The Market Ticker

How do you spell "No Confidence"?

I'd say that the futures market did a damn good job getting in front of Humphrey-Hawkins, wouldn't you?

Down 18 handles at the peak at roughly 5:30 this morning.  Hmmmm....

Why?

Because all we have seen is more jawboning overnight.  Ms. FDIC continues to chant "Banking deposits are overwhelmingly safe", instead of getting out in front of the actual issue and allowing us to see which banks hold crap (that is being intentionally mis-marked) and which are not.

The truth must replace gum-flapping.

Merideth Whitney apparently agrees - she said:

"For the financial markets to stabilize, we believe banks need to swiftly address true asset values and adjust their books accordingly."

Better late than never.  Now if we could only get a few regulators to agree with the only honest professional analyst in this sector.

The dollar has broken a consolidation pattern "the wrong way", that is, south, and if we do not get things under control fairly quickly there is the real possibility of a waterfall collapse.  A quick look at that chart reveals that this is the second "bearish" flag, the first of which proved out, and this one potentially takes the dollar into the mid-60s.  Such a collapse would result in an insane amount of price inflation being immediately reflected in all imports - another 11% could literally appear in everything you buy that is imported over the space of just a few months.

PPI up 1.8% monthly, 9.2% headline y/o/y.  1.8%?!  Oh.  My.  God.

Food up 1.5%, energy up six percent.  Ex-food and energy up 0.2%.

Now this is all "seasonally adjusted".  The details inside the report are the important component here.

What does this tell me?  It says that food and energy are screaming higher, but in the rest of the economy, as demand continues to soften and purchasing power goes in the toilet, we are seeing deflationary forces.

Empire manufacturing was only down 4.9 (was expected down 9).

Furniture, autos and machinery are down.  What's better in retail sales?  Gasoline. 

The Fed, unfortunately, probably sees this as validation of their policies and approach!  Why?  Because they are concerned about a wage-price spiral, and you can't get there so long as the labor market is not tight and your money is directed towards necessary purchases such as gasoline and heating oil!

So the perverse reality of what's going on right now in the world is that as your standard of living is shredded and your purchasing power destroyed, The Fed likes the outcome because their "liquidity games" allow their buddies to trade commodities and try to work their way out of the hole while you get the bill.

Unfortunately it is my view that this remains a sucker's game. 

Why? 

Because you can't work your way out of this hole; its too deep, too steep, and as you claw at the sides it collapses on top of you.

Ackman comes on CNBC this morning and starts running his book - a plan to "save" Freddie and Fannie. Of course he does this after he shorts their stock.  Tee hee.  While his plan isn't horrible, the fact that he went in and shorted them first is going to make this a non-starter in Congress.  There's a "book-talking" component to everyone's point of view, including mine, but that sort of thing has gone beyond reasonable.  Its also why when I put forward my view on Freddie and Fannie, I had no position on either firm; my intent, as I wrote that and as I write this today, is that if I'm going to play either name at all I will be daytrading them because the "tape bond" risk holding anything overnight on these names is just too high for my taste and I'd like some sort of shot at Congress - and the regulators - actually considering my point of view.

You can't get there when you put a trade on and then ask the government to make it pay.

I want to talk about IndyMac for a bit.

The news has covered a few really, truly sad stories.  People with $200,000, $300,000, $400,000 or more in there who have seen 50% of their balance over $100k disappear overnight.

Older people who literally have their life savings in these institutions.  People who are relatively unsophisticated, but have been told through the years that the government will make it all ok, and who believed it.

It tugs at your heart to see a 70+ year old man pleading for them to let him have his money - money that he worked and saved a lifetime for.

If only it were that easy.

People don't think of a bank as being an investment, but it is. 

You are lending your money to the bank so they can make money with it, and they pay your a coupon - interest, or the "safekeeping" in the case of a checking account that does not pay interest - in return!

We do such a horrible job of financial literacy in this nation that it truly makes me ill.  There is no excuse for this lack of knowledge among our citizens, and yet people like Bernanke, Congress and more like it that you're ignorant, because without that ignorance they can't pull their crap and rip you off.

Neither can stock brokers, mortgage brokers, car dealers, credit card issues or payday loan shops.

If you're a parent, you need to get off your ass and get in front of the local School Board.  You need to get your face in front of the Principal of your schools and raise hell.

Now.

Yes, you can teach your own kids about this stuff.  But unless we make sure that all of the kids of America learn this stuff, which means changes in our educational system that must start with you as parents raising hell with the schools, we will never break the back of this cycle.

We have 20 and 30-somethings that got snared in this housing bubble and the credit-card mess because our parents did not do their job and beat on the schools regarding this issue.

Now its our turn.

Will we do our job?

I told you so Hank, Ben, Congress, and the rest.

The entire credit system is all about confidence.

A year ago I started telling you, and everyone else via Market Ticker, they you had to cut the crap and stop allowing people to lie, or you risked confidence being destroyed.

Today, you're finding out what happens when you don't stop the lies on the balance sheets, don't stop the Level 3 crap, and don't stop lying to The American People.  You can't say "I'm for a strong dollar" and then make $250 billion more of them available, the exact opposite of encouraging scarcity, which is how you get a strong dollar, and expect people to take you seriously.

You can't say "subprime is contained" and never apologize for being 100% wrong.

You can't say "the banking system is sound" and then have the second largest failure ever recorded in FDIC history happen a short while later, when the balance sheets of these firms were available to everyone - with their warts displayed - for more than a year prior.

You can't tell people "the economy is fundamentally strong" when unemployment rises and the price of oil doubles in the space of less than a year as a direct consequence of your monetary and fiscal policy.

Bluntly: You've now got a run on the equity (if not the deposits) of virtually every regional bank in the nation because nobody believes you any more. 

Your attempt to stabilize confidence with Fannie and Freddie has failed because, in short, nobody believes you any more.

WaMu, National City, Wachovia, First Federal, Downey, Colonial.  All down 7% or more, with some down twenty percent today, and with most of them down 90% or more in the last year.

Why?

Because nobody believes you, the FDIC, the OTS or OCC any more.

There is one - and only one - way you can stop this.

You must force every financial institution in America to tell the truth.

NOW.

If you do not stop this NOW it will spread like a cancer from firm to firm, from financial company to financial company, until it consumes all of those who do not voluntarily "come clean" before it gets to be their turn.

You have not lost control; you, along with Congress, have abdicated control.  The Campaign Contributions and shell games have now reached critical mass with The American People, who are no longer willing to take the risk of their investments being destroyed without warning as a result of the lies.  They can and are running for the exits first, following the time-honored principle that "he who panics first gets out with the most of his money intact."

Bernanke, Frank, Dodd, Paulson - we may be literally days - or hours - away from an all-on equity market implosion.

If it happens, it will be because you have consistently refused to listen to those of us who have been telling you that you must force these institutions to to cut this crap out and tell the truth.

You cannot stop this by talking.

You must stop it by doing. 

You must issue a directive today that states quite clearly, here and now:

NO MORE OFF-BALANCE SHEET ANYTHING, NO MORE LEVEL 3 ANYTHING.  YOU MUST DISCLOSE AND MARK TO THE MARKET EVERYTHING YOU HOLD, TODAY AND FOREVER MORE, AND IF THIS LEAVES YOU INADEQUATELY CAPITALIZED, YOU WILL BE FORCIBLY MERGED OR SEIZED HERE AND NOW.

Now.

Today.

Period.

Time's up.

Well, that was no big surprise, really.

Fannie and Freddie got their announcement:

"Treasury Secretary Henry Paulson put the weight of the federal government behind Fannie Mae and Freddie Mac, the beleaguered companies that buy or finance almost half of the $12 trillion of U.S. mortgages.

Paulson, speaking on the steps of the Treasury facing the White House, asked Congress for authority to buy unlimited stakes in and lend to the companies, aiming to stem a collapse in confidence. The Federal Reserve separately authorized the firms to borrow directly from the central bank."

Yeah, ok.

Oh, the futures went higher on this announcement.  By a lot.

Huh?

Anyone look at the bond market?  It didn't like it one bit.  Granted, the reaction in electronic trading of the TNX was muted, but it was not what you want to see - yields up smartly.

Oh, and that's not "rotation away from risk and into stocks."  Not at 6:00 PM on Sunday.  Its more a function of "oh oh, here comes the risk of monetizing $5 trillion worth of bad paper stuck in these companies."

Now let me guess - are you so much of a fool as to believe that this is good for stocks?  If so, you should buy-buy-buy this morning. 

Please let me know what you're buying so I can short it to you.

Why?

Because when the market gets its arms around what's going on here, there is a very good chance that we're going to get an all-on market CRASH.

Not today.  Not tomorrow.  Of course today, with CNBC's cheerleading along with Chris Dodd, we go higher - at least at the open. But as the days wear on, and the facts come to light.......

Why?

Well let's do a little math exercise.

Fannie and Freddie together either hold or guarantee $5 trillion in mortgages.  Nearly all of that was issued in the last 20 years; these firms had tiny balance sheets back in 1990.

Now here's the problem - while Fannie and Freddie are claimed to be all 80/20 full-doc loans this is in fact a lie. 

In fact, a huge percentage of the loans they took on or guaranteed in the last five years were packed with fraud or serious deficiencies in underwriting in some form, whether it be appraisal fraud, claimed income fraud, LTVs as high as 100%, or all three! 

So how bad could this get?

Very bad.

I believe that Fannie and Freddie have as much as half of their paper subject to loss of some form, and that paper which is out in places like California could suffer losses as high as 50%.  Since this is the largest economy in the nation by far, there's no possibility that this is a "small issue."

In reality I believe that Fannie and Freddie could suffer as much as $900 billion in losses as this all plays out.  This assumes that 10% of their portfolio turns out to be essentially worthless and 20% is impaired by at least 10%, with the rest being 100% "money good." 

Frankly, I think that's a bit optimistic, but we'll run with it.

Congress of course has been asked for a "blank check."  If the market comes to the realization that this "blank check" could be as large as $900 billion, do not expect the reaction to be anything like what you have seen this morning.

Chris Dodd must have been reading Tickers, because he asked on the air this morning "Where were the cops?"

Well Chris?  Where were you, and other members of your committee?  After all, you are the cops!  You're the folks who write the bills that form these pesky things called laws that ultimately set the boundaries of regulation.

OpenSecrets.Org says that the cops are in the robber's pockets.  Specifically, Chris Dodd has received the following contributions from PACs linked to the following firms:

Gee, what do you think?  Citigroup, Bear Stearns, Goldman, Morgan Stanley, Credit Suisse, Merrill Lynch, JP Morgan, RBS, Lehman? 

These are a "who's who" list of firms that were involved in blowing the credit bubble and creating the housing mess!

But that's not even the real news here.

The real news is IndyMac, and the fact that the FDIC is a bit, uh, "off the ball".

See, there are reportedly 75 (or more) banks on the "troubled" list.  The FDIC doesn't publish that list. Gee, I wonder why, especially after Friday, when IndyMac went under. 

Not that this should have been a surprise to anyone, given that it was trading at well under a buck for about a week.  Do 'ya think that's a good stock price?

No, the real 900lb Gorilla is that IndyMac was not on the FDIC's "troubled bank list"!

Vigilant? 

Competent? 

How hard is it for these folks to look at a damn 10Q and understand that anyone booking capitalized interest as a significant part of their "earnings" in a declining housing market is in DEEP TROUBLE?

Apparently, its too much trouble for regulators.

Oh, and IndyMac was reported to have a Tier Capital ratio of just one point seven five percent when it went down.

The threshold for "well-capitalized"?  Six percent.

So IndyMac apparently managed to lose two thirds of its required capital before it was noted and seized!

Folks, this is an absolutely disaster.  We have regulators sleeping at the switch, paying zero attention to the issues until they threaten to literally explode in their face.  This has gone on for years, and most notably, became absolutely blatant last spring when WaMu started reporting less cash earnings than were required for them to pay their dividend!

"Now here's the problem: In 1Q 06, 194 million out of $985 is 19.7%. In December, it was 31%. But this last quarter, it was FORTY SIX PERCENT, more than a DOUBLE over the year ago levels.

And what's worse, not one dime of that "income" can be spent! It is entirely phantom.

This is the same sort of crap that sunk Lucent and Enron - booking "income" that is not in fact spendable, as it has an impairment associated with it (the LTV is INCREASED by this negative amortization) AND it is not CASH!"

There's that "E" word again - ENRON.

Folks, this sort of crap is exactly what I and others have been talking about.  It is willful and blatant neglect of any sort of rational standard of care among our regulators and lawmakers, and since they are in the government you can't sue them nor is there any criminal indictment that can issue for their blindness!

You want to know what I think?

This whole damn thing is a shell game.  Let's count the ways that you as a taxpayer are being absolutely frapping ROBBED by these clowns in Washington DC:

1. The OTS, OCC and FDIC are ignoring 10Qs like the WaMu one I cited above, which make quite clear that the bank's position is deteriorating rapidly and, absent something that historically-speaking is almost certain not to happen (housing to immediately turn around), they are threatened as a going concern.
2. As these firm's position deteriorates further they start advertising hard for deposits, offering to pay insane (compared to their peers) coupons on CDs and similar.  This of course further narrows their spread between what they pay for money and what they make on loans.
3. Their book continues to deteriorate in credit quality.  Still, nobody cares to mind the store.  Fancy that.
4. Finally, someone notices that the curtains are on fire and everyone (bank)runs. Suddenly regulators are forced to act, and then of course they blame the person who yelled "Fire!" - instead of yelling at either the guy who LIT the fire, or themselves, who had a bucket of water but refused to throw it while it was still smoldering.

The regulators have had more than a full year's worth of warning on this, and have done nothing, and that is working off only the published 10Qs and 10Ks from these firms!  But these regulators have much more - they are in these firms all the time looking at their books and "examining" them, so they have lots of material non-public information to go along with it!

Ok, that's bad.  In fact, its real bad.  IndyMac could consume 10% or more of the FDIC's available cash reserves, from their own claims.  Who knows what the real number will be.

How many more institutions can fail before the FDIC runs out of money?  And more importantly, if they do, then Congress will be compelled to literally issue more Treasury debt to bail out the FDIC, thereby monetizing the losses and permanently damaging your standard of living so the Banker Barons who got their vacation homes in The Hamptons don't have to give any of their loot back.

Still feel safe at your local bank when you're not sure if they're on the list of 75, never mind that the 2nd biggest failure in the history of the FDIC was not?

That's what I thought.

Over the weekend I pointed out that we all, as Americans, had damn well better wake up.

Are you starting to get a sense of urgency about this yet?

The SEC is supposedly all pissed-off about "rumor-mongering" that led to the Fannie and Freddie panic, implying that they're going to try to figure out where those newspaper articles that started the run on their stock originated.

Well, how about this - are we going to see the SEC go after the admitted falsehoods Friday?  Remember, The Fed was rumored to be talking about bailing out Fannie and Freddie as was Treasury, and The Fed explicitly denied having had these conversations after the market closed.

Hmmmm..... let me guess - that rumor made stock prices go higher, so its ok?  Just like the dozens of rumors started last year and early this year related to Buffett buying half the world, all of which caused insane spikes in stock prices? 

Let me point out to the SEC's Chris Cox that market manipulation is defined, under the law, as illegal irrespective of whether it makes prices go up or down, yet I've not seen ONE claim that the SEC is after the people who, over the last year, started blatantly false rumors that spiked prices HIGHER.

One final note.

I have received emails over the last year telling me that I'm "un-American" for suggesting shorting stock, or outright saying that I am short this or that (whether literally or via synthetics such as PUTs.)

Well, let me ask you a few things, if you truly believe that.

Is it "American" to sit still while you are lied to repeatedly by Hank Paulson and Ben Bernanke, along with Congress, when they all tell you that "the economy is fundamentally strong", "subprime will not spread to the broader economy", "we have a strong-dollar policy" and more, and as a direct result of listening to those lies you remain "fully invested" and suffer a twenty-one percent loss from October to now?

Is it "American" to buy stock in a company that has literally made up values for things that it holds on its balance sheet because it does not like the price the market attaches to them, and then claims that it made a profit or suffered a smaller loss than would be the case had it showed you what the market price was for those securities?  That is, do you believe it is "American" to buy stock in a company that is intentionally reporting a made-up number for its "value"?

Is it "American" to buy a bubble house you cannot afford, then go bankrupt trying to pay for it, because some banker told you that you "qualified" for a loan they knew you'd never be able to pay back?

Is it "American" to listen to people tell you to go "buy buy buy" everything you want in the store so long as your credit card is not declined, irrespective of the fact that you can't really afford it and have no savings, literally being one paycheck away from bankruptcy?

I think not.

I believe that an American shorts the stock of companies who lie, and then demands that the SEC force them to tell the truth.

I believe that an American calls for every banker and mortgage broker, along with every appraiser and Realtor, who fostered an unsustainable bubble on purpose so they could have their mansion in The Hamptons, to be jailed for fraud.

I believe that an American refuses to sit still for the sort of social injustice heaped upon the 401k holders in this nation who have no safe place to put their money in a market like this, as nearly none of these plans have an "exclusively short-term treasuries" option (Exception: If you work for the government, you DO have such a choice!  Fancy that.  How come the government doesn't require private 401k plan managers to offer one?)

I believe that an American refuses to sit still while the bankers and brokers demand bailout after bailout, intentionally damaging our nation's currency and driving up the cost of essential commodities, with the impact of that devaluation falling on every American and hurting those of the lower and middle classes disproportionately, simply because they spend more of their income on these very same necessities.

I believe that an American ought to be, right now, on the phone to their Congressmen or woman daily asking these very questions, and refusing to get off the damn phone until they see actual legislation addressing the issues and forcing those who profited unjustly through fraud to pay for their offenses.

And finally, I believe that an American should demand from our Presidential Candidates real answers to these issues, along with real prison sentences for the offenders and, if neither Republican or Democrat will provide it, then all Real Americans have a duty to vote for a candidate who will, irrespective of their party.

Oh, here's the market's reaction to Fannie and Freddie's "Home Loan Savior" action by Paulson last night.....

Ok folks, its time for a long sit-down type of Ticker - the sort that I usually don't write.

Let's start with Fannie and Freddie.

As anyone who has been reading The Ticker knows, I have been saying for quite some time that Fannie and Freddie are in fact "short to zero" candidates for the common stock.  This is simply due to the mathematics of their financial situation - they are levered up anywhere from 60 to more than 200:1, depending on what you include and exclude from "capital" and "credit book."

I use the worst-case set of numbers, because in a bad market, that's what you wind up with - therefore, I include all of their credit guarantees, and exclude all intangibles such as "good will" and "tax loss carryforwards", with the latter being particularly important in this case because Fannie, for example, has some $13 billion in deferred tax assets.

That's not money, its an offset against future taxes.  But to pay taxes you must first make a profit, and in a bad market, those are worth a big fat zero.

So here we sit with two firms that are running with leverage ratios that make a Hedge Fund look like a convocation of the Girl Scouts.

The Federal Government continues to claim that they are "well-capitalized."  Uh huh.  And I'm the Easter Bunny.  Nobody running with a leverage ratio of 60:1 is "well-capitalized", say much less someone running with a leverage ratio of 200:1.

How did this happen?  Quite simple - our government allowed it and in fact prodded these firms into doing it. 

Fannie and Freddie began as firms that existed to provide liquidity to the conforming marketplace for mortgages, defined as 80/20 full-doc 30 year and 15 year loans.  That is, you put down 20% of the purchase price of the house in cash, limiting your leverage ratio to 5:1, and in addition the typical "back end ratio", or total debt to income, was limited to 36%. 

These loans are extremely safe because they have a fixed interest rate, your leverage is limited, and even in a severely-down housing market if you find yourself unable to pay the losses taken by the noteholder are limited or non-existent (you may be wiped out, but the note holder is likely to get most or all of their money back at foreclosure.)

As the 1990s and especially 2000 passed, however, Fannie and Freddie began to loosen standards.  They put in place "automated approvals" that were, for the most part, essentially driven by FICO scores - that is, whether you pay your credit cards on time.  In addition Congress prodded them to be the "standard bearer" for what was and is a horrible mis-allocation of capital - that is, to push the "American Dream" of homeownership to the maximum possible extent, and to glorify not owning a small bungalow in which you had enough room to sleep and raise a kid or two, but rather the "McMansion" philosophy of building on every square inch of farmland within 100 miles of a population center.

This is a misallocation of capital for a simple reason - a house does not generate GDP.  It has utility value as shelter but, unlike a machine, it generates no new GDP by being in existence.

You cannot base an economy on housing for this reason.

Normally a private company could not pursue their end of the "bargain" in this sort of non-GDP-growing enterprise because as they continued to drop credit standards and increase leverage by issuing more and more debt the market would impose discipline.  That is, as your gearing ratio went up so would the coupon - or interest rate - that you'd have to pay to issue that debt.  The free market works quite well in this regard, and severely punishes those who buy debt that doesn't pay enough to cover their risk - its called "bankruptcy" and tends to result in big capital losses for the bondholders.

But Fannie and Freddie were seen to be "government backed", even though every one of their prospectuses for their debt clearly says it is not.  That is, the market has perceived that they would not be allowed to fail irrespective of the amount of risk they took on!  Thus, as we went through the 2000s, literally $5 trillion worth of credit was issued and sold off to people - but at a spread to Treasuries - that is, at an implied level of risk that was not equivalent to US sovereign obligations.

But was this marketing reasonable?  No.  In truth hundreds of billions of dollars worth of mortgages were sold into Fannie and Freddie using automated underwriting systems from firms like Countrywide, many of them refinances, that literally verified almost nothing more than the applicant's credit score!  Debt-to-income and even in some cases property appraisals were either done by "automated" (meaning - nobody actually LOOKED at the property) means or not done at all!  The former stodgy - and reasonably safe - 80/20 mortgage in fact represented only a fraction of the total "buy" of mortgages during the 2000s.

Even worse, Fannie and Freddie, who guarantee their own bond issues, started buying their own paper.  That is, they are writing insurance on a hurricane when they are both the writer of the insurance and the loss payee.  This looks brilliant in that the "expense" of providing that insurance effectively disappears, thereby making the entirety of the spread they get from their source-of-funds to their paper issue theirs to keep, but that's the wrong way to look at it.

In fact that paper is uninsured, because the money comes from one hand goes to the other, attached to the same body. 

Where were the regulators?  Congress?  Intentionally asleep.  Remember that back in 2003 and 2004 both firms were found to have improperly accounted for their results.  This should have led to an immediate clampdown and forced deleveraging to no more than 10:1 on an audited basis.

It did not, and in fact neither firm timely filed accounting statements until last year, more than three years after the "errors" were discovered.

But for Congress, The Fed and OFHEO looking the other way on purpose most of the Housing Bubble could not have happened, as the money necessary to fuel it simply would not have been available.

Now we are faced with the reality - Fannie and Freddie, under fair value accounting rules, are insolvent (if you listen to Bill Poole.)  What does that mean?  It means that if Fannie and Freddie were to sell their assets and net it out today, you'd wind up with a negative number.  That is, its assets are less than its liabilities.

The question now comes down to "what do we do about this?"

There are several choices, all of which will have bad side effects.  It is critical, however, that we understand those side effects and choose the path forward that represents the least risk to the broader economy and to the government, not just the most expedient or the one that the people who would lose will scream most loudly about.

Here are the options:

1. The Fed "decides" to "open the discount window."  This is a non-starter, right up front.  Fannie and Freddie need longer-term - years in length - money.  Repos for 28 or even 90 days don't do them a damn bit of good and in fact destabilize them further as the rate and thus cost of that money makes hedging their portfolio against interest risk extremely difficult.  Forget this one.
2. The Fed "decides" to essentially backstop Fannie and Freddie by exchanging what's left of their balance sheet (longer-term bonds and notes) with GSE paper.  Down this road lies the immediate implosion of the Treasury market.  If they attempt this the dollar will instantaneously implode as The Fed will have converted the "backing" of our currency to houses declining in value while people's jobs and thus incomes necessary to pay the mortgages on same are being lost!  If Bernanke is stupid enough to do this (and note that from Friday's Ticker, Ben said he will do whatever he wants unless Congress explicitly passes a law to stop him) you are very likely to need steel and lead, not gold or dollars, as this would almost certainly provoke an immediate currency and treasury market crisis.
3. The Federal Government steps in and decides to "formally" guarantee Fannie and Freddie's debt.  This is an unmitigated disaster as it does nothing about the risk management policies and procedures in these firms.  In fact, The Senate has just passed a bill that will increase, rather than decrease, the risk on Fannie and Freddie's book via their funding of the "mortgage bailout bill."  The threat of this possibility is why, on Friday, the risk of default on US Government Debt doubled!  In my years in the market I have never seen this kind of bond market dislocation - the spread moved from 9 to 20 basis points in one day.  Further, the 10 year bond moved 15 basis points higher on yield on a day when people were scared to death and should have been demanding Treasuries, not selling them.  "Risk free" was partially removed from the description of Treasuries and if this path is taken much more damage will accrue to US Government debt.  ALL debt costs will rocket higher if this happens as everything is referenced, with a spread, off US Treasuries.
4. The government could attempt to prop them up without actually formally assuming control, by, for instance, forcing them to issue preferred stock which the government then buys.  This would also impact treasury funding costs but not as severely as (1-3) above, and it also likely does little or nothing to stop the problem, because deleveraging to reasonable levels (e.g. 10:1) would require a literal $500 billion worth of capital!  It would also destroy equity holders (stockholders) of their shares immediately by diluting them to an insane degree.
5. The government can decide to do nothing.  If Fannie and Freddie are unable to fund, they go under.  Period.  This would produce a monstrous dislocation in the housing market, but it would not cut off all mortgages.  It would, however, have a fairly dramatic impact on funding costs, probably adding 300 basis points to the cost of a mortgage - in other words, 30 year money would immediately go to about 9%.  However, other forms of credit would be largely unaffected, including and most importantly, US Government debt.
6. OFHEO could step in and declare Fannie and Freddie "severely undercapitalized" and put them into "conservatorship."  The next obvious step would be to place them into runoff, where they slowly divest their bond portfolio as it matures over the next 30 years.  This would have the same impact on mortgage money as (5) above, but current bondholders would see different amounts of damage depending on exactly where they are in the capital structure and what and when they bought.  Those who bought "trash paper" backed by what amount to no-doc loans would get creamed, while those who bought paper backed by 80/20 loans would likely lose nothing.

The only sane path forward, folks, is option #6.

Here's why.

#1 through #4 simply transfer the risk of loss, all of which was taken by Fannie and Freddie as private companies, to the taxpayer, in either whole or part.  It potentially doubles the Federal Public Debt from $5 trillion to $10 trillion (there is another $4 trillion in Federal Debt that is "not publicly held".)  Depending on which path and what combination of "pieces" are done, the impact would change, but none of this actually addresses the issue, which is that the credit book is too-highly leveraged and needs to be cut back.

#5 is a bad choice as well.  Doing nothing will lead to these firms destruction.  They are incapable of publicly offering equity at these stock prices and with this volatility - nobody in their right mind is going to buy, and the amount of equity they need is insane.  Trying to raise $500 billion is simply not going to happen, but its what needs to happen in order to restore their leverage ratios to sane levels (e.g. 10:1)

So this leaves one with #6, conservatorship and forced runoff.

Where does that leave us as an economy?

1. A return to sound mortgage standards.  30 year fixed money on an 80/20 basis (you put up 20% of actual cash as a down payment) will likely blow out by 100-200 basis points from where it is now - that is, 1-2% higher.  8% rates with 20% down will become the norm, with somewhat-lower rates, say, 7%ish, for those who are very well capitalized and can prove it.
2. Low-doc, higher ratio loans will remain available but they will be extremely expensive, as they should be.
3. House prices will contract immediately to where the average American will be able to afford the average house in a given area under a 30/fixed, 80/20 loan at 8%.  For many parts of this country this means a further huge decrease in home "values" - back to actual historical norms of 2.5-3x incomes.
4. The people who bought those Fannie and Freddie bonds thinking they were "risk free", while getting a premium over Treasuries, will take some losses. We cannot allow those losses not to be suffered, as that will, in effect, have allowed $50 billion per year to have been siphoned off by the buyers of these bonds, or nearly a half-trillion dollars over the last decade!

By the way, rumor is that Treasury is going to try to step in for $15 billion of preferred stock and access to the discount window.  The latter means nothing and the former is like trying to take a leak on a forest fire to put it out - at best it buys them a small cushion against losses for a quarter or two.

The market already gave you its opinion of any such "recapitalization" on the back of The American taxpayer.  Default swap spreads on GOVERNMENT debt doubled Friday.  That has never happened before.  Clearly there is a LOT of nervousness about the impact on the fiscal stability of The United States (as a whole!) should this attempt be made.

Now let's talk about IndyMac.  You have to have been in a cave not to know that they were seized yesterday.

The good news is that the FDIC covers you up to $100,000.

The bad news is that the FDIC took a huge charge on this one, somewhere between 10-20% of their total balance sheet - they think.  Unfortunately the damage will only stop there if people don't show up Monday to take all their money out, and if it does not spread to the other similarly-situated banks that also wrote scads of Option ARMs in California.

Both of these beliefs are, if the public has one lick of sense, the sort of magical thinking we should not tolerate from lawmakers and regulators.

Who else is on the list?  As I said before, pick any bank with substantial real estate exposure in California and/or Florida that offered Option ARMs - that is, negative amortization loans.

Most of them are already near zero in their stock prices; here's a partial (very partial!) list - Downey, First Federal, Wachovia and Washington Mutual.

Not all of these are "modest regional" banks.  Washington Mutual, in particular, is one institution that I highlighted last spring when their 10Q showed they were effectively paying dividends out of capitalized interest (that is, money they hadn't received yet as it was "increase" in loan value on Option ARMs.)  I predicted then that this would end badly for them.

OTS was out complaining about Chuck Schumer "causing" IMB to fail by inciting a bank run. 

OTS, you're wrong - you are the reason that IMB failed, and you, Congress, The Fed and OCC are the reason that all other institutions similarly situated are likely to fail as well!

OTS and OCC (not to mention The Fed or Congress) could have stepped in last spring when that 10Q from WaMu was released and started going through all of these banks, hitting every one of them with enforcement orders demanding that they stop that crap and divest themselves of that paper immediately.

They did not.

In fact, Wachovia didn't stop offering PayOption Mortgages (albeit "fixed rate" ones) until just a week or so ago, and Downey announced they were going to stop doing so just this last week!

So OTS, I think you need to shut up.  While Mr. Schumer and I could probably count the things we agree on using the fingers of one hand, the fact remains that in this he was absolutely right, and you were absolutely wrong. 

Your job is to guarantee the safety and soundness of our thrifts.  That means paying attention to what they're doing and the embedded risk of loss and default in each of those scenarios and programs.  You seem to think this is some sort of game, where you can simply "hope and pray", while fostering whatever sort of bubble economy the banks wish to dream up, and it will all be ok.

That of course is pure nonsense.

As for The Fed, OTS and OCC generally, you put the banks into an impaired capital position in the first place by allowing them to play games with sweeps and such, thereby destroying the usual 10% reserve requirements.  This degradation of reserves means that much smaller problems destroy the bank than would otherwise be the case.

This too is intentional; The Fed could have hiked reserve requirements going into this mess and in fact could have done so when the property markets started to overheat.  It did not and you did not raise any warnings about this, nor have you been out there pounding the drum for raising more capital and taking down leverage.

I have no sympathy - at all - for your position at this time.  Zero.  This is a crisis of your own manufacture and you deserve what you get.

CNN is reporting that there are ninety other banks on the "troubled" list.  Yoo hoo - do 'ya think the $50 billion the FDIC has will be enough? 

That's what I think too.

Again, to Americans, I say:

• If you have more than $100,000 in a bank, get under the FDIC limits immediately.  Like Monday.  How many times do you need to hear this before you figure it out?  While nearly $200 million was cleared out of IMB before it blew up the fact remains that nearly a billion dollars of uninsured deposits remained, and those people are very likely to lose at least some of their money, perhaps as much as half.
• Consider getting all your liquid cash over immediate expenses into Treasury Direct and buying T-bills with it.  If the government goes down you will need steel, lead and brass, not money.
• Get away from a reliance on debt.  Immediately, if not sooner.  You simply cannot afford to be in debt in this environment.  Period.  The odds are very high that any callable line will be called as stress continues to increase, or interest rates, if adjustable, will be ramped significantly.

Look folks, OTS and OCC are not doing their jobs and haven't been since 2003 when the housing bubble began.  IndyMac bank was spun off by Countrywide to take paper that they couldn't sell to Fannie and Freddie!

This very same bank has been offering way-above-market CDs in an attempt to attract deposits.  How were they intend to pay the coupon on those CDs?  Isn't this like doubling down every time you lose at Blackjack?  Do you know what the Pit Boss in Vegas calls someone who does that?  BROKE.  Again - the regulators saw all this as it was advertised - where were they and why didn't they stop it?

The Fed has sat on its hands as well through all of this, and in fact instead of forcing people to deleverage they have made more liquidity available since August, just like, as I've noted, giving heroin to an addict instead of forcing him or her to detox and suffer withdrawals.

Finally, Congress has refused to step in.  In fact, their latest "Housing Bill", which The Senate passed last night and which a whole bunch of Senators didn't even have the gonads to vote on, attempts to continue the party for the drug addicts by further increasing the leverage in the FHA and pouring yet more liquidity - dope - into the addicts veins! 

Unfortunately at this point the addict is about to suffer heart failure and can't survive another hit.  In fact, he may not survive the hits he's already taken!

How much more of a warning do you need folks?

I have been saying that the clock is about to expire for over a year.

The alarm just rung.

Wake up.

Every American who reads this needs to understand that you must choose now whether you are going to sit idly by while Congress and the regulatory agencies put their fingers in their ears and allow the blasts to continue to occur at ever-increasing rates and sizes, including those that engulf and destroy you financially, or whether you are going to, right now, get every one of your neighbors and friends together and organize to shut down your local city and/or Washington DC in peaceful protest until Congress, OCC, OTS and The Fed cut this crap out.

Believe me folks, the French know how to do this.  Spontaneously, 5,000 people will appear and literally block the streets, effectively closing them until their complaints are heard.

We as Americans either act now or you are giving consent.

Do you need a bigger warning than the possible implosion of the mortgage agencies that hold more than half of all outstanding mortgages today?  Does not the failure of a large regional bank in California - the second largest failure in FDIC history - wake you up?

If not, you're beyond hope.

If so, its time to act. 

NOW.

Yesterday you heard Representative Garrett be one of the few members of The House with a pair of balls between his legs.

He had the temerity to challenge Bernanke and ask him point-blank whether or not he would commit to not monetize the debt of failed institution(s).

Ben dissembled.  But what he said was in fact important - the answer he gave was, in essence, that absent a directive from Congress in the form of legislation that barred specific conduct, Ben was going to do whatever the hell he and the rest of The Fed wanted to.

Listen to the excerpt (about 2 minutes) right here:

In fact, it appears to me that Ben lied.  He said they haven't "purchased" any of this paper.  Oh really?  What was the Bear Stearns purchase of $29 billion worth of who-knows-what paper that was then put "off balance sheet" in a separate LLC Ben?  If you have the right to benefit from increases in value, then you own equity, as I've repeatedly pointed out - you bought an asset, you didn't loan anything.

Now let's talk about what Ben and The Fed have done:

• They have exchanged all but $25 billion of their short-term Treasuries - the most liquid securities that are easy to turn into cash by simply "running them off" as they mature - for paper of unknown quality and we are not permitted to know from whom they've taken it or what sort of actual credit quality it has.  That amount of money, by the way, is about half of all the retained earnings that The Fed has managed to accumulate over the last 80 years.
• They have pumped well over $200 billion in excess liquidity into the system since last summer, making dollars very plentiful.  This is in direct contradiction to the claim of a "Strong Dollar Policy"; the way you make something desirable, and therefore expensive (strong) is to make it scarce.  Ben has done the exact opposite, on purpose, and he is unrepentant in this regard.
• They have taken steps that are arguably unlawful in that they explicitly overstepped the limits of "discounting a note", which is where their authority supposedly begins and ends, with Bear Stearns in that they effectively purchased that $29 billion in assets and are now operating a separate LLC (with Blackrock as the manager.)  The only paper that The Fed is supposed to explicitly purchase is United States Treasury paper.  Go read The Federal Reserve Act.
• He has granted a "no bid" contract using the excuse of "crisis", and yet when asked in the hearing whether, now that the crisis was passed, he would send it out for bid and see if it was appropriately priced (and possibly replace Blackrock) he said "he'd think about it."
• They have willfully looked the other way while financial firms - essentially all of them - have either lied repeatedly about their capital needs, losses and intentions, or know so little about them that one must question whether they have the internal controls and knowledge to be in business in the first place. 

As a direct result of making dollars too plentiful (instead of scarce) we have seen The Dollar plummet in value and commodities produced by other nations skyrocket in price.  This is exactly what Ben had to know would happen, since he holds a PhD in economics.

As a direct result of meeting falsehoods and hidden losses with "more liquidity", Bernanke's Fed has provided more heroin to the addict who is screaming for it, repeatedly, all the way from last summer onward.

And just like a drug addict, instead of getting better the addict is placated for a short while as their body rots from within.

Now perhaps it is true that these are the right choices to make for America. 

Perhaps $4/gallon gasoline is the price we should pay in order to bail out the Wall Street bankers and fraudsters, which happen to include a significant number of ordinary Americans, not to mention thousands of mortgage brokers and hundreds of regional and commercial banks.

Perhaps having your heating costs this winter going up by 50% is a reasonable thing to have happen so that Ben can bail out Bear Stearns, along with the other banks who made bad bets by writing garbage mortgages for $500,000 homes to people who had no job, no income and no assets (so-called "NINJA" loans.)

We are supposed to live in a Constitutional Republic.  That is, these policy decisions are supposed to be made by elected representatives, who we vote upon every two or six years, and send to Washington DC - and who are, allegedly, answerable to us.

This power has been usurped, and yesterday you heard Ben Bernanke say in blunt English that barring an explicit law from Congress prohibiting him from doing this sort of thing to whatever degree he feels is appropriate, he's going to act as he, not you or your elected representatives, see fit.

Perhaps you're ok with this.

I'm not.

But until and unless we, the people, stand up and make known that we demand that our Congressional Representatives put their foot down and pass explicit legislation to stop this sort of crap, this is what you (and I) are stuck with.

The time to choose has come America.

Do you like $4 gas?  Do you like food prices doubling in the space of a few years?  Are you going to enjoy heating costs going up by more than 50% this coming winter?

Is it ok with you that Wall Street can create bogus schemes to pump asset bubbles, including housing, and when they burst you get the bill at the gas station and in your electric and heat bills, while the people who devised these schemes get a new vacation home in The Hamptons and a yacht?

Its your choice America.

You heard, on national television, Ben Bernanke tell Congress to, quite frankly, "go screw".

Why?

Because he's quite sure you won't flood Congress with angry phone calls and letters demanding that they stop him.

Is he right?

That's up to you.

If you find it outrageous that Ben Bernanke can, without consultation of Congress, monetize debt if he chooses, bail out anyone he wants (irrespective of whether it doubles the price of oil and gasoline), and in general that he can do whatever he'd like - without consent of Congress and without regard to the impact on your life, then you need make certain that Congress hears from you today, tomorrow, the next day and every day - until they put a stop to it. 

You need to get angry, and you need to act.

Because Congress can, if you make clear that is what you insist upon, put a stop to this crap.

Or, you can choose the easy path forward - $4 gas, $4/gallon milk, a 50% increase in your heating costs this winter, all the good jobs going overseas and serial asset bubbles to feed the bankers on Wall Street, while your wealth and earnings capacity is siphoned off and buys a Wall Street banker a new vacation home in The Hamptons.

Its your choice America.