MolloMarketReport

 Financial Fears

            The financials led the market lower today with the big news being the Fannie and Freddie rescue plan and the fall of Indymac bank.  Let’s deal with Fannie and Freddie first.  It seems that all of the rumors of last week have forced the Fed to come up with a rescue plan for Fannie Mae and Freddie Mac.  The plan has a threefold component.  The first is that the GSE’s will be able to borrow from the Fed window and can put up mortgage securities as collateral.  This is the same arrangement that the investment banks have been able to since the collapse of Bear Stearns, and as I mentioned on Saturday it was a solution being touted by Senate Finance Committee Head Christopher Dodd.  Part two of the plan is that the mortgage lenders will temporarily be able to get a larger line of credit from the Treasury Department.  Currently each company has access to $2.5B credit line from the Treasury.  It makes sense that this would raised given that $2.5B is a paltry sum in a market that has already seen mortgage losses of over $400B and that are expected to top $1T.  If Fannie and Freddie make up 50% of the mortgage market, it is not unreasonable to suspect they may have 50% of the losses.  I personally think there underwriting while looser by past standards was tighter than that of Washington Mutual, Indymac, or some of the truly “fly by night” lenders.  Nonetheless it reasonable to assume each will see losses in the hundreds of billions.  Part three of the rescue plan came as something of a shock to me, and that is that the Treasury department will be able to purchase equity (i.e. stock) in the company to help bolster the balance sheets.  As I said yesterday, I thought that the first move should be to cut the dividend and issue more stock.  But, I’m not sure why the US government should be the buyer.  Do they feel there is too much panic in the market for other buyers to step forward?  Is it because the two companies were created by the government and hence that is where they should return?

There are a couple of “moral” issues / controversies that have been raised the announcement of the rescue plan.  The first is “the taxpayer is on the hook.”  I always find this to be a funny argument against the bail out of financial institutions.  Aren’t we already on the hook?  If Fannie and Freddie fold, is this a case where the taxpayer won’t notice?  Extending credit to the GSE’s is far better deal for the taxpayer then a collapse of the mortgage giants, followed by a likely collapse of the financial system and the rest of the economy shortly thereafter.  Another reason I think the “taxpayers on the hook” complaint is absurd is that the taxpayers are ultimately the responsible party.  Fannie Mae and Freddie Mac are heavily regulated and were even created by the US government.  If you will recall from civics 101 our government is one that is of the people, by the people and for the people.  We as citizens must take the ultimate responsibility for what happens within our own country.  Remember, everyone in the government was either voted into office or appointed by those voted into office.  If we elect fools, we should expect to be on the hook for Fannie, Freddie and a whole lot else.  Critics have been decrying the size of Fannie and Freddie for years.  Likewise, despite what many financial executives have been saying, the possibility of a housing collapse and mortgage crunch had been speculated for years before it happened.  Why did we not force our elected officials to do something about it?  And more importantly, will we force them to look, ahead at other looming financial crises such as the insolvency of Medicare and Social Security.  Guess what?  In a couple years we taxpayers will be “on the hook” for that one too.

The second complaint this is being tossed about, and this came up with Bear Stearns as well is that this just teaches financial institutions and the like to become “too big to fail.”  I would have to say that I agree, but I don’t know what to do about that.  Certainly in the cases of Fannie and Freddie it would behoove us to reduce the size of their portfolios over time, but what about another potential Bear Stearns?  Certainly you wouldn’t want to disallow a company to grow in size because it could then become too big to fail.  Perhaps when institutions hit a certain size they would need to be put under greater scrutiny if they could cause irreparable harm to the rest of the financial system.  Or maybe once a behemoth is in place we figure out a way to cushion the fall far before there is any hint of a problem.  Like planning for a natural disaster, it would be best to plan for your escape route before the disaster occurs.  I don’t know.  If anyone has any bright ideas, please bring them on.

As for price action, both stocks rallied on the opening with Fannie up 32% and Freddie up 26%.  But the rallies did not hold and Fannie closed down 5.07% and Freddie down 8.26%.  In other news Freddie held a regular auction of $3B of mortgage securities and it brought out the most bidders since October of last year.  Maybe we won’t be on the hook after all.

The other big news rattling the markets today is the collapse of Indymac.  Clearly Indymac was not too big to fail.  And the speculation was rampant for who else was “small enough to fail.”  Here is what I’m sure is only a partial list –

National City Bank – dropped 15% and halted briefly.  During the halt the company let everyone know they had enough money.

Washington Mutual – This institution has been on the short seller list for a while.  WAMU fell 35% to $3.23 a share from a Lehman Brothers report that said WAMU would have to raise its provisions for loan losses.

Goldman Sachs recommended a sale of Zion’s Bancorporation which fell 23% on the news.  Goldman also said that dividend cuts were likely for Zion’s, Suntrust, and Comerica banks.

Wachovia dropped 15% after being downgraded from a “buy” to “neutral” by UBS.

Lastly, the New York Times ran an article speculating that more bank closures were on the way, which also had a number of names for short sellers.

It was also noted that this credit crunch may be milder than the S+L crises as there are currently only 90 banks on the Fed’s watch list of troubled banks whereas during the S+L crisis the number on the watch list was 575.  By the way, when the watch list was made this spring, Indymac was not on it.

For the day the Standard and Poor’s was down 11.19 or .9% to 1,288.3, the Dow Jones Industrial Average dropped 45.35 or .41% to 11,055.19 and the Nasdaq slid 26.21 or 1.17% to 2,212.87.  All three indices began the day up over 1%.

David Mollo

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