The Market Ticker

You would have thought that PIMCO's McCulley was a 2-year old yesterday.

He was running his mouth all day long, along with Cramer and everyone else on CNBC, and the message was along the lines of:

• Paulson has to "show the color of his money" in bailing out Fannie and Freddie (why McCulley?  Are you getting nervous?)
• "Its only going to get worse" (if Paulson doesn't act now)
• "Agencies (Fannie/Freddie) need to be privatized" (I thought your problem with them is that they already are, they did unsound things, and now you're screaming for a bailout?)
• "The situation is worse than a year ago" (no kidding?  Who'd a thunk?  You don't read The Ticker, do you?)

Now let's digest all of this, in light of the facts.

See, just a few months ago, PIMCO disclosed that it had gone on an incredible Fannie and Freddie paper buying spree over the previous few months! 

That's right, into the eye of the hurricane PIMCO went out and intentionally bought debt they knew was distressed, issued by a company that might fail.

This was not done "blind".  It was done by a couple of very intelligent men who have been investing in the debt markets for a very long time and are experts.

So what's all this really about?

Simple - its about twisting the arm of the government and robbing the taxpayer.

Not because they were bamboozled, not because an unexpected calamity struck these firms, not because of an error.

No, this was a calculated act from the top down - buy a boatload of this debt at distressed prices after the threat has been identified by THEM, then WHINE at the United States Treasury and demand a bailout "or the end of the world will happen while Paulson sits and watches Rome burn."

In truth if Paulson doesn't do what PIMCO wants PIMCO will be the one who burns and PIMCO directly bought into a known distress situation!

See, this is where we've come to.  We are now beyond "moral hazard" and "too big to fail"; we've now transmorphed the entire financial system into a mechanism to literally rob the people as institutions intentionally place themselves in harms way and then demand that the government cover a bet they knew was bad when they placed it.

It is one thing to argue that someone is "too big to fail" and that they pose "systemic risk."  We've heard that countless times over the last year, and it seems to be the justification for every bailout and proposal that is put on the table - and has been since LTCM collapsed.

But now we've seen institutions take it one step further, and intentionally purchase securities issued by firms that they allege are "too big to fail" yet in dire trouble, then scream for the government to come in and bail them out!

Do you understand what's going on here? 

Fannie and Freddie have been running one gigantic hedge fund for the last couple of years.  They bought about $500 billion worth of trash ALT-A paper in the 2005-2007 time frame between them, with a goodly amount of "Option ARM" and "Interest Only" loans included.  In addition they took in over a hundred billion dollars more from Countrywide and Indymac, most of which was done using "automated approvals" and are in fact stated income loans, although they're called prime paper.

Institutions like PIMCO, The Chinese and Japanese Central Banks, and others all knew this.  This is NOT a surprise to any of them.

They all invested knowing full well that these firms were running with leverage ratios far in excess of anything that could be reasonably called safe.  In addition they knew these purchases of garbage mortgages had nothing to do with "sustainable housing" or any such claptrap.  Fannie and Freddie were "levering up" and "chasing yield" just like the rest of these market participants and the buyers of their paper knew it.

But the award for "truly outrageous" is reserved for those firms like PIMCO that have bought increasing amounts of this debt since the beginning of the year, knowing full well that it is impaired and that the firms behind it are at risk of failure, purchasing it on the back of being able to FORCE the government to do that which the black print on the front cover of EVERY prospectus says won't happen.

Why do we put up with this nonsense?

As for Paulson, were I him I would do what I recommended over the weekend - order up full audits, document that there is no possible way they can survive with the losses that are both being hidden and the projected future path for credit quality, place the firms in conservatorship, and run down the portfolios.

Guarantee nothing of the present debt.

But - provide a funding path going forward that is guaranteed for new security issue, with the strict stipulation that, as noted, only true prime paper can be underwritten, and no "hedge-fund" like activities are permissible.  And again, that's 20% cash down payments, 36% DTI, and 15 or 30 year fixed terms.  I suggest using Ginnie Mae, which already exists, but if the government wants to re-jigger Fannie and Freddie, once they've run down their portfolios, the equity has been wiped out, and can be sold back off to the public, that's fine too.

This does all of the following:

• Those who intentionally bought securities "in distress" thinking they were going to be able to blackmail or jawbone the Treasury into making them a profit will get it in both holes, as they should.  Let their shareholders come after those clowns for their obvious and transparently bankrupt strategy.  We must not let "moral hazard" morph into intentional acts of placing one's self in harms way so you can whine for a bailout!
• Similarly, idiots like Bill Miller who have been buying GSE common stock of late on the very same premise - that they'd be "saved" by the government - will also take it in both holes.  Again, we cannot allow firms to intentionally place themselves in harm's way and then scream for help.
• It places the responsibility for the bad debt where it belongs - in the GSEs and those who knowingly and willingly bought it.  Note that most of this debt is perfectly sound and as run down both coupon and principal payments will be made.  For some of the more risky paper, there will be losses.  This is as it should be.
• It insures that going forward we will have mortgage liquidity for those loans that are made under sustainable guidelines, with an explicit guarantee, but only for soundly-underwritten paper.

The "new" paper will be marketable folks.  It will have an explicit guarantee and be underwritten to sound standards.  That is, indeed, the "gold standard" when it comes to debt sold into the market - that it represents loans made to qualified borrowers with collateral valued at or above the amount of the loan written.

Those who are screaming for bailouts of the existing paper and firms are not interested in mortgage liquidity or a healthy housing market. 

Oh, and one of the screamers?  China.  Again:

"``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''"

You lying sack of dogsqueeze. 

You bought these securities knowing full well that they were not guaranteed, and like everyone else who did so, you were simply "reaching for yield."  You, along with the rest of your cronies over in China, Japan and elsewhere, were fully aware that the GSEs were buying ALT-A paper stuffed full of liar loans made to hairdressers on $500,000 houses in California and Florida.  YOU DESERVE WHAT YOU GET from such a purchase and, if this "is the end of the current international financial system", then IT NEEDS TO END RIGHT NOW, because that "current international financial system" has turned into one gigantic SCAM and YOU ARE THE WORST OF THE SCAMMERS!

These folks are ALL simply trying to force the government to cover a bet they knew was bad at the time they made it, in a raw act of arm-twisting.

Henry Paulson MUST SAY NO.

There is a fly in this ointment however - its that a tremendous number of banks have bought GSE Preferred and are holding it as part of their risk-based capital!

What?  You mean to tell me that banks are holding stock as part of risk-based assets?!  How the hell did that happen?

Oh, it happened because once again:

"Banks bought Freddie and Fannie preferred stock because they can be used as capital that regulators require to cushion against losses on loans. Banks also get a tax break on 70 percent of the securities, making them attractive to own, said Midwest's Wiest."

And guess what - those are the only two firms' preferred that this applies to. 

What sort of criminally stupid "regulators" do we have in this nation when banks are allowed to hold risk-based capital in the preferred stock of firms that are levered up at 60:1 or more?

This whole mess is one gigantic scam from the top down.

We the people need to run all of these people - every last one of them, from Bernanke to OTS to OCC to Treasury - out of town on a rail.  They have intentionally allowed banks and institutions to not only lever up to insane levels but also then allowed banks to buy and hold preferred stock, which is THIRD IN PRIORITY in liquidation, as part of their risk-based capital!

Oh, one more thing.  Has Henry Paulson shot off his Bazooka pointed at Fannie and Freddie themselves?  One has to wonder, given this:

"In July, Congress gave the Treasury authority to lend money to or acquire equity in the companies if needed to prop them up. That helped reassure buyers of Fannie and Freddie debt that the government would stand behind them in a crisis.

But the Treasury's authority may make it harder for them to sell equity because of uncertainty over how the Treasury would treat private shareholders if a bailout is needed."

You have to love unintended consequences.

Wouldn't it be ironic if Paulson's "Bazooka" turns out to be what kills the GSEs? 

The next obvious question is was that Paulson's intended outcome all along?

Things that make you go "hmmmmm..."

Paulson should have known better.

This is what he said when arguing for the Housing Bailout bill, and specifically, authorization to spend up to $800 billion of taxpayer funds on Fannie and Freddie just one month ago:

"Our proposal was not prompted by any sudden deterioration in conditions at Fannie Mae or Freddie Mac," Paulson said. "At the same time, recent developments convinced policymakers and the [firms] that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary."

"If you've got a squirt gun in your pocket, you probably will have to take it out," Paulson said. "If you have a bazooka in your pocket and people know it, you probably won't have to take it out."

Wall Street and The Debt Markets see it differently.

Notice that the stock price hasn't gone back up.  In fact, it has gone down.

We get to add this as yet one more piece of stupidity from our government, and one more lie.  It is now clear that Paulson's claim that he has this authority is being called - the "PUT", if you will, has just been exercised by Wall Street and the Debt Markets.

So Hank, what's it gonna be?  Is the counter-party good or not?

Remember, you argued that if you were given unlimited authority you would not have to use it, but if your authority was limited, you would. 

You were dead wrong - again.

This joins the list of other "dead wrong" statements you've made, of which I am keeping a running copy and sent them around on the 19th of July. 

How many times do you get to be wrong as Treasury Secretary Hank before you resign in shame?

And now I must ask again - is that really a Bazooka in your pocket, or an empty launcher?  I'm not the only one that's curious you know; the bond market seems to think it smells like BS, and so does the stock market.

Here is the mathematical reality of the situation folks.

The GSEs took on many hundred billion in "ALT-A" paper, representing about 10% of their total.  That's $300 billion roughly, for Fannie.

This paper is garbage.  It was not purchased due to any "affordable housing mandate", but rather to "lever up" as the GSEs have been doing for the last few years.  When times were good this was a great deal - gearing up at 60:1 sounds great when times are booming, and you make lots of money.

The ugly stick in this is that some of this "core capital" - in fact, fairly close to half of it - is in fact not money, but deferred tax assets.  That is, it is a tax deduction you can take against future earnings - if you have any.  Yes, counting this as "capital" is allowed by accounting rules.... but this doesn't change the fact that its not money and you can't spend it.

But that $300 billion of paper is in fact trash.  It is "ALT-A" loans made to people who may have overstated their incomes or otherwise performed some sort of trickery, or maybe the paper is Option ARMs which are even more toxic.  The point is that a large percentage of that paper is going to default; fully $100 billion of it is in two states alone - California and Florida, and sliced a different way, about $100 billion of it are interest-only loans - loans that are essentially all taken out by real estate speculators.

How much of this paper will go bad?  Maybe half, or $150 billion worth.

How bad will the losses be?  On average, about 50%.

So we have a real no-BS $75 billion loss. 

How much actual money did you say Fannie had again? 

Hmmmm... that's a problem isn't it?

Then we have to start counting the "streamline refinances" that Countrywide shovelled at the GSEs to the tune of $100 billion, all of which were done via automated underwriting and are, for all intents and purposes, stated-income loans - although they weren't sold to the GSEs that way!  While both Fannie and Freddie are making noises about "putbacks" of fraudulent originations, exactly who are you going to put them back upon?  Indymac and Countrywide were the two largest "shovellers" in this regard, and guess what - neither exists in a form that they can be "put" upon today with any degree of success.

This is why "bailing out" these firms was a bad idea in the first place.  They did wildly imprudent and outrageous things that NEVER should have been allowed to happen.  Our government IGNORED these risks through intentional blindness, fueled in no small part by the over $200 million dollars spent on lobbying.

Worse, the buyers of the debt knew these firms had done this sort of nonsense as all of these guys know how to read a balance sheet!  They're not stupid - they willingly and knowingly took the risk by buying that debt.

Additionally we now know from the GSE's latest reports that they are gaming their losses by making the interest payments on loans that have defaulted - on purpose - so as to avoid having to recognize those as defaulted loans.  This is an outrageous act of pure book-cooking and must not be allowed to stand.

PAULSON SAID the government wasn't going to bail out speculators.

YOU LIED TO CONGRESS AND TO THE AMERICAN PEOPLE PAULSON; the biggest speculators of all are in the corner offices of Fannie Mae and Freddie Mac, along with the bondholders who purchased their debt, and now you want to bail both of them out!

Nor does it end there.  An article in The Economist points out that a large percentage of the debt allegedly "sold" in recent auctions wasn't sold at all - it was part of an elaborate scheme known as a "switch":

"The banks that manage the agencies’ debt issues are pulling out all the stops to ensure their success—even to the point of artificially boosting demand through deals known as “switches”. In such an arrangement, an investor agrees to buy into a new issue in return for being able to sell back to the banks an equal amount of an old one, thus ensuring its net exposure does not rise. If enough of these deals are struck, large amounts of debt can be shifted even when demand is thin. A recent $3.5 billion issue by Fannie was helped along by “very significant” amounts of switching, says one banker involved in it. With a quarter of the agencies’ debt due to mature in less than a year, those charged with peddling it will have their work cut out—especially if the Asian investors continue to be put off by unkind headlines."

This sort of thing is kinda like check kiting or other forms of "not-true sales", including the kind of "carryback" deals that we've seen recently for other debt (E.g. "I'll sell you $100 billion of debt, claim it was $100 billion, but I'll finance $80 billion of it no-recourse"; the net result is that I only received an actual $20 billion and if the debt goes back, the seller eats the other $80, not the buyer!)  Yet another transparent scam perpetrated upon the market to make things seem better than they really are.

It is time to stop the game Henry.

Your bluff has been called.

The snakes must be decapitated and their writhing, bleeding bodies disposed of.

Fannie and Freddie MUST be forced into receivership.

Their portfolio MUST be placed into rundown.

Those people who bought specific debt products must get only the coupon and principal that can actually be generated by the performance, such as it were, from those loans, and not one penny more.

We have a means to provide true prime mortgage liquidity in the United States.  It is called Ginnie Mae, and they, unlike Fannie and Freddie, did not take imprudent actions, did not "lever up" and are performing just fine.

Extend Ginnie's charter to provide mortgage guarantees to any American Citizen subject to a 20% cash down payment, 36% DTI and a 15 or 30 year fixed, fully-amortizing loan schedule.

GOING FORWARD THE PROBLEM IS SOLVED.

You have no business bailing out the debt-market speculators who work in the executive offices of Fannie and Freddie with our tax money.

NONE WHATSOEVER.

If you are foolish enough to try to "draw" your Bazooka Mr. Paulson you will find quite quickly that instead of reacting "positively" and with "stability" to your actions the credit and equity markets will instead react as they did after Bear Stearns - with a short "pop" followed by yet another resumption of the collapse in process. 

ALL YOU ARE GOING TO DO IS WASTE TAXPAYER MONEY!

You cannot stop what is happening Henry, and you know it.  Stop lying to The American People.  This is not just Fannie and Freddie, it is ALL structured debt that is under stress because ALL of it was done with too-lax underwriting and intentional blindness as to the credit condition of the borrower.  It is ALL toxic, in ALL classes, as is evident in the CMBX and elsewhere. 

CMBX spreads are MUCH HIGHER than they were in February.  Why? 

BECAUSE THE MARKET KNOWS YOU CANNOT, AND HAVE NOT, PROVIDED STABILITY - JUST BS.

Repudiate your so-called "Bazooka" now Paulson, before the market forces you to draw an empty tube, and level with The American People.

We're tired of being lied to.