I recently heard a great joke that reminded me of the current economic and market conditions and the emotions surrounding every trading day. I should preface this by saying that if you are not familiar with Bulgarians you should know that they have endured a brutal history, which has earned their citizens a reputation as being some of the most untrustworthy and cynical folks from the former Eastern bloc. Here’s the joke: Two Bulgarians meet each other on the street. The pessimist says, “Things can’t get worse!” to which the optimist says, “I think they can get worse!”
I know that it would have been nice to think that Tuesday’s rally in stocks would be the much-anticipated bottom in the price of stocks. (If you were sleeping for a day, stocks shot up by 3.5-4% after the Fed announced that it was dropping short-term rates to 2.25% from 3%. The Dow enjoyed its biggest point gain since July, 2002 and financial companies reversed Monday’s losses after stronger-than-expected earnings from Lehman Brothers and Goldman Sachs. Even Bear Stearns added 23% to $5.91!) I heard a bunch of pundits quoting the Bulgarian pessimist, noting that the Bear Stearns deal was evidence that perhaps things can’t get worse.
I hate to insult the Bulgarian pessimist or American optimists, but the Federal Reserve’s two-tiered actions--providing financial institutions creative access to liquidity facilities and cutting short interest rates to help beleaguered consumers--can not stop the housing market from falling and the housing data has not yet indicated that the damage is done. In fact, this week it was announced that building permits fell to the lowest level in 16 years in February. From where I sit, the housing market continues to hold the key to providing confidence to investors and by extension, forming a true bottom in stocks.
We should not be surprised that it takes time for recovery. When a good idea (“I should use cheap money to buy assets that I think will rise in value!”) turns into a boom (I’ll only put down 10%) and then a bubble (I don’t have to put down anything!), the aftermath is not pretty. Perhaps that is why Joseph Stiglitz, the Nobel-prize winning economist and former chief economist at the World Bank, told Radio New Zealand “This is clearly the worst financial problem we've had since the Great Depression…More and more Americans are going to walk away from their mortgages, and that's going to undermine the foundations of these banking institutions.” In other words, the Bulgarian optimist may be right---things can get worse.
Thursday, March 20, 2008
Wednesday, March 19, 2008
We Like Good News Too!
My parents have a friend (“JR”) who has a sign on his desk that says: “We like good news too!” It seems lately that investors have been inundated with massive quantities of the bad stuff, so in a nod to J.R, it might be time to trudge out some glimmers of good news.
The Fed is our friend: It may have taken six months for Ben Bernanke & Co. to jump on the problem, but it is now clear that the Fed is acting aggressively and creatively. Whether that means using arcane rules to supply the financial industry with much-needed liquidity, or dropping the Fed Funds rate (the Fed slashed rates by ¾ of a point yesterday to 2.25%, a full three percentage points from last year’s peak of 5.25%). Investors greeted the news with great fanfare, sending stock prices soaring higher!
Some companies are making money: We have not officially entered the statistical definition of a “recession” (the economy has yet to post even one quarter of contraction), but earnings at many firms have already started to contract. While the financial companies are the obvious big losers, there are some companies that continue to thrive, including exporters and large multi-national firms with a major overseas presence. According to Thomson Financial, if you exclude the financial sector, profits for the rest of the S&P 500 companies are expected to have grown nearly 12% in Q4 of 2007 and to grow nearly 9% in the first quarter this year.
Because this slowdown/recession started in the US, there is no way to shield most US companies from the damage, but growth abroad has been a powerful driver for many US firms. Also, US companies came into this period better prepared than in the last recession--based on almost any fundamental metric, corporate balance sheets are healthier today than they were in 2002.
Velocity can work both ways: From the market’s recent peak on Oct. 9, 2007, and recent bottom on March 10, the S&P 500 fell 19%. There have been three other periods in the last 20 years when stocks have lost so much in such a short time: in 1990 (S&L), 1998 (Asian currency crisis) and 2000. The 2000 swoon, prompted by the bursting of the tech bubble, quickly developed into a nasty bear market. But in the other two cases, stocks recovered the next year. In the 12 months after the 1998 sell-off, the S&P 500 soared 40% and 12 months after the end of the 1990 correction, stocks had jumped 34%. The numbers may not work out exactly, but so far, we have in fact been pretty close to them. US stocks have on average peaked four-six months before the onset of recession and troughed eight months after the start of recession. We peaked last October and many believe that we are on target to meet the historical standard.
Negative may be positive: It may sound crazy, but the very fact that people are turning negative may be a positive development for the slumping markets. Often, stock market bottoms form when sentiment is at its worse, hence the old chestnut, “sometimes, when things look bleakest, it’s a sign the market is near a bottom.” We could be a long way from that point, but when you start to hear the words “crash”, “recession”, or data points from the Great Depression, you might think to yourself, we are closer to the end of this mess than the beginning of it.
The Fed is our friend: It may have taken six months for Ben Bernanke & Co. to jump on the problem, but it is now clear that the Fed is acting aggressively and creatively. Whether that means using arcane rules to supply the financial industry with much-needed liquidity, or dropping the Fed Funds rate (the Fed slashed rates by ¾ of a point yesterday to 2.25%, a full three percentage points from last year’s peak of 5.25%). Investors greeted the news with great fanfare, sending stock prices soaring higher!
Some companies are making money: We have not officially entered the statistical definition of a “recession” (the economy has yet to post even one quarter of contraction), but earnings at many firms have already started to contract. While the financial companies are the obvious big losers, there are some companies that continue to thrive, including exporters and large multi-national firms with a major overseas presence. According to Thomson Financial, if you exclude the financial sector, profits for the rest of the S&P 500 companies are expected to have grown nearly 12% in Q4 of 2007 and to grow nearly 9% in the first quarter this year.
Because this slowdown/recession started in the US, there is no way to shield most US companies from the damage, but growth abroad has been a powerful driver for many US firms. Also, US companies came into this period better prepared than in the last recession--based on almost any fundamental metric, corporate balance sheets are healthier today than they were in 2002.
Velocity can work both ways: From the market’s recent peak on Oct. 9, 2007, and recent bottom on March 10, the S&P 500 fell 19%. There have been three other periods in the last 20 years when stocks have lost so much in such a short time: in 1990 (S&L), 1998 (Asian currency crisis) and 2000. The 2000 swoon, prompted by the bursting of the tech bubble, quickly developed into a nasty bear market. But in the other two cases, stocks recovered the next year. In the 12 months after the 1998 sell-off, the S&P 500 soared 40% and 12 months after the end of the 1990 correction, stocks had jumped 34%. The numbers may not work out exactly, but so far, we have in fact been pretty close to them. US stocks have on average peaked four-six months before the onset of recession and troughed eight months after the start of recession. We peaked last October and many believe that we are on target to meet the historical standard.
Negative may be positive: It may sound crazy, but the very fact that people are turning negative may be a positive development for the slumping markets. Often, stock market bottoms form when sentiment is at its worse, hence the old chestnut, “sometimes, when things look bleakest, it’s a sign the market is near a bottom.” We could be a long way from that point, but when you start to hear the words “crash”, “recession”, or data points from the Great Depression, you might think to yourself, we are closer to the end of this mess than the beginning of it.
Tuesday, March 18, 2008
The Bear Necessities
I thought that I had accomplished a lot over the weekend, until I read about the stunning Bear Stearns deal. In a remarkable turn of events, Bear agreed to sell itself two days after receiving emergency funds from J.P. Morgan Chase & Co. and the Federal Reserve Bank of NY.
Actually, the sale wasn’t the shocking part, but the price was: after closing down 47% on Friday to $30 per share, the 85-year old investment banking firm will sell itself for $2 per share to JP Morgan. To help grease the wheels of the deal, the Fed approved a $30 billion credit line to JP Morgan and said that it would effectively take over the huge Bear Stearns portfolio.
Separately, the Fed also lowered the rate for borrowing from the discount window by a quarter of a percent to 3.25%, in order to facilitate smoother financial market operations and further expanded last week’s $200 billion liquidity injection by creating the Term Securities Lending Facility (TSLF). The TSLF will make money available to the 20 large investment banks that serve as primary dealers and trade Treasury securities with the Fed. This program will allow the Fed to hold as collateral a wide array of investments, including the now-tarnished mortgage backed securities, and will have no limit on the amount of money that can be borrowed.
While I understand how many believe that those who created this mess should suffer, officials are thankfully pushing aside the worries about “moral hazard” so that financial system does not become crippled altogether. I see the Fed actions as necessary to help halt the forced sell-off of high quality mortgage backed securities. These moves are less financially-motivated than confidence-builders. Clearly the root of the economy’s fundamental problems can not be solved by the Fed. After all, the central bank can not stop housing prices from falling. But what it can do is provide liquidity to financial institutions which might prevent what is known on the street as a “death spiral”, or a bank run.
If you do not own Bear Stearns stock (which you may, because it was part of the S&P 500 Index), how is all of this going to affect you? Well it has created a ripple throughout the entire financial services industry. Shares of investment banks in the S&P 500 are down almost 30% this year, the overall market (as measured by the S&P 500 index) is down over 12% this year and over 17% from its most-recent high last October. But in a larger sense, the events of the past week imply that the Fed will do everything in its power to stave off financial instability and that is actually a good thing.
Actually, the sale wasn’t the shocking part, but the price was: after closing down 47% on Friday to $30 per share, the 85-year old investment banking firm will sell itself for $2 per share to JP Morgan. To help grease the wheels of the deal, the Fed approved a $30 billion credit line to JP Morgan and said that it would effectively take over the huge Bear Stearns portfolio.
Separately, the Fed also lowered the rate for borrowing from the discount window by a quarter of a percent to 3.25%, in order to facilitate smoother financial market operations and further expanded last week’s $200 billion liquidity injection by creating the Term Securities Lending Facility (TSLF). The TSLF will make money available to the 20 large investment banks that serve as primary dealers and trade Treasury securities with the Fed. This program will allow the Fed to hold as collateral a wide array of investments, including the now-tarnished mortgage backed securities, and will have no limit on the amount of money that can be borrowed.
While I understand how many believe that those who created this mess should suffer, officials are thankfully pushing aside the worries about “moral hazard” so that financial system does not become crippled altogether. I see the Fed actions as necessary to help halt the forced sell-off of high quality mortgage backed securities. These moves are less financially-motivated than confidence-builders. Clearly the root of the economy’s fundamental problems can not be solved by the Fed. After all, the central bank can not stop housing prices from falling. But what it can do is provide liquidity to financial institutions which might prevent what is known on the street as a “death spiral”, or a bank run.
If you do not own Bear Stearns stock (which you may, because it was part of the S&P 500 Index), how is all of this going to affect you? Well it has created a ripple throughout the entire financial services industry. Shares of investment banks in the S&P 500 are down almost 30% this year, the overall market (as measured by the S&P 500 index) is down over 12% this year and over 17% from its most-recent high last October. But in a larger sense, the events of the past week imply that the Fed will do everything in its power to stave off financial instability and that is actually a good thing.
Monday, March 17, 2008
Grin and Bear it
Alan D. Schwartz, the CEO of Bear Stearns seemed stoic as he conducted a conference call Friday to explain the nation’s fifth largest investment bank’s dramatic move: it had received emergency funds from J.P. Morgan Chase & Co. and the Federal Reserve Bank of New York to meet its obligations and to protect against rumors that have been swirling around the firm for the past week. Whether or not the rumors became self-fulfilling prophecies are not yet known, but what is crystal clear is that Bear’s liquidity has fallen so much that it needed cash.
The mainstream media jumped on the story with headlines that repeatedly said the government is “bailing out Bear”. How unfair, said CNN’s Lou Dobbs! Your taxpayer money should not be used to ease the pain of Wall Street-ers! Before you go too crazy with that line of thought, let’s remember that a liquidity crisis that is not contained at Bear could easily spread to other banks, investors or industries, which is why the Fed, the Treasury Department and the SEC were all involved.
Authorities needed to step in because Bear does business with so many large firms (counter-parties) and is a significant player in markets for debt, particularly for securities backed by mortgages. If Bear were to fail, many of the counter-parties would become ensnared, prompting a potential domino effect throughout the brokerage and banking industries. And to the “rescue” of Bear, let’s remember that the stock fell 47% on Friday to a nine-year low of $30 per share and is down a staggering 79% from 52-weeks prior. That seems like a healthy dose of pain and suffering.
The mechanics of the deal involve using a little-used Depression-era provision of the Federal Reserve Act. J.P. Morgan will borrow directly from Fed's discount window and relend to Bear Stearns for 28 days. (Unlike investment banks like Bear, JP Morgan has the advantage of being able to borrow directly from the Fed.) The money that is borrowed will be secured by collateral furnished by Bear, but here is where the accusations of “bail-out” come to light. Under terms of the deal, the Fed, not J.P. Morgan, bears the risk of losses if the Bear Stearns collateral falls in value.
CEO Schwartz noted that the firm is seeking sources of permanent financing “or other alternatives for the company.” In other words, Bear needs a buyer-and fast. The assumption is that this deal is likely to lead to JP Morgan’s acquisition of Bear Stearns, and in a broader sense, perhaps this is the beginning of the bottoming process of the credit crunch.
The mainstream media jumped on the story with headlines that repeatedly said the government is “bailing out Bear”. How unfair, said CNN’s Lou Dobbs! Your taxpayer money should not be used to ease the pain of Wall Street-ers! Before you go too crazy with that line of thought, let’s remember that a liquidity crisis that is not contained at Bear could easily spread to other banks, investors or industries, which is why the Fed, the Treasury Department and the SEC were all involved.
Authorities needed to step in because Bear does business with so many large firms (counter-parties) and is a significant player in markets for debt, particularly for securities backed by mortgages. If Bear were to fail, many of the counter-parties would become ensnared, prompting a potential domino effect throughout the brokerage and banking industries. And to the “rescue” of Bear, let’s remember that the stock fell 47% on Friday to a nine-year low of $30 per share and is down a staggering 79% from 52-weeks prior. That seems like a healthy dose of pain and suffering.
The mechanics of the deal involve using a little-used Depression-era provision of the Federal Reserve Act. J.P. Morgan will borrow directly from Fed's discount window and relend to Bear Stearns for 28 days. (Unlike investment banks like Bear, JP Morgan has the advantage of being able to borrow directly from the Fed.) The money that is borrowed will be secured by collateral furnished by Bear, but here is where the accusations of “bail-out” come to light. Under terms of the deal, the Fed, not J.P. Morgan, bears the risk of losses if the Bear Stearns collateral falls in value.
CEO Schwartz noted that the firm is seeking sources of permanent financing “or other alternatives for the company.” In other words, Bear needs a buyer-and fast. The assumption is that this deal is likely to lead to JP Morgan’s acquisition of Bear Stearns, and in a broader sense, perhaps this is the beginning of the bottoming process of the credit crunch.
Friday, March 14, 2008
Consumer Reports’ Money Mistakes 2
Yesterday I recounted a great story in Consumer Reports called “12 Money Mistakes That Could Cost You $1,000,000”? A million bucks within your grasp! The two that stick out are the ones that carry the biggest bang for the buck. I started with investing too conservatively during retirement and today we move on to the elephant in the room for most pre-retirees: Retiring before you need to.
Whenever people come in to discuss various investment strategies to enhance retirement portfolio returns, I like to remind them that they control the two most important variables of retirement planning: retirement date and spending needs. I know that it’s hard to accept this, but it is more important when and how you retire than whether you have a four or five-star rated mutual fund in your portfolio.
The first hurdle is reaching your full Social Security retirement age so that you can maximize your benefits and qualify for Medicare. If you are planning to retire prior to that time and grabbing a smaller Social Security check, remember that by doing so, you will permanently reduce your (and your non-working spouse’s) retirement benefits. And if you are not eligible to be in the Medicare program, you may have the additional cost of individual health insurance. Some have pointed out to me that if they die early, then early SS is worth it. Call me crazy, but somehow premature death does not seem like a prize.
Perhaps of greater importance than the simple math associated with Social Security, is when you retire early you are foregoing your income during what may be some of your highest earning years. And of course without that income, you will start dipping into your savings and investments. Consumer Reports tried to quantify the early retirement decision by analyzing a hypothetical $54,592 (the median U.S. household income for 62-year olds). Assuming Mr. Early- Retirement stopped working at the beginning of 2008 at 62 and started to collect SS, his reduced benefits and private health insurance, plus his four years of lost income (including 4% annual raises) cost him approximately $237,000-$309,000.
Need I point out that it is very difficult to earn hundreds of thousands of dollars on a risk-free basis? Given the amount of time and energy that everyone spends on contemplating retirement, one of the easiest solutions may be the one you don’t want to hear: keep working!
Whenever people come in to discuss various investment strategies to enhance retirement portfolio returns, I like to remind them that they control the two most important variables of retirement planning: retirement date and spending needs. I know that it’s hard to accept this, but it is more important when and how you retire than whether you have a four or five-star rated mutual fund in your portfolio.
The first hurdle is reaching your full Social Security retirement age so that you can maximize your benefits and qualify for Medicare. If you are planning to retire prior to that time and grabbing a smaller Social Security check, remember that by doing so, you will permanently reduce your (and your non-working spouse’s) retirement benefits. And if you are not eligible to be in the Medicare program, you may have the additional cost of individual health insurance. Some have pointed out to me that if they die early, then early SS is worth it. Call me crazy, but somehow premature death does not seem like a prize.
Perhaps of greater importance than the simple math associated with Social Security, is when you retire early you are foregoing your income during what may be some of your highest earning years. And of course without that income, you will start dipping into your savings and investments. Consumer Reports tried to quantify the early retirement decision by analyzing a hypothetical $54,592 (the median U.S. household income for 62-year olds). Assuming Mr. Early- Retirement stopped working at the beginning of 2008 at 62 and started to collect SS, his reduced benefits and private health insurance, plus his four years of lost income (including 4% annual raises) cost him approximately $237,000-$309,000.
Need I point out that it is very difficult to earn hundreds of thousands of dollars on a risk-free basis? Given the amount of time and energy that everyone spends on contemplating retirement, one of the easiest solutions may be the one you don’t want to hear: keep working!
Thursday, March 13, 2008
Consumer Reports’ Money Mistakes 1
I like a catchy headline, which is why I picked up Consumer Reports for the first time since purchasing a car a few years ago. Who would not want to know the “12 Money Mistakes That Could Cost You $1,000,000”? I can’t give away all of the mistakes, but two in particular should be shouted from the mountaintops across the nation.
According to the Consumer Reports “Money Lab”, the number one, costliest mistake that people make is investing too conservatively during retirement. I have seen this problem first-hand – as people retire, they abandon riskier assets like stocks and allocate much of their portfolio in bonds or cash. I always try to explain that for most people, this decision can be problematic. The reason is that the number one goal of retirement portfolio allocation is to keep pace and hopefully beat inflation. To do this, you probably need a broadly-diversified portfolio, which means that you can not abandon risk all together.
Conventional wisdom has long suggested that as retirees age, they should shift money out of stocks and into more stable investments, such as bonds or certificates of deposit (CDs). But the problem with that philosophy is that those safer instruments’ annual returns may barely keep pace with inflation, while stocks, over time, typically provide returns significantly above inflation. And inflation can be a retiree's worst enemy.Consumer Reports teamed up with investment-research firm Ibbotson Associates, to back test the idea of a diversified portfolio using data from 1940 through 2006. In the exercise, they assumed that the investor retired at 65 with $500,000 in savings to invest. They also factored in that the retiree would need to pull some money out of the portfolio at a rate of 3 percent each year during retirement and adjusted returns for inflation. The results were impressive: “we found that an asset mix leaning more toward Standard & Poor's 500 stock index than bonds provided bigger returns and annual cash draws…the team estimates that the cost of this mistake to people who are risk-averse to be in the range of $360,000 to $750,000.”
On some level you know this information, but it is difficult to stick to it, especially as the stock market meanders at these lower levels. But with CDs earning a paltry few percent and inflation on the rise, the alternative does not seem appealing. Tomorrow we’ll tackle another great Consumer Reports Money Mistake.
According to the Consumer Reports “Money Lab”, the number one, costliest mistake that people make is investing too conservatively during retirement. I have seen this problem first-hand – as people retire, they abandon riskier assets like stocks and allocate much of their portfolio in bonds or cash. I always try to explain that for most people, this decision can be problematic. The reason is that the number one goal of retirement portfolio allocation is to keep pace and hopefully beat inflation. To do this, you probably need a broadly-diversified portfolio, which means that you can not abandon risk all together.
Conventional wisdom has long suggested that as retirees age, they should shift money out of stocks and into more stable investments, such as bonds or certificates of deposit (CDs). But the problem with that philosophy is that those safer instruments’ annual returns may barely keep pace with inflation, while stocks, over time, typically provide returns significantly above inflation. And inflation can be a retiree's worst enemy.Consumer Reports teamed up with investment-research firm Ibbotson Associates, to back test the idea of a diversified portfolio using data from 1940 through 2006. In the exercise, they assumed that the investor retired at 65 with $500,000 in savings to invest. They also factored in that the retiree would need to pull some money out of the portfolio at a rate of 3 percent each year during retirement and adjusted returns for inflation. The results were impressive: “we found that an asset mix leaning more toward Standard & Poor's 500 stock index than bonds provided bigger returns and annual cash draws…the team estimates that the cost of this mistake to people who are risk-averse to be in the range of $360,000 to $750,000.”
On some level you know this information, but it is difficult to stick to it, especially as the stock market meanders at these lower levels. But with CDs earning a paltry few percent and inflation on the rise, the alternative does not seem appealing. Tomorrow we’ll tackle another great Consumer Reports Money Mistake.
Wednesday, March 12, 2008
Aunt Fannie and Uncle Freddie
You may have noticed that two previously-sleepy companies have been in the news. The mammoth mortgage lenders Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) have come under severe pressure from the housing crisis. This prompted someone to ask me, “What’s up with Fannie and Freddie—I thought they were supposed to be safe!”
Before I go into the why, a brief overview of the companies is necessary. Fannie and Freddie are Government Sponsored Enterprises (GSEs), a group of corporations created by Congress that are intended to enhance the flow of credit to the housing market by maintaining an active secondary market for mortgages. Fannie and Freddie are publicly traded and are authorized to make loans and loan guarantees. However, they are not government agencies and Uncle Sam does not guarantee them. Although they are not directly backed by the full faith and credit of the US, GSE bonds have long been considered to be high credit quality and investors have assumed the government would bail them out in a crisis.
With Fannie’s stock down from over $70 in August to a low of $19.81 just a few days ago and Freddie’s from over $68 to a recent low of $17.52, some might say that the crisis is here. The stocks dropped over the past week as forced sales of securities by some distressed investors drove the yields on mortgage securities guaranteed by Fannie and Freddie to as much as about 3.5% Treasury securities, the highest since 1986. But over the course of the past year, Fannie and Freddie have been slammed as a result of the housing recession and anxieties that home-mortgage defaults will force the companies to raise more capital.
This may seem crazy, because GSEs mostly guarantee prime fixed-rate mortgages, not the more exotic subprime stuff. But even good borrowers have come under pressure as the housing market has continued to reel and the economy cools. Fannie says about 1% of the conventional single-family loans it owns or guarantees are 90 days or more overdue and that it expects credit, or default-related, losses equal to 0.11% to 0.15% of its mortgage portfolio this year, up from a previous forecast of 0.08% to 0.10%. Yes, these are teeny numbers, but considering that at the end of 2007, Fannie had guaranteed $2.55 trillion of mortgages, small numbers add up. Based on Fannie's estimate of 0.15% of losses, the total would be approximately $4 billion.
For this reason, the Federal Reserve stepped in yesterday to help. The US central bank said that it would lend up to $200 billion of Treasury securities and allow banks and dealers to pledge various flavors of mortgage-backed securities as collateral to help ease the strain on the credit market. That announcement helped Uncle Sam’s beleaguered cousins Aunt Fannie and Uncle Freddie tremendously, at least for the day, which judging by the reaction of investors (US stocks were up 3.5-4%), was necessary treatment.
Before I go into the why, a brief overview of the companies is necessary. Fannie and Freddie are Government Sponsored Enterprises (GSEs), a group of corporations created by Congress that are intended to enhance the flow of credit to the housing market by maintaining an active secondary market for mortgages. Fannie and Freddie are publicly traded and are authorized to make loans and loan guarantees. However, they are not government agencies and Uncle Sam does not guarantee them. Although they are not directly backed by the full faith and credit of the US, GSE bonds have long been considered to be high credit quality and investors have assumed the government would bail them out in a crisis.
With Fannie’s stock down from over $70 in August to a low of $19.81 just a few days ago and Freddie’s from over $68 to a recent low of $17.52, some might say that the crisis is here. The stocks dropped over the past week as forced sales of securities by some distressed investors drove the yields on mortgage securities guaranteed by Fannie and Freddie to as much as about 3.5% Treasury securities, the highest since 1986. But over the course of the past year, Fannie and Freddie have been slammed as a result of the housing recession and anxieties that home-mortgage defaults will force the companies to raise more capital.
This may seem crazy, because GSEs mostly guarantee prime fixed-rate mortgages, not the more exotic subprime stuff. But even good borrowers have come under pressure as the housing market has continued to reel and the economy cools. Fannie says about 1% of the conventional single-family loans it owns or guarantees are 90 days or more overdue and that it expects credit, or default-related, losses equal to 0.11% to 0.15% of its mortgage portfolio this year, up from a previous forecast of 0.08% to 0.10%. Yes, these are teeny numbers, but considering that at the end of 2007, Fannie had guaranteed $2.55 trillion of mortgages, small numbers add up. Based on Fannie's estimate of 0.15% of losses, the total would be approximately $4 billion.
For this reason, the Federal Reserve stepped in yesterday to help. The US central bank said that it would lend up to $200 billion of Treasury securities and allow banks and dealers to pledge various flavors of mortgage-backed securities as collateral to help ease the strain on the credit market. That announcement helped Uncle Sam’s beleaguered cousins Aunt Fannie and Uncle Freddie tremendously, at least for the day, which judging by the reaction of investors (US stocks were up 3.5-4%), was necessary treatment.
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