Saturday, July 12, 2008

The owners of our "Paper"

With oil and the euro rallying, amidst the rumours of a bailout of Fannie and Freddie, does anybody really wonder about that relationship?

If you were an overseas institution that got burned on our AAA packaged products, how inclined would you to be to buy more paper amongst this "bailout that won't happen" news? China has over $370 billion of this paper, while the oil producing world owns just $30 billion. How much of our paper does China really want?

Would you rather own our dollar, that depreciates, or the euro, gold, or for that matter, oil? You can buy all the oil you want for delivery in December 2016 at $141 a barrel. I suppose when you just want to get through next week, it's pretty hard to look out a few years.

But the NY Times assures us that the panic in the GSE's are now over:

A day that began with a stomach-churning drop in stock prices for the two largest mortgage finance companies ended with a measure of relief, after government officials and lawmakers managed to calm investors worried about the health of the two companies.

Bush administration officials had worked into the early morning hours on Friday drawing up contingency plans to rescue the companies, Fannie Mae and Freddie Mac, should their financial plight worsen. And when both companies’ stocks fell 50 percent initially, some investors feared the worst.

But by the end of the day, the shares rebounded after both were able to easily continue the regular borrowing of money they need to finance their day-to-day operations and keep the nation’s mortgage machinery humming....

“There is a sort of a panic going on and that’s not what ought to be,” said Senator Christopher J. Dodd, the Connecticut Democrat who heads the Senate banking committee. “The facts don’t warrant that reaction, in my view.”

Mr. Dodd said that he was persuaded by conversations with Mr. Paulson and Mr. Bernanke that the two companies “are fundamentally sound and strong.”

Well Fannie Mae traded as low as 6.688, and as high as 11.89, closing at 10.25, while Freddie traded as low as 3.89, and as high as 8.63, to close at 7.75; both trading around 400 million shares apiece. That's normally what bottoms look like, and if you look at the above chart on who holds their paper, the repercussions would be worldwide. (page 10 of the link)

Be that as it may, with the housing market in freefall, the government can't afford to let the GSEs fail. Not only do they own or guarantee about half of the $12 trillion in U.S. mortgages, Fannie and Freddie securities have become major holdings for foreign central banks that, like the rest of the market, have come to expect the federal government to stand behind those securities.

The impact of a failure of Fannie and Freddie, though technically insolvent, is beyond imagining, far greater than the bankruptcy of a Bear Stearns. For that reason alone, such an eventuality is unthinkable.

I'm surprised that the three blind mice just didn't come out and say we'll just lower taxes and housing and GSE's will take care of itself.

But who is going to make a bottom call in this market when Curly, Moe & Larry are in charge?

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