Peak Debt

The Two Major Residential Mortgage Insurers And Underwriters Have Collapse

One of the most important questions ever asked and that one can ask is "what is truth"? ... I once saw an interview with Bill Clinton, who remarked "We will not know truth till we reach the next life" ... Truth is that which is reliable for belief or that which is a trust worthy promise. Truth is evidenced by facts and established by the testimony of credible and hopefully disinterested people.

Truth is that the two mortgage GSEs that underwrite and securitize homeowner loans are toast, they are goners, relics of the former age of prosperity; image: Fannie Mae and Freddie Mac rest in peace.

Mike Mish Sheldon relates in article U.S. Taxpayer Bailout of China Over Fannie Mae that If the US bails out Fannie Mae bonds as suggested in 'We're All Homeowners Now, Nationalization of Fannie, Freddie Unavoidable', inquiring mind just might be wondering "Who is the biggest beneficiary?". It's a good question too. Please consider Chinese Government is 'Top Foreign Holder of Fannie Mae, Freddie Mac Bonds'.

And Mr. Sheldon relates that IndyMac Bank, IMB, was seized by the Federal Authorities, it was the king of financialization of the no documents and unverified home loans, that is the Alt-A loans, which are at the very epicenter of the subprime debacle.

The good news is that the FDIC covers depositors up to $100,000. The bad news is that the FDIC took a huge charge on this one, somewhere between 10-20% of Indy Mac's total balance sheet. And further bad news is that there are a massive number of banks such as Downey, First Federal, Wachovia and Washington Mutual which have offered Option Arm loans. And there is going to come a point in time when depositors are going to make a run on these banks and be able to get funds; or a time when the FDIC will run out of funds to cover the defaults and make payments to depositors.

Mr. Sheldon also relates Treasury Secretary Paulson's Statement that the Treasury is working with OFHEO to contain, mop-up, and stabilize the capital collapse of the two GSEs.

And he provides a reference to the Marketwatch news service website for the Text of Paulson Statement On Fannie, Freddie where one finds comments such as:

Tomcat29: Based on what we're seeing now, Fannie and Freddie's "important public mission" would appear to be to put people in homes they can't afford so they can ultimately default on their mortgages. Bailout dead ahead.

Davidluk8: FNM and FRE don't need bailout. They need LIQUIDATION! (That's what I am thinking, there needs to be an application of the Liquidation Thesis)

Drop73: The US Gov needs to remember that FNM and FRE aren't the only ones that will need a bailout. Soon add to that LEH, BAC, WB, C, GS, ABK, MBI and whoever else you can add to the list that's in the same boat. These companies are in water way over their heads, and now they're getting tired of treading water and there is no life ring. The momentum on this great unwind of the OTC and credit-default swap derivatives markets is about to get very ugly. It's dog-eat-dog now.

Ponkap: Notice he didn't say anything about what their "primary focus" would be tomorrow...just what it is today.

Realgara: How can anyone believe a word he says! He says one thing like US has strong dollar policy over and over again... what does the dollar do? All he and the rest are doing is trying to fool the shorters into closing out and hope they will be able to prop the market up long enough so they can scratch their heads and think of a solution.

The News Flow Before The Capitulation Of The GSEe To The Short Sellers.

July 9 - Dow Jones: "Mortgage financiers Freddie Mac and Fannie Mae are both 'adequately capitalized' at current levels, the head of the Office of Federal Housing Enterprise Oversight said... Ofheo Director James Lockhart... said Fannie's $15 billion capitalization is enough for the company 'to ride out the storm' in the housing market over coming months. He also said recent pledges by Freddie to seek $5.5 billion in fresh investment would help sustain that company as well."

July 9 - Bloomberg (Shannon D. Harrington and Dawn Kopecki): "Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower. Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's... Traders are overlooking the government's implied guarantee of the debt as credit losses grow and concern rises that the companies don't have enough capital to weather the biggest housing slump since the Great Depression."

July 10 - Bloomberg (Dawn Kopecki): "Borrowing at Fannie Mae, the U.S. government-sponsored mortgage company, has never been so expensive and it may not get better any time soon. Fannie Mae paid a record yield relative to Treasuries on the sale of $3 billion in two-year notes yesterday amid concern the biggest provider of financing for U.S. home loans won't have enough capital to weather the worst housing slump since the Great Depression. The company's credit-default swaps show traders are treating the AAA rated debt as if it were five steps lower... Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said... 'Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,' Poole, 71, who left the Fed in March, said..."

July 11 - Dow Jones (Michael R. Crittenden): "The regulator for Fannie Mae and Freddie Mac on Thursday afternoon took the dramatic step of publicly addressing the firms' capital position in an effort to calm jittery Wall Street investors. James Lockhart, director of the Office of Federal Housing Enterprise Oversight, repeated an assurance he made earlier this week that the two mortgage-finance firms are 'adequately capitalized.' 'They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets,' Lockhart said..."

July 11 - Bloomberg (Shannon D. Harrington): "The U.S. government should increase its $2.25 billion credit line to Fannie Mae and Freddie Mac to as much as $100 billion to bolster investor confidence that it won't allow them to fail, according to Barclays Capital. The government should expand the credit line to at least $50 billion as a 'grand gesture' to ease investor concern, Ajay Rajadhyaksha, head of U.S. fixed income strategy at Barclays Capital in New York, said..."

Outcome Of The Collapse Of Freddie and Fannie

Jesse in article Fannie and Freddie are Levered Up Like Hedge Funds (or any Wall Street Bank) relates that former U.S. Treasury Secretary John Snow said that Fannie Mae and Freddie Mac have relied on leverage to fund their businesses in the same fashion as a hedge fund, and that the government should avoid taking them over.

Yes, spectacularly, unbelievably, the GSEs are terrifically leveraged up. Karl Derringer writing in Fannie Freddie Banks And Government Debt relates: "They are levered up anywhere from 60 to more than 200:1, depending on what you include and exclude from "capital" and "credit book. 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."

Mr. Derringer presents a historical account of what has brought about the GSE mortgage imbroglio, and presents outcome scenarios.

Mike Mish Sheldon presents presents his outcome scenario: covered bonds like those issued in Germany will be the nature of the Fannie Mae Bailout.

My outcome scenario: the capital collapse of Fannie and Freddie has to be solved; but it will not be. They are now processing 80% of the mortgages in the US. Without them the housing market is going to quickly grind to a halt; and housing prices will drop even beyond Gary Shilling's pessimistic views. Freddie and Fannie are going to go out of operation and a receivership set up to handle the real estate and debt.

The Chinese and the world assumed the implicit backing of the government in buying the bonds of Freddie and Fannie, I think they are going to be disappointed, and they will take economic action to express their dissatisfaction.

Rob Alford relates that Fannie Mae was established in 1938 as part of FDR's "New Deal", and its collapse and coming liquidation, and resulting systemic risk event meltdown, that is economic collapse, will mark the end of the New Deal Age, and beginning of the Age of State Corporate via enforcement of the provisions of the Security and Prosperity Partnership of North America.

Senate Passes The Dodd Frank Housing Bill In A 63 To 5 Vote

As of written in this blog, the Dodd Frank Housing Bill is not housing bailout it is a great example of crony capitalism and a bailout of the banks most responsible for the current crisis.

Julie Hirshfeld Davis of the Associated Press writes that the Senate passed the Dodd Frank Housing Bill in a 63-5 vote which: "provides a plan that lets homeowners buckling under mortgage payments they can't afford keep their homes and get more affordable mortgages backed by the Federal Housing Administration, FHA. Banks that agreed to take substantial losses on those distressed loans could avoid costly foreclosures and be assured of recovering at least some money. The new program would let the FHA insure as much as $300 billion in new mortgages, helping an estimated 400,000 homeowners. Representative Barney Frank, Democrat, of Mass, said he was working to find a way to shift the funds to a must-pass spending bill that would be approved before lawmakers scatter for the year in September. Dana Perino, Bush's spokeswoman, said the money should be stripped out of the measure "so that they can get a housing bill to the president that he could sign right away.""

The last two sentences relate the important funding dynamic of the proposed legislation; Democrats want the bill funded and the President does not.

Congress is totally disconnected from economic and investment reality, they are unaware of the bankrupt status of Freddie and Fannie, and disconnected from the reality that the financial marketplace has, through short selling, extinguished the two GSEs, and they are unaware of multiple systemic risk events, any one of which is going to cause a financial system collapse.

There is no money now or in the future for funding of the Dodd Frank Housing bill: its cost is two years of war in Iraq. Like I presented above we have reached Peak Debt, the market place is now extinguishing debt and will not be buying Treasuries to fund Dodd Frank.

Keith at HousingPanic looks at it this way: How can I put this simply? Let's say you had an uncle who was an unemployed cocaine-using junkie. But instead of putting him in rehab, you gave him your brand new no-limit credit card, and a kilo of coke. And the keys to your car. And your kids. Yup. That about sums it up.

We Have Arrived At Peak Debt

We have reached Peak Debt, an economic situation where debt will never ever be worth more than it was before the collapse of Freddie Mac and Fannie Mae. Debt will be seen as increasingly toxic and irredeemable. Market place interest rates will be forever going up and bond values across the board going down.

CreditWritedowns reports that Spain Can't Sell Its Bonds: CreditWritedowns reports that Spain Can't Sell Its Bonds: "Spain pulled a potential sale for 15-yer bonds as the appetite for the issue just wasn't there. Before the Euro, some in the European debt capital markets, where I worked, pejoratively called Portugal, Italy, Greece, and Spain, the PIGS. Because they had very poor government fiscal management before the Euro, as sovereign debtors, they had spreads which were very wide to German Bunds, then considered the gold standard of European sovereign debt issues.

But, after the Euro was agreed to, many in the bond markets went short Bunds and long PIGS as a 'convergence' play causing sovereign spreads to tighten -- and with good reason as those countries got their fiscal houses in order and have generally performed well in the decade since.

However, with global market turmoil roiling a number of major markets world-wide, it seems that de-convergence is now underway and spreads are widening".

Charts show that despite the sell off in stock, there was no compensatory purchasing of debt -- there was no interest in buying debt of any type today; all debt either manifested bearish:

US Treasuries - TLT weekly manifested a doji at the edge of a massive head and shoulders pattern.
US Treasuries - TLT daily fell wiping out three days of gains.
US Treasury Bonds in the futures marketplace - USB weekly manifested a gravestone doji.
US Treasury Bonds in the futures marketplace - USB daily fell wiping out three days of gains.
Aggregate Debt - AGG daily manifested bearish engulfing.
The zero coupon mutual fund BTTRX weekly manifested a gravestone doji candlestick.
Corporate junk bonds - HYG weekly manifested bearish engulfing.

Returning to the above mentioned Karl Derringer article Fannie Freddie Banks And Government Debt where he presents option three, he relates: "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."

And Mr. Derringer continues: "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."

Peak Debt means that the bond marketplace will now, just as it did on March 18, 2008, when the Fed announced the facilities of TAF, TSLF, and PDCF, call interest rates higher and bond values lower: bond portfolio values are going to deflate, and the interest rate on the 10 Year government bond, $TNX, and the interest rate on the 30 Year government bond, $TYX, are going higher.

Not Only Asset Deflationary, But Consumer Good and Producer Product Price Inflationary As Well

The current level of increasing deficit spending due to reduced tax revenues, will be amplified by FDIC bailouts, the Dodd Frank Housing bill, and now by the higher interest rates that are coming via the failure of Freddie and Fannie: the result will be higher consumer goods and producer product prices -- the cost of things people and corporations buy is going to inflate higher.

Investment Application

Because of many investment market dislocations, weaknesses, and multiple systemic risk potentialities, one may not have immediate and full access to one's wealth in brokerage accounts and in money market funds in the near future, that is at the time of a systemic risk event: I recommend that one invest in the gold ETF, in a trust account (not a brokerage account) this next week, as well purchase gold at both BullionVault.com and GoldIsMoney.com