Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
United States Coronavirus Infections and Deaths Trend Forecasts Into End April 2020 - 29th Mar 20
Some Positives in a Virus Wracked World - 29th Mar 20
Expert Tips to Save on Your Business’s Office Supply Purchases - 29th Mar 20
An Investment in Life - 29th Mar 20
Sheffield Coronavirus Pandemic Infections and Deaths Forecast - 29th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast - Video - 28th Mar 20
The Great Coronavirus Depression - Things Are Going to Change. Here’s What We Should Do - 28th Mar 20
One of the Biggest Stock Market Short Covering Rallies in History May Be Imminent - 28th Mar 20
The Fed, the Coronavirus and Investing - 28th Mar 20
Women’s Fashion Trends in the UK this 2020 - 28th Mar 20
The Last Minsky Financial Snowflake Has Fallen – What Now? - 28th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

Fannie, Freddie Common Stock Now Valued as a Call Option

Companies / Credit Crisis 2008 Aug 12, 2008 - 03:45 PM GMT

By: Mike_Shedlock

Companies Best Financial Markets Analysis ArticleJohn Hussman had some interesting comments on Fannie Mae's last earnings statement in Nervous Bunny .
With regard to Fannie Mae's report, the most interesting figure wasn't the reported $2.3 billion loss, but rather the much larger deterioration in the reported fair value of Fannie's balance sheet. We can observe what's going on by comparing Table 32 of Fannie Mae's Q2 2008 10Q filing with the same table in Fannie Mae's Q1 2008 10Q filing.


As of June 30, 2008, the fair value of Fannie Mae's common equity (that is, the book value available to common shareholders) was -$5.39 billion, compared with a March 31 fair value of -$2.07 billion. What's notable here is that this deterioration (-$3.32 billion) was even larger than the -$2.30 billion loss that Fannie reported to investors, which was itself about four times higher than the loss analysts had estimated. Note that balance sheet losses are excluded from earnings. Financial stocks tend to be reasonably valued when they trade at tangible book value, but simply put, Fannie Mae has no tangible book value. The common stock is now a call option.

Even if we include the fair value of preferred equity, we find that on a fair value basis, Fannie Mae is operating at a gross leverage multiple of 72.7 (total assets comprised primarily of mortgage loans, divided by shareholder equity). In other words, a slight 1.4% deterioration in the value of Fannie's book of assets will wipe out all of the remaining shareholder equity. This makes Long Term Capital Management look like a conservative strategy.

Another Take On Fannie and Freddie Options

Minyanville Professor Bennett Sedacca was also talking about Fannie Mae and Freddie Mac options in a A Tale of Two Markets, Part 1 .
Freddie was supposed to raise $5.5 billion according to its earnings announcement back in June 2008. The problem is that it decided to wait for a better time in the market to raise this capital. However, in the meantime, its common stock price plummeted from $25 at the time of their announcement to a recent $5. While they only have 750 million shares outstanding, issuing 1.5 billion new shares really wasn't an option as this would dilute the current shareholders beyond recognition.

Now Treasury Secretary Paulsen is cooking up a bailout of Fannie and Freddie, which I imagine will eventually end up as full-fledged nationalization as I have been talking about for some time. After many discussions with informed traders and bankers, the plan that I envision (as revolting as it may sound) goes like this:

The Treasury would issue a ‘super-senior' preferred stock offering that gives them effective control of Fannie and Freddie. At the same time, though, the equity shareholders who have ridden the stocks down 95% will get little if anything. I would also imagine (and the market seems to be pricing this in now) that the dividends on the $50 billion or so of outstanding preferred shares (mostly owned by institutional investors) will be suspended. Keep in mind that these issues are non-cumulative, non-mandatory preferred shares.

This means that if/when they stop paying dividends, they don't get to accrue future dividends, they just simply resume at some point in the future if this all works out. So what is the value of a preferred equity that doesn't pay a dividend...? Very little. Effectively what you own is an option on a future uncertain stream of dividend income that may start again in the future.

What sickens me is that Hank Paulson & Co. are rather aware that Fannie and Freddie must be able to function normally to avoid global, financial systemic risk. And they will do anything to support them that they have to, including ‘throwing taxpayers under the bus.'

While I am fairly confident my view will play out, I openly wonder if this model won't be used for other troubled institutions (like overleveraged financial concerns like Lehman (LEH), Merrill (MER), Citigroup (C) and AIG). They are important to the system as well. The Fed and Treasury know this, of course, and the while many important entities will probably be saved, there may be many others that are too small to care about and so poorly run that no one wants them -- you can throw National City (NCC), Zions (ZION), Regions Financial (RF), KeyCorp (KEY), into this category -- not to mention countless privately controlled community banks.

Fannie Mae Daily Chart



Freddie Mac Daily Chart


Financial Intervention

Paulson and the SEC acted to initiate a short squeeze in Fannie Mae, Freddie Mac and financial in general. Please see Panic By The Fed: Anatomy of a Short-Squeeze and Selective Enforcement of Regulation SHO for more details.

The squeeze " worked " until the juice dried up. Fannie rose from $6.68 to $18.48 in one week flat. In two weeks flat it was back at $8.40. Freddie Mac rose from $3.89 to $11.60 only to fall back to $5.43.

Now it appears that the common stock of both is likely to drift towards zero, especially if the situation plays out as describe above by professor Sedacca.

One of the purposes of of Paulson's and the SEC's manipulation was to force the price of Fannie and Freddie up so that new capital can be raised. The above charts show the manipulation failed spectacularly. Yes, some financials held their gains but some like Washington Mutual (WM) did not. Did the squeeze partially work then? The answer is no, not really.

As we have seen many times in the past, every time sentiment gets extremely bearish there is a rally. Sentiment against financials was nearly off the scale a few weeks ago. What Paulson and the SEC did was goose the initial bounce, no more, no less, and it appeared to "work" only because financials were poised to rally anyway. Careful scrutiny will show that financials, like the dollar, rallied because they were damn good and ready to rally.

For more on this idea, please see Currency Intervention And Other Conspiracies .

Sadly, many otherwise extremely bright people make the mistake of equating correlation with causation, time and time again. Sadder still is some of the acrimonious debate over this point.

But the fact of the matter is the dollar was poised to rally. Sentiment was as bearish as I have seen it in spite of the fact that fundamentals on the dollar (expected movements in interest rate differentials, declining oil, and improving balance of trade prospects) were rapidly changing for the better.

So along comes a minuscule (to the forex markets) intervention, and it was supposed to have caused this dollar rally. Sorry folks, it did not cause a damn thing. If the dollar was not poised to rally, intervention would have failed as it did 13 consecutive times before that. Still another chart shows that over $300 billion in currency intervention by Japan did no good.

The key point is that intervention does not work although at times it may appear to work. And this is what leads otherwise bright people to confuse correlation with causation. In the micro-sense, if one is trading very short timeframes, then I suppose from that perspective these manipulations could have meaning. In longer timeframes, attempts to manipulate the market fail every time.

China put curbs on shorting stocks. The Shanghai index fell 52% anyway. The TAF, the TSLF, and the PDCF were all supposed to prevent a collapse like we saw with Bear Stearns. Bear Stearns collapsed anyway.

And I cannot count the number of times in this downturn that people blamed the PPT for propping up homebuilders, or Ambac (ABK) or MBIA (MBI). If the PPT was acting, it sure failed miserably.

Ambac fell to as low as $1.04. So why did Ambac rally? Ambac rallied because pessimism was excessive, Ambac had enough cash to survive for at least a while, and for some, a $1-$3 share price was tantamount to being a rather cheap call option on the possibility it surviced longer. For others, shorts have to cover sometime anyway. Why not start at $1-$3?

So if you think manipulations caused , the rally in Amback (or any other financial) to stick then you are not thinking clearly.

Yes, the Fed, and the SEC, and the Treasury have been openly intervening. Yet, there is no evidence if one looks closely (avoiding the trap of equating correlation with causation), that any of this manipulation caused anything other than a small blip on a screen in a very short timeframe.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2008 Mike Shedlock, All Rights Reserved

Mike Shedlock Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules