Monday, September 8, 2008

Drilled Baby, Drilled

A month ago I brought up the issue of Fannie Mae as having once been called the only stock one needs to own. Well that's come full circle now as yesterday the US government stepped in to effectively put Fannie Mae and Freddie Mac into "conservership," the equivalent of chapter 11 bankruptcy. When the first word came out on Friday that there was a bailout in the works I began to consider what the investment themes coming out of the government intervention in the private company that holds or guarantees $5.3 Trillion in mortgages in the United States would be.

By last night when the final announcement was made, I was no nearer to really having my finger on it. Two things were clear from the beginning. Being a huge net debtor to overseas lenders (i.e. China, Japan etc) we were likely not calling the tune. As our nation has gotten into ever deeper debt we can expect the cost exacted in times of crisis will increase. It would not do to bite the hand that feeds us, so Fannie Mae bonds will remain intact. If you happened to own the stock, you've been "drilled baby drilled!"

To let the bond holders go down would have been a global meltdown the likes of which no one has seen in this country perhaps ever. Every bank who writes a mortgage and subsequently sold the mortgage to Fannie Mae in return for a Fannie Mae note would have dissolved in a pool of lost capital. So that was never in the cards. Some institutions do hold FNM equity and they will be punished for their judgement.

Secondly, what about other financial institutions in trouble. Now that the government has established a willingness to bail out troubled institutions what next?
Bear Sterns; Fannie Mae .....obviously if you are among the troubled banks the helping hand will be the kiss of death, at least to owners. However the moral hazard created by government intervention is significant.

Several years ago our hefty labrador retriever discovered an untended sixteen pound Honey Baked spiral cut ham in the kitchen. I found the gold foil on the kitchen floor and Ruth on the basement floor where she stayed for the rest of the day and the better part of the next. The nationalization of Fannie Mae and Freddie Mac is likewise a very big meal to digest and the markets may well have a similar glazed look for sometime to come. If we look at the market response to the action thus far we see the most troubled financial institutions down (fnm -90%, leh -12%, wm -4%) but the beneficiaries of decreasing risk from housing debt up (home depot 5%, citigroup 7%, JP Morgan 5%) I think we will have more trouble digesting this and for a lot longer time than Ruth and her ham and the consequences more far reaching. As the economy continues to weaken, the line of companies, all important to the national health, with their hands out will lengthen. Ford, General Motors, Airlines? No good options exist.

And don't think this budget buster won't have political implications as taxpayers just put up $200 billion into the pot, not to mention another billion to the nation of Georgia to poke Vladimir Putin in the eye. We can't afford WHAT?! Looks to me like we can afford anything!

John Barnyak