An Occasional Letter From The Collection Agency
Welcome to the Weekly Report. This week we look at the end of Fannie and Freddie and ponder why PIMCO are screaming for help.
Regular readers may have noticed that the Weekly Report hasn't been available on the excellent Safehaven.com or The Market Oracle since July. Nothing sinister to report, I just thought that subscribers deserved a bit of added value and some excellent TA on the direction of gold.
By the way, I see John Mauldin is beginning to see the problem that some of us saw coming over the past 2 years and a situation I reiterated in this article. (About half way down.) I mention this because I believe it may be related to the PIMCO poser mentioned in the headline. For now, let's just say that I believe there is a major problem in the bond markets and those Fund Managers that have supported (and partied) with each other are not adverse to a bit of supportive cheerleading. It's an example of why traders and investors should be very careful about divining the future from the readings of some writers.
Speaking of taking care about what someone says and then does, Bloomberg reports that Treasury Secretary Hank Paulson is yet again doing overtime on a Saturday, announcing the end of Freddie and Fannie:
"Sept. 6 (Bloomberg) -- Treasury Secretary Henry Paulson is preparing to announce plans to bring Fannie Mae and Freddie Mac under government control, seeking to halt the crisis of confidence in the companies that make up almost half the U.S. mortgage market.
The decision follows the Treasury chief's repeated comments to lawmakers in July that he wasn't likely to use taxpayer funds to prop up the federally chartered, shareholder-owned firms.
Pacific Investment Management Co., manager of the world's biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, said Newport Beach, California-based Pimco fund manager Bill Gross, in a Bloomberg Television interview.
Washington-based Fannie and Freddie dropped in after-hours trading. Fannie fell $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70."
The New York Times comes to the same conclusion as myself, that the preferred and common shares will be worth peanuts, or less.
This wasn't difficult to see coming since the turn of the year, as I have mentioned before the "borrow short and lend long" business model, funded by selling debt into the marketplace is dead and has been for sometime. However the taking of F&F into "conservatorship" reopens the debate about moral hazard, the moving of the liabilities from the private sector, the bond holders and investors to the Tax Payer. Simply put the US financial system is being socialised, the capitalist responsibility to losses abrogated and those that bought F&F debt are being bailed out. The problem is no one wants to buy F&F bonds unless it has an actual guarantee from the US Government, implicit was no longer enough in these days of deleveraging and liquidity tightening.
Yet again, just like Bear Stearns, we see the markets bypassed as the bailout is implemented after hours on a Friday. How long will investors being willing to hold stocks over a weekend in any company that has a weakened capital position? It is more than possible that this bailout may well trigger another, that of investors heading for the exit. No wonder the Dow had a week like this:
Looks to me that some have already tip toed out of the theatre but there may still be an opportunity for those watching banks and financials:
Note the resistance around 75.
Note the resistance at, errrrr, 75. No recommendations of course, just an observation. So here we are faced with another bailout, another acceptance of moral hazard only this time the Fed and the Treasury ensured the rules, regulations, laws and mandates, not forgetting to mention the funding, being pre-approved (remember that phrase?) by the lawmakers and the President in the summer.
However will the nationalisation of F&F be enough to placate the bond holders? If I held the debt I would be wondering whether the next move might be a debt swap, devaluing the worth of the debt I own as the US Government attempts to re-negotiate its position. This whole mess is very far from over, if you want to recap my thoughts on this, click here to visit my free 21 month update which included a resume of F&F's problems.
Bill Gross at PIMCO is looking more nervous each time I see him.
- "And now, while some will compare current government bailouts to Slick Willie, citing moral hazard, near criminal regulatory neglect, and further bailouts for Wall Street and the rich, common sense can lead to no other conclusion: if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the US Treasury - not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A., via subsidised home loans issued by the FHA and other government institutions. A 21st century housing-related version of the RTC such as advocated by Larry Summers amongst others could be another example of the government wallet or balance sheet that is required during rare periods when the private sector is unable or unwilling to step forward."(PIMCO)
Common sense is now the excuse to bailout those who bet the wrong way, those who went in too early, citing at the time that it was all overdone, it's not as bad as it looks etc. Oh dear:
- "Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for "they are all underwater." We, as well as our SWF and central bank counterparts, are reluctant to make additional commitments."
The last time I mentioned PIMCO in an article was on the 16 March 2008 in this free report which looked at PIMCO exposure to Municipal Bonds. Ahhh you thought I was going to mention that circa 6/10th of PIMCO exposure was to Agency debt?
Its no wonder PIMCO and anyone holding PIMCO Funds are screaming for intervention to help prop up the price of Agency debt, for PIMCO this is the second shoe falling, not the first. As I said back in March:
"Mr Gross is saying, quite rightly, that his job is to avoid any potentially toxic assets leaking into his pond. Unfortunately sometimes a previously healthy asset already in the pool begins to decay, leaking toxins into the pond. In a small pond its easy to fish out the decaying matter, in a large lake, filled with cumbersome assets it can be much more difficult.
Has PIMCO found an Old Maid hidden in its hand?
Consider this, from Bloomberg :
- "Ross, chairman of WL Ross & Co., and Gross, chief investment officer of Pacific Investment Management Co., said they jumped at the chance to buy $1 billion of municipals each. Their interest helped to drive last week's rally in fixed-rate debt. Investors remain concerned that a flood of new issues from borrowers refinancing auction-rate debt will overwhelm demand while hedge funds and banks pare their purchases, analysts at New York-based Citigroup Inc. said in a March 7 report."
- Now this could be viewed as an attempt to capture some cheap assets with high yields. It could be viewed as an attempt to catch a falling knife. I don't think the reasoning behind such a move is either of these options. Mr Gross has no qualms about causing a moral hazard which in financial markets means intervention. I suspect the intervention, an attempt to restore confidence, has more to do with PIMCOs own position than it does with the Municipal Bond market.
Replace the word municipal with agency and you see what I mean? As I said then, maybe I am worrying too much, now I have no such qualms, I strongly suspect PIMCO is in deep trouble, as are those holding PIMCO products. Bill has discovered that the deck was loaded, containing not one but two "old maids" and he has them both in his hand. Check your pond for leaking, toxic assets and more importantly check the assets of those Funds indirectly related to or use PIMCO assets. That includes any absolute return strategies. Don't be the one holding an "old maid".
For those who think I might be off the mark, have a look around at the collateral damage over the past 14 months and remember Governments have the ability to re-price their debt in their own favour. PIMCO, Russia and the Chinese are not immune from the fallout and they will have to take major losses.
That's it for this week. If you are interested in a long term, unbiased view of the economic conditions we are facing visit the Collection Agency.