Sunday, August 24, 2008

New shorting rules this week?

SEC Commissioner Cox let the short sale rules expire on August 10 regarding the vaunted 19 financial stocks. He also promised new rules regarding shorting in the next couple of weeks.

Look for this market moving action soon, as the bears have been trying to press their bets to no avail, except for the GSE's.

The ironic part is that the bears are digging their own grave. Look at IndyMac. Now that it has been nationalized by the government, foreclosures have been stopped, and work-outs are being devised for homeowners. Forbearance of principal, modifications of loans and a cap of 6.5% interest rate on mortgages, are allowing homeowners to keep their property. This supply is being kept off of the market, as the FDIC is actually doing something with it's seizure of IndyMac. Just last week, you had full arenas in Northern FL, Orlando, and Miami with loan reps and homeowners, actually coming to terms with their mortgages and doing something besides lip service.

If Washington Mutual would hit the skids just like IndyMac, half of our housing problems would be over!

Now let's look at Fannie and Freddie. The preferreds on these numbers have already hit the skids. But does anybody think that Treasury will wipe out these preferreds with the GSE bailout? Big owners of the preferreds are banks. So Treasury will wipe them out in their bailout? Doubtful! Preferreds can be used as capital, and the buyers get a tax break. The system was designed for this "implicit" relationship and the "implicit" guarantees!

The derivative play by the bears on Fannie and Freddie's demise were the purchase of credit default swaps on their sub-ordinated debt. UBS, which lost well over $40 billion last year, had this to say:

"If we reasonably assume that the Treasury would only intervene in the event that Fannie or Freddie is declared significantly undercapitalized by its regulator then interest payments on the qualifying subordinated debt is automatically deferred for up to five years."

He picked this up off Fannie's website:

In order for Fannie Mae subordinated debt to "qualify" for the above-referenced capital calculations, it must require the deferral of interest payments for up to 5 years if (1) Fannie Mae's core capital falls below minimum capital AND, pursuant to Fannie Mae's request, the Secretary of the Treasury exercises discretionary authority to purchase the company's obligations under Section 304(c) of the Fannie Mae Charter Act, or (2) Fannie Mae's core capital falls below 125% of critical capital.

So the thinking is, if Treasury intervenes, then Fannie and Freddie's sub-ordinated debt gets deferred, and thus those who sold the swaps get kiboshed, and do these sellers have the money to pay the buyers of this insurance?

Isn't that rich? Wall Street is supposedly buying insurance on swaps, from those who can't pay so they can cause a panic?

Here's Fannie's take on their subordinated debt 7 years ago.

And here is what the WSJ had to say after Moody's and S&P downgraded their ratings:

The preferred shares that were downgraded are hybrid stock-bond securities that are supposed to pay steady dividends over long periods. That has made them attractive to banks and insurers, which have viewed them as a way to get safe returns.

The value of Fannie and Freddie preferred has dropped sharply. Fannie's Series S preferred, for example, closed at $11.29 a share on Friday, down from $15.20 a week earlier and $25.70 at the end of 2007. Fannie and Freddie's preferred shares remain on review for possible further downgrades, Moody's said.

Moody's cited the risk that the companies will have to skip dividend payments on the preferred shares if losses deplete their capital below certain thresholds. It also pointed to uncertainty about how the preferred stock would be treated if the Treasury Department acquires stakes in Fannie or Freddie. If Treasury decided to buy preferred shares in the companies to boost their capital, it could further reduce the value of the existing preferred shares.

Fannie has about $21.7 billion of preferred stock outstanding, based on the par value of that stock, and Freddie has about $14.1 billion. Those preferred shares are held by many U.S. insurance companies and banks.

Ratings Cut

Moody's lowered preferred-stock ratings for both companies to Baa3, the lowest investment-grade rating, from A1. Standard & Poor's Ratings Services recently made a more modest cut, taking the preferred ratings to A-minus from AA-minus.

Moody's kept the companies' senior long-term debt rating at AAA, reflecting expectations that the U.S. government would make sure holders of such debt, which include many central banks and commercial banks, are repaid.

What does it mean? Just that Fannie and Freddie are the "government's" Auction Rate Securities!

Eventually everyone gets paid, but first you gotta panic the holders!

And that you had better be buying the banks and the brokerages on this news. When the market is sweating the GSE's, you've hit the bottom. And instead of a panic, it will be a relief.

Remember this statement in 1962? "You won't have Nixon to kick around anymore because, gentlemen, this is my last press conference." Or how about this in 1973? "I am not a crook. I have earned every cent....I have never obstructed justice."

It's the same here. We'll hear pontifications on "moral hazard" but it won't be the last time. And unless Uncle Sam wants to be known as the crook to the world, the holders will get paid.

After all, it's not the government's money. It's yours!

And unlike politicians, at least you "have earned every cent!"

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