for the residential market turning around.  And, I would add that ARM repricings (the fire starter of the subprime mess) are projected to peak next month.

Back to the Hitchhiker’s Guide: The words ‘Don’t Panic’ are printed on the cover of the Guide (always capitalized) "in large friendly letters".  The novel explains that this was partly because the device "looked insanely complicated" to operate, and partly to keep intergalactic travelers from, well, panicking.

The mortgage market today does look a bit ‘insanely complicated’ to operate…probably even from the standpont of an intergalactic traveler.

However, it will eventually recover, although with significant changes.  FNMA, FHLMC and GNMA (and the US Government) will continue, in some form or other, to be the cornerstone of the market.  And, where there is money to be made, Wall Street will find a way to securitize mortgages – more transparency, more risk sharing, improved ratings methodologies, etc – but I believe it will happen.

Meanwhile, we should all follow the guidance from the Hitchhiker’s Guide to the Galaxy: Don’t Panic

We would, however, recommend discussions with your investment manager about the FNMA and FHLMC securities your company owns.

 
 
 

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