Florida Mortgage Report

Fannie and Freddie to Go Jumbo? Is the Government Going Insane?

"Stop the insanity" is the first phrase that comes to mind after reading this headline.  Why?  Think about what is truly happening in the mortgage market and where all of this is headed.

Basically, the government is trying to overtake the mortgage market through endless regulation.  They feel they must do something or else and are succumbing to pressures to "bail out" a market that was in desperate need of a correction to bring itself back to reality.

But is "over-regulation" what we truly need?  Don't take me wrong here as I am all for added regulation which protects the consumer, but when the government steps in, they tend to overdo it.  Allowing Freddie and Fannie to go into the Jumbo market, even if only temporarily, is one case in many of how the government is throwing Band-Aids on the gaping wound.  Sure it stops the bleeding some, but basically just prolongs death.

Paulson and Bernanke are doing everything in their power to Band-Aid the mortgage market.  Bernanke and crew are cutting the Fed Funds Rate and Discount Rates even with inflation showing signs of growing and the economy slowing.  He is giving stagflation an "open door".  Both are looking for any changes they can make or get other parts of the government to make in order to "save homeowners from foreclosure." 

Who stands to win though?  The homeowner?  Not likely.

The real winners in this game they are playing are the lenders and other financial institutions that are struggling due to their risky lending practices or over leveraged positions on mortgage backed securities.  Citigroup, Wachovia, Bank of America, Washington Mutual, Countrywide, the list goes on and on.  All are shouldering huge losses and will likely continue to do so into 2008.  They "need" the government to do something.

The homeowner's facing foreclosure, for the most part, deserve to be foreclosed upon.  While the media and government play that the typical foreclosure is a subprime borrower facing increased mortgage costs due to their payment adjusting, that represents the minority, yes the minority of foreclosures out there.  Factor in that the government portrays the mortgage professional that sold them the loan as an unscrupulous one and reality shrinks even further from the truth.

Again, don't get me wrong.  There are unscrupulous originators and there are homeowners that truly should be helped somehow, but they are the smallest percentage of the pie. 

So, why is the government willing to screw up the entire industry over the few?  Well, because that is what they do.  They disguise "bail outs" as "homeowner salvation plans".  They usually go out of their way to appease the minority groups on an issue, while sacrificing the desires of the majority groups. (Note:  I am not talking about racial or ethnical issues here, so don't even go that route in any comments please).

More Trouble in The Financial Sector and the Number One Stock to Short is...

Bank of America came out saying it will set aside $3.3B to cover losses in the fourth quarter.  The CEO, Ken Lewis said “While we do not make a practice of forecasting quarterly earnings, I think you certainly can assume results will again be quite disappointing.” That's gotta hurt.

B of A started what other banks decided to follow up with.  A slew of losses being shown across the board with Wachovia setting aside around $1.0B and PNC around $1.5B.  Washington Mutual is around $1.6B.  Others have issued warnings as well.

The most interesting announcement yesterday is that from Morgan Stanley.  They came out and said the #1 stock to SHORT is none other than Citigroup.  Their analysts are saying Citi will try all kinds of methods from spinning off units to selling funky securities, all of which will dilute shareholder value.

I think it goes without saying that any attempt by the Fed to prevent failure is not working, at least not enough.  Throwing money at the problem (yesterday's Fed announcement) moved the markets temporarily, but when reality set in, investors saw through the Fed's attempts.

The reality is that the markets need to work through the issues and move on, but the beatings to the financial companies will continue, at least into the first quarter, if not beyond.

What Will Happen If Citigroup Gets Priced Like E*Trade?

E*Trade experienced a fire sale of mortgage backed securities that resulted in a worst case scenario of pricing subprime assets lower than expected.  Analysts say E*Trade got as little as 11 cents on the dollar for its $3.1 billion portfolio of asset-backed securities.

Since this was among few observable trades, the negative connotations for the valuation of other financial institutions own portfolios, namely Citigroup's.

Citigroups' own analyst stated E*Trade received 11 cents on the dollar.  Goldman Sachs analysts said they were surprised by the size of the discount considering 73 percent of the E*Trade portfolio consisted of prime mortgages, loans to people with good credit.

So, what would happen if we are to see similar pricing with other financial companies, like Citigroup?  Simply put, it will be ugly, very ugly.  Here are numbers presented by Susan Katze of Credit Suisse, assuming 26 cents (numbers would be even higher with only 11 cents)...

• Citigroup's after tax write down would be around $26 billion
• Merril Lynch's after tax hit would be around $9 billion on subprime paper

One thing to note, Susan's take on Merrill is on subprime paper only and E*Trade's markdown was on all paper, including 73% of which was prime mortgages!

So, the government, including Bernanke (behind the scenes) backs a SIV bailout, which Treasury Secretary Paulson announced is a failure already.  With that failing, and the fact Citigroup is over leveraged, the losses if required to price to market would be enormous.

Citigroup may be facing major losses, even potentially exceeding the "equity" shown on their September 30th balance sheet.

What Should be Done About the Continued Credit Crunch? How About Nothing?

The economy runs in cycles and that is a healthy thing.  When the government steps in to try and "fix" it, that is a bad thing as it prolongs the process.  Why doesn't the government just let it go, stop screwing around with the economy trying to fix things and just let it run its course?

Politics is politics, but politicians need to stop trying to "look good" and focus on reality.  Of course, it isn't just the politicians trying to fix things either.  What about Big Ben and the gang, making statements letting the market at least believe there is another rate cut coming?

Why can't we just let things work through the cycle, so the cycle can complete itself and start moving in the opposite direction?

That's right, it may get worse, but it always ends up getting better down the road, but only when the cycle has a chance to complete itself.  It is all part of a healthy economy.  Screwing with it only makes things worse, as we are seeing now.

• Let the foreclosures happen and affordable housing will be a reality again.
• Raise rates and recession (if the economy decides that's what it needs) will happen, then be over and we will see an economic bounce later.  At least the dollar won't continue its death spiral and we won't continue to have stagflation (that's when the economy slows, yet inflation increases).
• Countrywide, Citigroup, whoever deserves to go under for their past mistakes, let them fail.  It is a necessary part of the solution.  Bail outs only cause more problems and prevents companies from learning from their mistakes.
• Sellers need to lower prices to that which buyers are willing to pay, then the inventory will shrink and eventually the market will start moving higher again.

I could go on and on, but I think you get the point. 

The Continued Fallout of SIVs, and Pensions

With the government backing SIV bailouts and pension funds in Florida (and elsewhere I am sure) being frozen, it is time to take a humor break yet again.  Unfortunately, this humor is spot on....

 

(Bremner, Bird and Fortune - Subprime, SIVs)

A Very Interesting Story Unfolding Overseas That Could Forecast Troubles Here

"Stricken mortgage lender Northern Rock may see the value of its equity wiped out and is expected to owe the Bank of England billions for years to come, according to documents seen by the Financial Times.

A briefing memorandum prepared for prospective buyers of Northern Rock by the bank’s advisers Merrill Lynch, Citigroup and Blackstone Group details a number of future scenarios for the bank."

This is how an article in FT.com started today.  Does anyone else see the writing hidden within the print?

Here we have Citigroup and Merrill talking about Northern Rock losing all of its equity and is expected to still owe billions.  Both of these two "advisors" are in the same situation when you look at their Level 3 Assets being larger than their equity, so it questions whether or not, by their own analysis, they can even avoid the same fate.  The difference is, I guess, that in the US it is OK to "hide" things from the balance sheet or create funds that artificially inflate value to offset losses.

The article continues...

"Two likely options include selling Northern Rock’s assets and business to a willing buyer and leaving shareholders invested in a rump company holding only the massive Bank of England loans. Northern Rock’s shareholders would get only “residual value” from the vehicle, after the bank’s huge debts had been unwound."

Doesn't sound like much reason to own the stock if you ask me.  I may have to go over and "short" Citi and Merrill at this point as soon they may be worthless as well.

Maybe I am reading too much doom and gloom and irony into this, but it is interesting nonetheless.

Is Citigroup Going Down for the Count?

Citigroup is making headlines (yes, I know Merrill Lynch did too).  Now they are changing leaders, but can Rubin save Citi?

Just yesterday, we were hearing about the $11B write offs Citi was going to make over mortgage backed securities.  Not too long ago, I wrote about Citi's SIVs and the problems they could create for Citi.

Now a MarketWatch article shows Citigroup has over $134B in Level 3 Assets.  Since Level 3 Assets are the scariest, that could spell major trouble for an already troubled company.

So, what are Level 3 Assets?  Simply put, they are assets that are absent of reliable price as there is non one crazy enough to buy them.  So, expect plenty more "write-offs" from Citi and they can only hope that it won't destroy them.

Comparing Citi and Merrill, and you will see Citi is in considerably worse shape, even before factoring in SIVs. 

Mish (Michael Shedlock) had an in-depth analysis that sums it up in this...

"Level 3 assets at Citigroup exceed shareholder equity. Now take a look at level 2 assets sitting at $939 billion dollars. A mere 10% haircut in the value of those assets would eat up 74% of working capital. A 10% haircut in Level 2 assets in conjunction with steeper losses in level 3 assets would make Citigroup insolvent."

The answer to the question remains to be seen, but reality may prove that Citi is currently fighting for its life and not likely to survive.