“IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac. It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses.”- Jonathan Lang in Barron’s August 18, 2008
And so began phase two of the Fannie and Freddie “deathwatch” on Wall Street. Perhaps you thought that the crisis over the two government-sponsored enterprises (GSEs) had passed in July when the Treasury Department stepped in and quelled frayed nerves. The Barron’s article highlighted the fact that the continuing decline in real estate values has led to a spike in mortgage delinquencies and foreclosures, which in turn have severely damaged the balance sheets of both Fannie and Freddie.
While the two companies may be adequately capitalized according to their regulator’s current definition, according to Barron’s, “On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.”
While both companies maintain that they have enough money to weather this storm (remember when Bear Sterns said the same thing a week before it practically filed for bankruptcy?), it has become clear that the GSEs need to raise cash and fast. But who in his right mind would take the plunge right now? Two weeks ago, the companies added another $3.1 billion in losses to the $11 billion they had already reported in recent quarters. Talk about throwing good money after bad!
When in doubt, you can count on good ol’ Uncle Sam to provide the big-time safety net. Last month, Congress gave the Treasury Department the authority to lend money to the firms or take an equity stake in them. It is estimated that the federal government would have to pump approximately $20 billion into each company, possibly through a guarantee rather than through a direct injection of capital. Legislation passed last month allows the government to do so to stabilize financial markets and to prevent disruption in the mortgage industry. Barron’s noted that a government bail-out might “take the form of a preferred stock with such seniority, dividend preference and convertibility rights that Fannie's and Freddie's existing common shares effectively would be wiped out, and their preferred shares left bereft of dividends.”
Time is ticking for Fannie and Freddie but one thing is for sure: investors are convinced that the government will take steps to end the patient’s suffering. We can only hope that the end is swift and as painless as possible.
Friday, August 22, 2008
Thursday, August 21, 2008
Inflation Gyration
There has been so much talk/hype about inflation this year because it touches all of us and therefore is a story that attracts everyone. Indeed, the surest sign of price increases has been seen at the pump and at the grocery store, places we frequent weekly.
The good news is that almost all commodity prices across the board have cooled—crude oil has backed off from a high of $147 to the $114 level, down 22% in about 6 weeks and grain prices have retreated--rice is down 40% since May. Unfortunately, just as it takes time for price increases to work their way into the system, so too do decreases experience a lag effect. The Labor Department’s release of the July Producer Price Index (PPI), that is, prices that businesses pay for goods (versus what consumers pay), indicated that high prices are still with us.
PPI rose by a seasonally-adjusted 1.2% in July, marking a 9.8% from July 2007. It was the highest annual increase since June 1981. The index of core prices, which excludes food and energy to gauge underlying inflation, rose 0.7% in July for a 3.5% increase from a year earlier, its highest in 17 years. The surge does not yet account for the decline in oil prices, since the survey was taken too early in July, but given the data recently released for consumers, it is startling to note that businesses are absorbing a large portion of the price increases. Consumer prices have increased by 5.6%, compared to this 9.8% spike. The net result of the differential amounts to a squeeze on the margins of the nation’s businesses, which does not bode well for profits in the future.
One worrying fact in the stubbornly-high PPI reading was noted by Wall Street Journal columnist Mark Gongloff on August 19th: the July PPI report marks “the third consecutive month that PPI growth has hovered above 7.1%, an important threshold for investors. That level has been broached on only five occasions in the past 60 years. In each case, PPI continued to surge for several months thereafter, according to Natixis Bleichroeder technical analyst John Roque. And each time, PPI growth clocked in at double digits before cooling. This suggests inflation takes time to lose steam.”
What it does not mean is a return to the price shocks of the early or late 1970s, the last time commodity prices took off and created mayhem for the economy. Gongloff notes that “Two major ingredients are missing from the recipe that kept inflation so hot for so long in the 1970s: The Fed is more diligent, and organized labor is much less able to win higher wages. Those two factors, along with slowing global demand for commodities, should keep inflation from getting out of hand in the long term, though there may be some hair-raising numbers to come.”
That’s the good news…the bad news is that inflation, like the housing and credit crises, will take time to unwind. With investor patience hanging by a thread, the additional evidence of “more to come” is unsettling, challenging and demoralizing. Unfortunately, it is exactly where we are.
The good news is that almost all commodity prices across the board have cooled—crude oil has backed off from a high of $147 to the $114 level, down 22% in about 6 weeks and grain prices have retreated--rice is down 40% since May. Unfortunately, just as it takes time for price increases to work their way into the system, so too do decreases experience a lag effect. The Labor Department’s release of the July Producer Price Index (PPI), that is, prices that businesses pay for goods (versus what consumers pay), indicated that high prices are still with us.
PPI rose by a seasonally-adjusted 1.2% in July, marking a 9.8% from July 2007. It was the highest annual increase since June 1981. The index of core prices, which excludes food and energy to gauge underlying inflation, rose 0.7% in July for a 3.5% increase from a year earlier, its highest in 17 years. The surge does not yet account for the decline in oil prices, since the survey was taken too early in July, but given the data recently released for consumers, it is startling to note that businesses are absorbing a large portion of the price increases. Consumer prices have increased by 5.6%, compared to this 9.8% spike. The net result of the differential amounts to a squeeze on the margins of the nation’s businesses, which does not bode well for profits in the future.
One worrying fact in the stubbornly-high PPI reading was noted by Wall Street Journal columnist Mark Gongloff on August 19th: the July PPI report marks “the third consecutive month that PPI growth has hovered above 7.1%, an important threshold for investors. That level has been broached on only five occasions in the past 60 years. In each case, PPI continued to surge for several months thereafter, according to Natixis Bleichroeder technical analyst John Roque. And each time, PPI growth clocked in at double digits before cooling. This suggests inflation takes time to lose steam.”
What it does not mean is a return to the price shocks of the early or late 1970s, the last time commodity prices took off and created mayhem for the economy. Gongloff notes that “Two major ingredients are missing from the recipe that kept inflation so hot for so long in the 1970s: The Fed is more diligent, and organized labor is much less able to win higher wages. Those two factors, along with slowing global demand for commodities, should keep inflation from getting out of hand in the long term, though there may be some hair-raising numbers to come.”
That’s the good news…the bad news is that inflation, like the housing and credit crises, will take time to unwind. With investor patience hanging by a thread, the additional evidence of “more to come” is unsettling, challenging and demoralizing. Unfortunately, it is exactly where we are.
Tuesday, August 19, 2008
The Best May Not be Yet to Come
In my family, we love to ask the following trivia question: What was written on Frank Sinatra’s gravestone? The answer: “The Best is Yet to Come”, the title of the song written by Cy Coleman with lyrics by Carolyn Leigh and famously sung by old Blue Eyes himself in 1964. I thought about that classic after reading a particularly downbeat assessment of the global credit crisis yesterday.
According to Professor Kenneth Rogoff, a leading academic and a respected former chief economist of the International Monetary Fund from 2001 to 2004, it’s going to take some time before we can croon those famous lyrics. Speaking at a conference in Singapore, Rogoff said “The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come.”
How much worse could it get, you ask? Rogoff contends that the problems could devolve further and cause the failure of a large US bank within months. “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one — one of the big investment banks or big banks.” So far, only eight federally regulated banks or thrifts have failed this year, but more than 100 others are on the government’s watch list.
I find this particular prediction both ominous and welcome. Of course if a major US institution were to fail, there would be widespread panic and markets would get roiled for the third time this year. The first time occurred when Bear Sterns came within hours of filing for bankruptcy in March and the second instance was the Fannie Mae/Freddie Mac melt-down in July, which has continued into August, as concerns reignited about the government sponsored entities’ viability this week. Shares of Fannie and Freddie plummeted to their lowest levels since the early 1990s yesterday, amid fears that both would be nationalized sooner than later.
To some extent, a third crisis would not be a big surprise, although the guessing game of which firm might actually meet its maker could become a sport in and of itself. Odds-makers would probably make Lehman Brothers tops on their “death” list, but don’t count out another biggie like Merrill Lynch or Citi from the dubious distinction, or perhaps another firm that is not on the radar right now. Regardless of whether or not there will be an outright failure, it is indeed likely that divestment and consolidation of the financial services industry will go on for some time.
But perhaps a third phase of cleansing is necessary for us to put in a bottom in this mess and that would definitely be a welcome occurrence. Of course the bottom does not mean that everything is going to turn around quickly, but it would signal an end to the worst part of the suffering. Then, and only then, we just might be able to sing a few lines of the following and hope that better times are just around the corner.
“The best is yet to come, and wont that be fineYou think you’ve seen the sun, but you ain’t seen it shine”
According to Professor Kenneth Rogoff, a leading academic and a respected former chief economist of the International Monetary Fund from 2001 to 2004, it’s going to take some time before we can croon those famous lyrics. Speaking at a conference in Singapore, Rogoff said “The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come.”
How much worse could it get, you ask? Rogoff contends that the problems could devolve further and cause the failure of a large US bank within months. “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one — one of the big investment banks or big banks.” So far, only eight federally regulated banks or thrifts have failed this year, but more than 100 others are on the government’s watch list.
I find this particular prediction both ominous and welcome. Of course if a major US institution were to fail, there would be widespread panic and markets would get roiled for the third time this year. The first time occurred when Bear Sterns came within hours of filing for bankruptcy in March and the second instance was the Fannie Mae/Freddie Mac melt-down in July, which has continued into August, as concerns reignited about the government sponsored entities’ viability this week. Shares of Fannie and Freddie plummeted to their lowest levels since the early 1990s yesterday, amid fears that both would be nationalized sooner than later.
To some extent, a third crisis would not be a big surprise, although the guessing game of which firm might actually meet its maker could become a sport in and of itself. Odds-makers would probably make Lehman Brothers tops on their “death” list, but don’t count out another biggie like Merrill Lynch or Citi from the dubious distinction, or perhaps another firm that is not on the radar right now. Regardless of whether or not there will be an outright failure, it is indeed likely that divestment and consolidation of the financial services industry will go on for some time.
But perhaps a third phase of cleansing is necessary for us to put in a bottom in this mess and that would definitely be a welcome occurrence. Of course the bottom does not mean that everything is going to turn around quickly, but it would signal an end to the worst part of the suffering. Then, and only then, we just might be able to sing a few lines of the following and hope that better times are just around the corner.
“The best is yet to come, and wont that be fineYou think you’ve seen the sun, but you ain’t seen it shine”
Monday, August 18, 2008
All that in TWO weeks!
It used to be that July and August was a safe time to take some time off from work – that was until a series of bad summers occurred. Still, when else can you stay close to home and enjoy some of the world’s best beaches? When I left for vacation on July 31st, I did not expect that the summer doldrums would infiltrate the volatile investment landscape of 2008, but I was still a little surprised with the number of big stories that did break. Given the breadth and impact of the news, I thought it might make sense to extrapolate lessons for investors from the headlines – indeed; there was ample material from which to draw over the past fourteen days.
The ho-hum build up to the Olympics morphed into a frenzy of excitement, starting with the breathtaking opening ceremony (loved the fireworks!); continuing with the amazing 23-year old Michael Phelps winning eight gold medals; and of course an opportunity to laugh at our friends up north in Canada, whose uniforms spurred numerous outbursts of “yuck!” Even the most jaded could not help but get caught up in the wonder of the world’s athletes - investors should take note of the discipline, determination and planning necessary for each success story.
Russia’s invasion of Georgia was the antithesis of the Olympic spirit, but considering that I had read “War and Peace” over vacation (yes, all 1215 pages of the new translation!), I was steeped in the Russian spirit and could understand how bitter divisions could escalate into a larger conflict. As I read about the Russian march into Georgia, there seemed to be a uniform criticism of the world’s leaders, who missed a variety of signals leading up to the conflict. The take-away on this one is important: investors need to prepare for a variety of outcomes, even those that they really do not want to occur. By doing so, there is a chance to limit downside problems and perhaps the ability to find a good opportunity while others are in full-blown panic mode.
Now on to some of the financial headlines, the biggest of which is that commodity prices collapsed in my absence. Part of the plunge was attributed to the strengthening US dollar and weakening global demand, but a good bit of the action has been caused by the unwinding of a speculative fervor that gripped investors over the past three years. Although I own commodities on behalf of our clients as a long-term hedge, there is no way to interpret the pull-back as anything but good for the overall health of the global economy and the markets, as inflationary fears recede. Investors should take note that when price action is extreme on the upside; it stands to reason that the regression back to the norm will be equally as violent.
Finally, as we mark the one-year anniversary of the credit crisis, journalists continue to reflect on how the financial system got to a place of near-collapse. Investors should draw comfort by the uniform explanation offered by the pundits: when returns are pursued regardless of the risks involved, nothing good is likely to occur. In the end, this crisis can be boiled down to the same ol’ culprits that investors encounter every day: greed and fear. As the pendulum swings from greed to fear, the system has a tough time operating effectively. But this crisis will pass, just not as quickly as any of us would like.
The ho-hum build up to the Olympics morphed into a frenzy of excitement, starting with the breathtaking opening ceremony (loved the fireworks!); continuing with the amazing 23-year old Michael Phelps winning eight gold medals; and of course an opportunity to laugh at our friends up north in Canada, whose uniforms spurred numerous outbursts of “yuck!” Even the most jaded could not help but get caught up in the wonder of the world’s athletes - investors should take note of the discipline, determination and planning necessary for each success story.
Russia’s invasion of Georgia was the antithesis of the Olympic spirit, but considering that I had read “War and Peace” over vacation (yes, all 1215 pages of the new translation!), I was steeped in the Russian spirit and could understand how bitter divisions could escalate into a larger conflict. As I read about the Russian march into Georgia, there seemed to be a uniform criticism of the world’s leaders, who missed a variety of signals leading up to the conflict. The take-away on this one is important: investors need to prepare for a variety of outcomes, even those that they really do not want to occur. By doing so, there is a chance to limit downside problems and perhaps the ability to find a good opportunity while others are in full-blown panic mode.
Now on to some of the financial headlines, the biggest of which is that commodity prices collapsed in my absence. Part of the plunge was attributed to the strengthening US dollar and weakening global demand, but a good bit of the action has been caused by the unwinding of a speculative fervor that gripped investors over the past three years. Although I own commodities on behalf of our clients as a long-term hedge, there is no way to interpret the pull-back as anything but good for the overall health of the global economy and the markets, as inflationary fears recede. Investors should take note that when price action is extreme on the upside; it stands to reason that the regression back to the norm will be equally as violent.
Finally, as we mark the one-year anniversary of the credit crisis, journalists continue to reflect on how the financial system got to a place of near-collapse. Investors should draw comfort by the uniform explanation offered by the pundits: when returns are pursued regardless of the risks involved, nothing good is likely to occur. In the end, this crisis can be boiled down to the same ol’ culprits that investors encounter every day: greed and fear. As the pendulum swings from greed to fear, the system has a tough time operating effectively. But this crisis will pass, just not as quickly as any of us would like.
Subscribe to:
Posts (Atom)
