Friday, July 11, 2008

Fred's dead, baby, Fred's dead

Fabian: Butch, whose bond yield is this?

Butch: It's a stock price, baby.

Fabian: Whose stock price is this?

Butch: Fred's.

Fabian: Who's Fred?

Butch: Fred's dead, baby, Fred's dead

-Pulp Fiction, alternative universe financial version

Now, let Macro Man say right at the outset that he is not intimately acquainted with Freddie and Fannie's balance sheets, and does not run his own models on their capital adequacy/requirements. That having been said, he's been reading stories of their misadventures for years, and could see with his own eyes how they aggressively expanded their balance sheets even as the US housing bubble was inflating and deflating. Moreover, the graph of the share price, which is presumably set by people more intimately familiar with the firm's financial standing than your humble scribe, conveys only one message: Fred's dead, baby, Fred's dead. The similarity to the stock chart of Bear Stearns (and Northern Rock, and Bradford and Bingley) is telling.
So the question then becomes what to do with Freddie and Fannie. Clearly, allowing them to die is a non-starter, as it would eviscerate the financial system and send the housing market into a full-fledged depression. That's obviously politically unpalatable, particularly in an election year. Government intervention would appear inevitable, therefore. Of course, if the Feds step in, private sector shareholders should be left with a goose egg. As a US taxpayer, Macro Man can assure you that he has little interest in paying to clean up someone else's mess, only to see them reap all the rewards after the fact. The NY Times suggests that plans are being readied for some sort of nationalization.

The more interesting question is what becomes of Fannie and Freddie's bonds? The rapscallion in Macro Man would like to see substantial losses for the bondholders as well. After all, people like Voldemort and the Russkies have been buying a helluva lot of Agency bonds with the proceeds of their FX piss-taking. If globalization has brought about of economic realpolitik, it would be refreshing to see SAFE, CBR, et al hit with hundreds of billions of losses as a "reward" for their currency manipulation.
Obviously (and sadly), that's not going to happen. Somehow, the quasi-government guarantee on Agencies will likely to become more formalized. The implication is that 1) the stock of US Treasury debt may be about to go up- by a lot 2) The spread between Agency and Treasury bonds could converge to zero 3) Irritatingly, the FX reserve managers will receive a windfall proceed from their piss-taking. Come on, Hank, grow a pair and tell 'em to quit taking the piss or they'll get nowt for their Agencies!
So we're left with the seemingly ironic scenario wherein the lower Freddie's share price goes, the higher its bonds could/should trade relative to Treasuries. So far, that's not been the case, but one wonders if the fixed income RV traders will start making those bets. Of course, another way to play a Federal assumption of Agency debt would be to simply sell Treasuries. US CDS have ticked wider this morning on the notion that the stock of UST is about to get a lot bigger.

Finally, a word on oil. Macro Man has some sympathy for the notion that a lot of the oil price rise over the past few years has been demand driven, and has met with an inadequate supply response. And he's not totally convinced by the spec-bashing of a guy like Michael Masters, who happens to be long a lot of stocks in a crappy industry (airlines) that is badly hit by higher oil prices.

But still. Perhaps those who say that fundamental supply and demand are the only driver of price can tell the rest of us how that dynamic changed between 19:12 and 19:25 London time last night to generate a four buck rally in the price of crude?

29 comments:

Anonymous said...

Is there a bloomberg screen for CDS on US federal debt or is it just broker runs only? Can't imagine there is a lot of flow in it.

LFY

Macro Man said...

I got a broker run today. I am sure there is a screen, but I have to concede that I don;t know what it is. That's what brokers are for! ;)

Anonymous said...

That, and dinner.

Cheers,

LFY

Anonymous said...

take a moment to consider the likelihood and implications of the US losing its AAA rating.

ward said...

so is USD over DEM in sov CDS yet?

Macro Man said...

LFY, I personally would rather go out for a Ruby with Mrs. Macro!

Anon no. 1: I find it more amusing to mull the irony of the US possibly losing its AAA rating because of the impact of a bunch of securities that should never have been AAA in the first place!

Ward: I assume so, as they are through France!

Anonymous said...

well finally they starting to sell the buck on this thing--as i mentioned yesterday but mr market seemed a bit slow to the point--u want to take the piss outof swf just let the currency go down anther 15%--u sure a shoot don't make it up on your agency t-bond convergence trade taht fur sure---but question is if this the real deal why is the us yield curve much much steeper--im not that big in the pos yet cause 1. if this the real deal you gonna have a lot of time to get on board 2 yield cureve out got be steeping and it ain't (yet)

Macro Man said...

At the risk of outfoxing myself, I am wondering if a Freddie-inspired USD rout isn't the perfect excuse for FX intervention. Hell, the realpolitik threat of default is the perfect excuse to get China, Russia, and GCC on board!

Macro Trading Ideas said...

At the same time we have Lehman and GSE collapsing and crude oil new highs.. perfect storm! The problem is how do we get out of this? If us nationalizes then we have Merril, Morgan, Goldman and Citi, what's next?
However US cds going higher, according to me a good trade is steepening 10/30 us by option. USA aren't more AAA. Their status had until now been guaranteed by "East" recycling. Also EU steepening is a cheap option.

cordura21 said...

I found some CDS in euros, you go to the Bloomberg to "CDSD", and then choose Government (8) and change the currency to EUR. You will see United States on the second page. I have the cheapest and lousiest price feeds, but anyways, yesterady's closings and tickers:

6 mo 2.46/8.34
1 yr 2.46/8.34 (CT786880)
2 yr 4.26/8.14 (CT786884)
3 yr 4.94/9.26 (CT786888)
4 yr 6.38/9.22 (CT786892)
5 yr 7.5/9.5 (CT786896)
7 yr 8.619/11.779 (CT786904)
10 yr 11.729/15.27 (CT786916)

I love the site, cheers

Anonymous said...

One of the really frustrating things is that the agencies apparently spent the last months transferring questionable mortgages onto their books. I have no idea how large the transfer was, but it certainly seemed like a calculated effort to stick it to the taxpayer.

People do need to go to jail.

Anonymous said...

the Agencies have both insurance and their own capital to absorb losses. Sure the mortgage insurance is probably not worth 100%, but it is there to absorb the losses. So what's the net damage to Fannie and Freddie AFTER recovery ? Probably no more than $100B in the worst case. This is not going to break the US Treasury - this is 1/10 the cost of Iraq so far. Shooting Treasuries for $100B ???? Sounds stupid to me.

A $25B capital injection over the weekend would more than solve all the short-term fears with the promise of more if needed. Freddie was only looking to raise $5B recently...so why is everyone going wild ? Yeah, its bad, but its a small tractable problem in the big scheme of things.

Macro Man said...

OK, so what about all the mortgages that the Agencies themselves insure? Will the insurance really cover most of the losses on all the structured credit crap that FNM and FRE have been buying? If so, who's the sucker that issued it?

And if tax dollars are being used to shore up Fannie and Freddie's capital, I tell you what- all of their profits from here to kingdom come should accrue to the government, not the current shareholders. With the hole in the budget, if taxpayers are going to socialize the downside, the subsequent profits need to be socialized as well.

I for one have tired of the crap caused by assholes who screw things up while using other people's money.

D said...

Macro Man -

Thanks for calling out that bullshat talk about hand-outs to the GSEs! People need to warm up to the reality that government isn't and shouldn't bail out every institution in a manner that keeps them private. It rewards poor corporate governance and robs the tax-payer.

Fortunately, oil is reminding everyone that a dollar revaluation (printing) is not a viable option.

Deflation is well underway, we are seeing the lagging effects of the oil-USD recycling racket come to a head.

Nationalize and start pressing charges already! How the hell is Mozillo still tanning?

Anonymous said...

I'm a bit irritated what would a 5 bln capital raising by the GSEs change? they guarentee trillions of mortage debt (not sure how much, have heard numbers between 3-5 trillions). Though this debt is prime(isn't it?), considering the current economic situation default on 5% of this debt is absolutely reasonable. Of course they can forclose the homes,but the recovery rate will be quite low. so what to we get? losses around 150-250 bln $. I cannot see how the GSEs can survive this.

A Thinker said...

Everyone has called for a base in the USD - long term guys have bought USD's and option players have sold EUR/USD vol (even bbg quoting DNT's) All these players are likely to get a rude awakening over the next 2-6 weeks in my view. US assets are falling (Govt bonds, corp bonds and equities) - USD will follow - 1.65 Eur/usd 1 touches look good value to me 20% in 1m. Exchange rates rarely peak without an overshooting '5th wave'. We are about to embark on one.

Charles Butler said...

Considering the time and circumstances under which FNM was created, it would be a cruel irony if it were to find itself bailed out by taxpayers. Too cruel.

Anonymous said...

this anon -$25B injection,

Ha, just open the discount window amd the shorts run.Looks like intermediate term bottom today in equities.

Don't get me wrong, I'm a 100% libertarian, but I'm here to make money not cry about the government bailout.

If you look at potential losses from the whole mortgage mess(not CRE, etc), then its at most $1T and that's an upside number. The vast majority has been taken by non-conforming loans, not on the books on FNM/FRE. Then, they have mortgage insurance- whatever that is worth, then their own capital. Again, the net loss to them is very little. So why would you short Treasuries for that. Its such a minor amount.

The vast majority of the book is conforming loans and the vast vast majority of that was made pre-2005. Because of fear, many of the securities may be quoted low because of lack of liquidity, but looking at actual defaults over the lifetime and assuming the worst still doesn't get you in any major trouble as far as the US treasury is concerned. Most of the losses in the mortgage market will be taken outside of Fannie,freddie.
People are blowing everything out of proportion on these two. All buy and hold holders of Agencies will be whole at maturity.

The danger was that the government did nothing. Then you could get a meltdown, but on the other hand the cost is very minor at this point.

Get rid of them later later. I'm all for it, but the investment today advice is another story. The play today was to buy the preferred/sub debt in the morning when the FUD was off the scale.

Anonymous said...

Anonymous said...
this anon -$25B injection,

Ha, just open the discount window amd the shorts run.Looks like intermediate term bottom today in equities.

--------------------------------

It was a 10 minutes heaven for bulls...lol.

Do not worry, there are 20 minutes for market to close, and there will always be another day.

D said...

anon is smart than me if he can handicap the credit losses...

LOL

Corey said...

agree with "a thinker"...action in commodities, bonds and yen/franc would suggest a dollar route is on the horizon...

i'm holding sept yen futures, reminding myself the biggest up days will be near the end of the route.

Macro Man said...

Who is insuring the mortgages that the GSEs hold? I can't help but observe that MGIC, PMI, RDN all have stock prices on a 1 handle. If the GSE are being ensured by them...well, good luck collecting on the claims.

To my mind, the single most likely impediment to a $ rout is intervention, which I personally think would be fairly likely if this mess really whacks the buck.

Anonymous said...

I'm not getting it, but was the GSEs problem solvency and not liquidity, so what will access to the fed's discount window change?

D said...

The GSE - discount window rumor was an "orchestrated" bull raid. LOL It makes my stomach turn when I hear talk about reinstating uptick and blaming short-sellers for poor corporate governance. Oh well, longs will take their pain as will weak shorts along the way.

jdc said...

I was thinking more Magic Dance.

You remind me of the bear.

What bear?

The bear from the twenties.

What twenties?

Nineteen twenties.

Etc.

wcw said...

Ah, FNM and, most especially, FRE. What could have been: after hating them for years, I finally pulled started shorting them into residential housing. Let's check.. my first FRE print was September 2006. Not the top, by any stretch, but a nice entry. But here's the sad part: my last, closing FRE print was December 2007. I had been roped into a contract that was taking way too much of my time (and that I hated besides), so I closed all my interesting positions, since I was losing perspective on my trades.

Leaving this last half-year on the table for a contract I hated.. ugh, it rankles. There is a happy ending, at least: I fired that client and am working elsewhere as of this week. I fear the new compliance regime is stricter than I would like, but on the bright side, I no longer despise half my immediate coworkers and half my responsibilities.

On-topic, it strikes me as likely that FRE and FNM will toddle along somehow with more- or less-explicit liquidity support. At worst, and I don't think it likely, though it is possible (I was short for a reason), the government will step in and shareholders get the Bear Stearns treatment. The enterprises themselves, however, will continue, though probably in better-regulated and less-risky form.

Adrem said...

Has anybody worked out what all these accumulating bail-outs are going to cost, plus a fiscal stimulus, plus falling revenues in a downturn, all on top of an enduring budget deficit, and McCain on the stomp promising more tax cuts. America’s current fiscal and economic postures make Alice in Wonderland seem a tale of banal normality.

wcw said...

All that is a pimple on the ass of the holes that GWB blew in the budget with tax cuts for the rich and the Iraq war. The US has survived the big blows already, though we are wobbling a little.

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