House of Cards Falling Down

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


U.S. housing data for May was out today and no matter how you look at it the report was bleak. The number of houses under construction fell to a record low of 475,000. The 17% drop in single-family homes was the biggest since the 1990-91 recession. Applications for permits were the lowest in a year.

There were hints that the housing market was already in trouble last month when construction permits fell 10%. They dropped an additional 5.9% in May. The federal government housing tax credit expired at the end of April and builders clearly understood that without government subsidies consumers were going to take a hike. And take a hike they did - mortgage purchase applications peaked on April 30th, the last day of the tax credit, and are now at a 13-year low even though mortgage rates have come down.

Housing starts are now down 70% from their peak even though the federal government has made Herculean efforts to support the market. U.S. housing was in a bubble and there is no case in history of a bubble being reinflated immediately after a collapse. Trying to do so is equivalent to pouring money down a drain. There is no better example of this than ongoing federal government subsidies of Fannie Mae and Freddie Mac. Bloomberg has just estimated that these will reach $1 trillion (more than the entire TARP program). U.S. taxpayers are footing the bill. Fannie and Freddie are going to be delisted from the New York Stock Exchange, probably on July 8th. So much for unlimited financial support from the federal government leading to success.

Housing was the epicenter of the Credit Crisis collapse. The market has not returned to health and it is not likely that it will for many more years. The overall U.S. economy itself is now on the verge of turning down again as well. ECRI leading indicators turned negative last week. The last time they did so was in September 2007. A recession began two months later. So far, the ECRI is downplaying its own data and claiming that its numbers indicate that the U.S. economy will be experiencing 'slow' growth in the next six to nine months.

The 'fast' growth that has been occurring in U.S. GDP has been based on changes in inventory levels and not an actual recovery in the private sector. In Q4 2009, a slower decline (yes decline) in inventories was responsible for approximately two-thirds of the increase in GDP. In Q1 2010, inventory replenishment accounted for more than half of the growth.

While the Credit Crisis had its origins in the U.S., the new unfolding global financial crisis is centered in Europe. There are reports that the IMF and the U.S. Treasury are in talks about a 250 billion euro bailout for Spain. While Spain and the IMF have denied the report, the market indicates some serious problem exists. The risk premium on Spanish bonds over equivalent German bonds has risen to the highest level since the creation of the euro.

Government spending can certainly make the economy or any given sector of it better for a while. Based on the evidence so far, the government has to continually spend or the economy falls right back down to where it was before the spending took place. Even reduced, but still substantial spending is not likely to be enough to keep the economy in the black under such circumstances. Governments have faced similar problems many times in history and have seen that major inflation is the outcome of utilizing this approach. Apparently the world's current regimes are now determined to make the same mistakes again.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Housing Hype Fades with Sales Numbers

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


During last summer and fall, the mainstream media was filled with glowing reports of recovery in the U.S. housing market. Government programs were juicing the numbers, which doesn't represent recovery of anything, but that wasn't the spin the media put on increased home sales. Special tax credits, which are still in place, were behind the better numbers. They are losing their affect though and the housing market is already beginning to turn down again.

According to the NAR (National Association of Realtors), existing home sales fell 0.6% in February to a seasonally adjusted 5.02 million units. This is the third monthly drop in a row. The impact of the 'seasonal adjustments' seems to have caused sales in the snow-buried Northeast and Midwest to rise significantly during the month. The overall number would have been much worse without the supposed strong sales in those geographic areas. Inventories of homes on the market, which are not seasonally adjusted, jumped 312,000 to 3.59 million. This represents an 8.2 month supply based on current sales rates. The median sales price was $165,100, down 1.8% year over year.

While the federal government has a number of programs to prop up the housing market, including funneling questionable mortgages through the FHA (Federal Housing Administration) and its blank-check support of nationalized and money-bleeding Fannie Mae and Freddie Mac, the first-time home buyers credit was the most immediate impetus for increased sales during the second half of 2009. The credit was originally slated to expire on November 30th, but at the last minute was extended to this April 30th and expanded to include non first-time buyers. Nevertheless, sales started to dip after November. It is now clear that the credit merely sped up purchases that were already going to take place and higher sales last fall mean lower sales early this year.

Existing home sales peaked in 2005 at 7,075,000. The latest number at 5,020,000 represents and almost 30% drop - and we are now entering the fifth year since the top. The pattern of sales from the homebuyer's tax credit indicates that it was too little to fix what is a massive systemic problem. House prices went too high during the bubble, actually doubling or more in a four-year period in some cities, and they need to come down to market clearing prices. Until this happens, the market cannot recover and grow again, nor can the overall U.S. economy.

Disclosure: None

NEXT: Will Expanding Euro Crisis Continue to Benefit U.S. Stocks

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

U.S. Economy Continues to Deteriorate Despite 'Recovery'

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


A number of economic reports in the last few days indicate that the U.S. economy has not only not failed to recover from the recession, but continues to fall deeper into a hole. Banking, consumer confidence, employment numbers, durable goods and the housing industry - each representing a different aspect of the economy - are all sending out troubling signs. Despite the onslaught of negative data, mainstream economists continue to echo the official U.S. government view that "the recovery is still on track".

Updated statistics from the FDIC indicate that there were 702 banks on the troubled list as the end of 2009. This is an increase of 27% from the third quarter. FDIC numbers also show that U.S. banks cut lending by 7.5% in the fourth quarter of last year. Since lending is the lifeblood of the economy this doesn't bode well for the future. The FDIC also had to put aside an additional $17.8 billion for future bank failures. Its deposit insurance fund is now at a negative $20.9 billion. Despite statements that it has enough cash to keep operating (Bear Stearns and Lehman Brothers made similar claims), it is only a matter of time before the FDIC is bailed out. This will take place before the end of the year and will be done by tapping a line of credit from the Treasury department. Expect this event to be downplayed by mainstream media reports with claims that it is not really a bailout.

While the U.S. banking system continues to dissolve, consumers are losing confidence in the economy. The Conference Board numbers for February fell a whopping 10.5 points to 46 (around 100 is a good number). The present situation subindex fell to 19.4, the lowest level since February 1983 when the U.S. was trying to recover from a severe double dip recession. Before the Credit Crisis, consumer spending represented 72% of the U.S. economy. Without their participation, a sustainable recovery is not possible. Other reports indicate there is no way in the near future that consumers can resume their vital economic role. Consumers not only don't have credit, credit card debt was dropping at close to a 20% annual rate at the end of last year, but they are worried about the job market as well.

The weekly jobless claims indicate why the job picture is still troubling. Initial claims were up 22,000 last week to 496,000 (a number around 400,000 indicates recession and 300,000 indicates a healthy economy).  These numbers are highly volatile because they come from state unemployment offices that are notorious for backlogs in processing the claims. This problem occurred during the holiday season and the claim numbers were consequently lower. The mainstream media then fell all over itself to report the tremendous improvement in the employment picture, instead of the real story of bureaucratic incompetence that was preventing accurate numbers from being produced.  Market watchers usually only pay attention to the four-week moving average to get around this problem. This number has risen by 30,000 to 473,750 in the last four-weeks.

The just released Durable Goods report got major headlines about how bullish the number was. This is only the case as long as you don't look at the details of the report. Responsible for the good headline number was a 126% increase in civilian aircraft orders (these orders can be cancelled by the way). Outside of transportation, orders fell 0.6%. Core capital equipment and machinery orders dropped 2.9% and 9.7% respectively. These two numbers are the important ones that determine the direction of the economy. For all of 2009, durable goods fell a record 20%.

Finally, housing doesn't look like it is in recovery mode either. Housing was the epicenter of the Credit Crisis and it will be years before all the damage wrought by the bubble will be worked out. According to the Mortgage Bankers Association, mortgage applications for home purchases have just fallen to a 13-year low. New home sales in the U.S. fell to the lowest level on record in January (records go back almost 50 years). Government nationalized Freddie Mac reported it lost another $7.8 billion in the fourth quarter. That brings its total loss to $25.7 billion for all of 2009. Freddie Mac purchased or guaranteed one in four U.S. home loans in 2009. The Obama administration has promised a blank check to Freddie along with its companion housing entity Fannie Mae, also nationalized and bleeding money, to cover losses up until 2012.

This is little evidence that the U.S. economy has recovered from the recession or is going to recover from the recession any time soon. The support for the recovery viewpoint comes from government statistics that have been highly manipulated. All governments of course want to present a rosy picture of their handling of the economy for political reasons and it is much easier to make the numbers better than it is to actually make the economy better. Eventually the public catches on to this game however. The recent consumer confidence numbers indicate that the American public is no longer buying the public relations story, but is starting to pay more attention to the realities they have to face on a day to day basis.

Disclosure: No positions

NEXT: The Impossible Contradictions of U.S. Consumer Spending

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

World Economic Leaders Need IQ Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


There are few things investors can count on during our current era of financial turmoil. One of them is the unerring obliviousness and incompetence of the world's elected leaders and central banks. Somehow they both manage to find the highest cost, least effective solution for every Credit Crisis problem they try to solve. Moreover they usually don't bother to act until every dog in the street has been aware of the problem for some time. There was more than enough support for this view on both sides of the Atlantic today.

There was a summit meeting in the EU today, where the leaders of the 16-nation block struck a deal, at least in principle, on assisting Greece with its debt problems. No details of the rescue package were forthcoming, but there were suggestions of some form of loan program. This is enough to open up the Pandora's box of 'moral hazard', but probably won't be enough to fix the problem - at least not with the initial measures. The final cost for any help to Greece will be much more than early expectations and this will pale in comparison to the cost of future bailouts for other member states such as Spain and Italy.

The whole scenario currently taking place in the EU should seem vaguely familiar to Americans. The much maligned TARP bailout program was initially only supposed to be loans, so it wasn't really costing the taxpayers anything. A number of other bailout programs mushroomed around it and by some estimates reached $11 trillion in promised money (compared to $700 billion for TARP).  While it has been claimed that some TARP money was returned, it is not clear how much actually was. When Citibank announced it was paying back $20 billion (of the $45 billion it received), the U.S. government agreed to give it a $38 billion tax break. It's not clear how many similar deals were worked out to shift the burden from a loan program to a direct cost for the American taxpayer, who after all would have to pay extra taxes to make up for the federal government tax breaks given to the big banks.

While the EU leaders were busy sowing the seeds of future financial disaster for their currency union, the ever out of touch U.S. Fed chair Ben Bernanke was testifying on Capitol Hill about a proposed exit strategy from his easy money policy. As a reminder, Bernanke didn't realize that subprime loans would cause a problem, didn't realize the U.S. was in a recession months after it had begun, and didn't realize that not bailing out Lehman would lead to a possible collapse of the world financial system. Now he doesn't realize the recession and economic problems caused by the Credit Crisis are still not over.  At least he's consistent.

Those who think the U.S. economy is healthy only have to look at the state of the housing market. Almost one in three borrowers have mortgages that are for more than the value of their property. As of November 2009, 5.3% of U.S. home mortgages are three or more months behind in their payments. A year earlier in 2008, it was only 2.1%. In 2009, 2.8 million mortgage holders received a foreclosure notice. Current estimates are this number will rise as high as 3.5 million in 2010. Fannie Mae and Freddie Mac, both nationalized by the U.S. government, have just announced that they will buy back troubled loans contained in securities they have sold to investors (this is a major bailout for the big money players, although the mainstream media did not report it as such). Last year, the Obama administration pledged to cover unlimited losses for both companies through 2012. Draining liquidity from an economy with these conditions in the housing market would send the U.S. into a major depression.

The U.S. experience in the Credit Crisis shows that once you start bailouts, there is potentially no end in sight for how many there will be, nor any limit to the final cost. The disaster precipitated by not bailing out Lehman Brothers also indicates that you must bail out everyone once you start the process. Of course, bailing out no one is the other option. Half and half measures don't work and produce the worst results at the greatest costs. The EU seems not to be aware of this lesson. Maybe they're getting their advice from Ben Bernanke?

Disclosure: No positions

NEXT: China Worries About Inflation, The EU Needs to Worry About Growth

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Future U.S. Bailouts - FHA, FDIC, PBGC, U.S. States

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

There is no end in sight for U.S. bailouts stemming from the Credit Crisis. Once you've bailed out wealthy Wall Street bankers (and there are a handful of Federal Reserve programs for this in addition to $700 billion TARP program), it isn't politically tenable to say no to pensioners, savers, homeowners. and local governments. It should be kept in mind that the Credit Crisis didn't create the problems, but merely exposed the rot in the system that had been there for many years. As Warren Buffett most famously said, "you only know who's swimming naked when the tide goes out". Well, a lot of U.S. government operations have been swimming naked for years and the Credit Crisis caused the tide to go out.

The problems center around housing, banking, pensions, and government operations that don't have the money printing ability of the federal government. The government already nationalized massive housing loan entities Fannie Mae and Freddie Mac in 2008 and these have become bottomless pits for government aid. Fannie lost $18.9 billion in the third quarter of this year and requested an additional $15 billion in funding. Things would be even worse, if much of the loans that had previously been handled by Fannie and Freddie weren't now being insured by the FHA (Federal Housing Administration). The FHA is now backing loans that would have made a crooked subprime mortgage broker blush in the heyday of the housing bubble. When it comes to getting FHA insurance these days, bad credit, a spotty work history, and even a previous foreclosure aren't deal breakers. Not surprisingly, FHA finances are spiraling downhill fast and warnings about a need for a bailout are already becoming louder.

The FDIC has temporarily solved its need for a bailout, with temporarily being the operative word. On November 12th the FDIC mandated that banks pay three years of their insurance premiums up front. This will provide the FDIC's insolvent bank deposit insurance program with an immediate cash infusion of $45 billion. Unfortunately, the FDIC itself estimates that its funding needs will be $100 billion in the next four years. Assuming they only need that amount (which is possibly very optimistic), they will still have a serious short fall. There have been 123 U.S bank failures as of mid-November and the ones on November 13th cost the FDIC approximately a billion dollars. That's for just one week. At that rate, the FDIC would be out of money again in 45 weeks.

The PBGC (Pension Benefit Guaranty Corporation), a government chartered company that insures U.S. pensions is another operation which is heading toward a bailout. In its 35 years of operation, it has lost money in 29. Losses have even taken place when the U.S. economy was strong and the stock market rallied. In bad years, the PBGC loses even more money. So far in 2009, it has taken over 144 failed pension programs compared to 67 in 2008. It was $22 billion in the red this year. According to an inspector general's report, the PBGC's former director was alleged to have had improper contacts with Wall Street. When questioned by a congressional panel, he took the Fifth Amendment (refusing to answer because it might incriminate him). Fannie Mae and Freddie Mac executives also had serious ethical problems. Corruption and bailouts seem to go hand in hand.

While California's budget woes are well known, there are nine other U.S. states that are in serious financial trouble and an additional ten not far behind them. California has a $121 billion budget gap and is resorting to IOUs to make payments. According to the Pew Center, the nine other states in serious trouble are Arizona, Michigan, Nevada, Florida (states hit hardest by the housing downturn along with California), Rhode Island, Oregon, New Jersey, Illinois and Wisconsin. High unemployment and reduced business activity have caused tax receipts to plummet and are behind the current fiscal distress. There is little evidence the problem is getting better despite claims by the federal authorities and mainstream economists that the recession is over. The federal government has the same problem as the states, but it just prints money to make ends meet. While the feds can bail out the states, who's going to bail out the U.S. when money printing doesn't work anymore?

NEXT: The Art of Inflation

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A Golden Opportunity with a Silver Lining

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

In the current uncertain environment there are only three things that we know will take place - death, taxes, and that the U.S. Treasury will continue to flood the financial system with newly 'printed' money. While the first two are unabashedly negative, the third can be a golden opportunity with a silver lining. The ability to borrow the money needed to pay for the all the bailouts the government is engaging in never existed. The U.S. reliance on foreign sources to fund its operations was already stretched to the limit when the budget deficit was $400 billion, so printing money is the only way to fund the current year's budget deficit which is approaching $1750 billion. Even worse, news out of China indicates that the foreign money that the U.S. has previously tapped can no longer be relied on. In the last few days the markets seem to finally be grasping this situation with traders dumping U.S. government debt and the dollar and buying up gold and silver.

As long predicted in this blog, China has been selling its U.S. debt. It is not yet dumping it wholesale however (just wait, that day will come), but is rotating out of more risky to less risky paper. China sold a large amount of agency debt (Fannie Mae and Freddie Mac) and it looks like the U.S. Fed bought it. Certainly no one else in their right mind would have done so.If you go back and look at the Fed's first announcement on quantitative easing, you will see that one of the major purchases for the newly printed money was Fannie Mae and Freddie Mac bonds. China has also finally admitted it is worried about inflation in the U.S. and has been buying shorter term paper and avoiding longer term bonds.

The China news was of course negative for the U.S. dollar, but it is by no means the only thing pressuring the currency. A return to normal operating conditions for the global financial system (see comments on the TED Spread in yesterday's blog) is highly dollar negative The dollar has been kept up for the last many months because of its safe haven appeal and as conditions improve outside the U.S., particularly in developing economies, that appeal is waning rapidly. Foreign traders dump U.S. treasuries and repatriate their money under such circumstances. Indeed, long term treasuries broke above the key 3.25% resistance this week (when traders sell bonds the interest rate goes up) as the dollar has sold off against almost every currency. Overnight even the British pound had a major rally against the dollar. Talk about embarrassing!

The inevitable corollary of a falling dollar is rising gold and silver prices. Gold hit a two-month high yesterday, closing above 951. It is on the verge of a major breakout. Silver traded above major resistance at 14.50 during the day and it is only a matter of time before it closes above this key level. Figures released today show the demand for gold bars and coins was up 396% in the fourth quarter of 2008. The spectacular rise of 223% for gold purchases from ETFs seems small in comparison. None of this activity is taking place because Wall Street analysts and other mainstream 'experts' have been telling people to buy precious metals. And don't expect to be hearing about the opportunity from them either while there is still a lot of money to be made. They are usually the last to know about such things.

NEXT: North Korea, OPEC and Precious Metals

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Invest Now for the Coming Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The Federal Reserve finally fessed up yesterday, announcing it was going to print new money to buy U.S. Treasury bonds. While my initial reaction was, 'so what else is new?', the public has not previously been officially informed of the massive inflationary policies that the Fed is implementing. While Bernanke did admit that the Fed was printing money to pay for the bailouts (how else could they have been paid for?) in his 60 Minutes interview, the markets didn't react to his statements on Monday... but they did yesterday. The dollar dropped like a rock, gold shot straight up and interest rates plummeted. Financials had the biggest rally on the good news that worthless government paper was going to be used to purchase their worthless debt paper (for some reason this seems like some sort of scam to me), although all metals and oil went up as well.

In yesterday's announcement the Fed said it will buy $300 billion of U.S treasuries (mostly in the 2 to 10 year range), $750 billion in Mortgage Backed Securities (MBSs) from Fannie Mae and Freddie Mac (both bailouts are black holes for government money), and increase purchase of Fannie Mae and Freddie Mac debt to $200 billion. The Fed signalled it would increase its balance sheet to $4 trillion. It was $900 billion last year and $2 trillion more recently. Take these numbers with a grain of salt, they are on balance sheet only (think Enron accounting). To increase its balance sheet the Fed must print new money. Even without knowing this, it is obvious that new money was being printed for some time now. To pay for all the bailouts, there has been huge new issuance of treasury bonds. Even though this created a big increase in supply, interest rates went down indicating that demand for U.S. treasuries was increasing even faster. Where do you think all of this extra demand came from?

The reaction to the Fed's announcement is a prelude to the future. The dollar tanked almost 3% in minutes, something that previously would have been a major move in a month. Gold which had been selling down and traded as low as $889 reversed course and rallied $57, also in minutes. Silver which traded as low as the 11.75 went up a dollar - and is still a major bargain. Oil which was also selling off Wednesday morning, reversed and closed up. It traded as high as $51.65 a barrel overnight, which is a breakout that confirms that a double bottom was made last December and February. All other metals and coal went up as well and you should consider them to be good inflation hedges too. It is possible that even steel stocks put in a bottom because of the Fed's move.

You should be adding to your commodity positions at this point. Consider buying commodities that you don't already own or have large postions in. If you already own enough oil, you might want to buy some more silver for instance. You might want to consider picking up some base metals and coal, if you already own a lot of gold. While, gold, silver and oil are the foundation for inflation investing, any tangible asset that has a useful function and a limited supply that can't be increased significantly is also a good choice.

NEXT: Commodities Rumble, Financials Tumble

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - The Government Takeover

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: TBA

It took only about six weeks after congress passed a bailout package before the U.S. government had to take direct control of Fannie Mae and Freddie Mac. The terms of the bailout package were open ended and extremely generous at Treasury Secretary Paulson's insistence. He claimed that if it was made obvious that the full financial power of the United States government was behind Fannie and Freddie, the need to take any action would be minimized (despite the fact that is was universally agreed that Freddie was insolvent and would therefore need continual cash infusions to keep operating). The Congressional Budget Office backed up Paulson by estimating that there was a greater than a 50% chance that the bailout would cost nothing.

On September 7th, the U.S. government seized Fannie Mae and Freddie Mac, firing their top management and taking direct control of their operations. The Treasury department announced almost immediately that it would initially be pumping $200 billion into the two companies (so much for the bailout costing taxpayers nothing). Auditors who had been examining Freddie and Fannie's books found that Freddie had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of 2008, which it wouldn't have had to disclose until early 2009. Fannie Mae had used similar methods, but to a lesser degree. Both companies needed capital and a lot of it to keep operating. One wondered how many U.S. banks and brokers were doing similar things with their books, but the public didn't know about it because there were no outside auditors to tell them.

With the government takeover, Fannie and Freddie's over $5 trillion in debt would now reasonably have to be added to the official U.S. national debt figures. Adding Fannie and Freddie's total debt to the national debt would increase it to between $14 or $15 trillion or roughly the size of the official GDP figures (the actual GDP figures were much lower than those claimed by the government and the actual national debt, including social security, medicare and medicaid entitlements was somewhere around 50 to 60 trillion dollars). Ironically, the idea of privatizing Fannie Mae was conceived of in the 1960s during the Johnson administration to get its debt off the government's books.

The government bailout was intended to support Fannie and Freddie's bonds, many of which were held by foreign governments including China and Russia. U.S. banks and thrifts also held an estimated $1 trillion of this debt. If Fannie and Freddie defaulted on their bonds, the U.S. would have had great difficulty ever borrowing again from foreign sources and both our government and economy would wind up seizing up almost immediately. A number of U.S. banks would likely have gone under soon thereafter as well in the event of a bond default. While bonds holders got bailed out, the stockholders were wiped out. This included U.S. pension funds, most of whom were major holders of Fannie Mae and Freddie Mac stock.

Fannie and Freddie were by far the largest bailout in U.S. financial history. Where would the already debt ridden U.S. government get the money to pay for it? If it couldn't borrow the money, which was indeed likely, it would have to print it. Only time would tell how much inflation this would cause and how much value the U.S dollar would lose as a result .

NEXT: Probable Future Outlook for the United States

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - The Risks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=w0am1FJVD88.

While not bailing out Fannie Mae and Freddie Mac posed major risks to the world financial system, the bailout itself had the potential to be extremely risky to the United States itself and extremely costly to the U.S. taxpayer. The blank check guaranteed by congress for Fannie and Freddie was likely to be utilized in any number of ways.

By the time the bailout bill was passed, an audit had already revealed that Fannie and Freddie had $20 billion of known losses that they had yet to declare (unrecognized losses were probably much larger). New accounting rules meant that both companies would have to raise an additional $75 billion in capital and it was unlikely this could be done on the open market. These costs were minor though compared to those that would be generated if mortgage insurers went under (a high probability event) and couldn't pay off defaulted mortgages. Fannie and Freddie had over a $1 trillion of exposure to insured mortgages, mortgages that were for over 80% of the purchase price and therefore the riskiest in a market with falling home prices. These were also the mortgages that cost Fannie and Freddie the most when they defaulted.

Recession and falling house prices weren't the only major risks to Fannie and Freddie's finances, so was inflation. Obviously, the worse the economy, the more foreclosures there are and the less money recovered in the sale of a repossessed house. Fannie had $4.7 billion in foreclosed properties on its books by the first quarter of 2008, double the amount from a year earlier and increasingly rapidly. The prices being obtained for these houses were no where near their previous purchase prices and the gap was widening further. An inflationary environment however wouldn't do away with Fannie and Freddie's financial risks. Since both receive income based on long term mortgages (those in the 2000s had very low interest rates), but have to borrow short term to fund there operations, high inflation is potentially disastrous for both of them. If short term rates went into the higher single digits or more, Fannie and Freddie would continually lose money and the losses would become greater and greater as interest rates rose.

In the longer term, perhaps the greatest risk of the the Fannie and Freddie bailout was that the U.S. government could lose its triple A credit rating and then all government borrowing would cost more. S&P made a statement in spring 2008 that a government takeover of Fannie and Freddie was likely to result in such an action. Moody's made a similar comment in June.
The bailout bill passed by congress in late July was of course not the same as a takeover of the two companies, although it set up the possibility. Only six weeks later that possibility became reality.

NEXT: Exposing Fannie Mae and Freddie Mac - the Takeover

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - The Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=Q8XU5XhwdyY..

In mid-July 2008, Fannie and Freddie's stock prices were plummeting, with Freddies stock getting into the low single digits. Knowing that they had to do something right away, the Federal Reserve and Treasury department announced emergency measures to rescue the two companies. First, the Fed opened its discount window to Fannie and Freddie, something that had only been available to commercial banks for more than seven decades until broker-dealers also got access to the Fed in March 2008 (it was clear that the expansion of this privilege to more and more industries was a trend in the making). Secondly, the Treasury department went to Congress with a bailout plan. Secretary Paulson asked for a blank check from the U.S. government on behalf of Fannie and Freddie on the grounds that just having such strong financial backing would prevent their problems from getting worse. In less than two months the U.S. government would be forced to take direct control of both institutions, indicating that this was either one of biggest lies or most imbecilic statements in U.S. financial history.

The U.S. congress passed the 'Federal Housing and Economic Recovery Act of 2008' in late July. In the bill, Paulson got the blank check he requested, at least until the end of 2009. Provisions were also made to give up to 400,000 homeowners lower fixed-rate interest rates loans and an additional $3.9 billion was allocated for neighborhood grants (which seemed to be some pork barrel provision). The bill also established a new regulator for Fannie and Freddie to replace OFHEO. There was nothing wrong per se with OFHEO's regulation, other than every time it tried to control Fannie or Freddie, powerful politicians stepped in to prevent it. Of course, the politicians responsible for creating the Fannie and Freddie mess were not going to put the blame on themselves, but tried to make OFHEO the fall guy instead.

Without question, the most outrageous part of the bailout bill was its cost estimate. The Congressional Budget Office (CBO) predicted it would cost only $25 billion (the same as the cost they predicted for the Iraq War, now estimated by a recent outside study to be over 100 times higher at $3.2 trillion). The CBO even made the preposterous statement that there was a greater than 50% chance the bailout would cost U.S. taxpayers nothing. What thinking, or lack thereof, led to this conclusion is not clear. Since everyone agreed that Freddie Mac was insolvent, by definition it would have to have money pumped into it to keep it operating. So from the beginning there was a zero percent chance that the bailout would cost nothing.

There is certainly evidence that Congress itself had a more realistic assessment of the potential bailout costs. As part of the rescue package, they raised the national debt ceiling $800 billion (the sixth time the national debt ceiling was raised during the Bush administration) to $10.6 trillion. If the bailout was going to cost only $25 billion, there was no need for a higher debt ceiling. Clearly the cost estimates were meant for a gullible public, not Washington insiders who knew the truth. It was the New York Investing meetup's opinion that the Fannie Mae and Freddie Mac bailout would cost U.S. taxpayers at least a trillion dollars - and even that might be an optimistic projection.

NEXT: Exposing Fannie Mae and Freddie Mac - Future Risks

Daryl Montgomery.
Organizer, New York Investing meetup.
http://investing.meetup.com/21.

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - Subprime Crisis

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=pQjgEAMa5SA.

By August 2007, it became clear that the U.S. housing market was in trouble. Banks and brokers were starting to face massive write downs for all the irresponsible home loans they had been granting for the previous several years and this was causing available mortgage money to dry up. Federal government officials, including President Bush, the Treasury Secretary Henry Paulson, the Fed chair Ben Bernanke, the head of the Senate Finance committee Chris Dodd and his counterpart in the House Barney Frank, unanimously supported using government backed Fannie Mae and Freddie Mac to help prop up the faltering mortgage market. While this was done purportedly to help struggling home buyers, it was in reality an attempt to help the U.S. banking system. The likelihood that the U.S. taxpayer would be stuck with one huge bill because of these actions didn't seem to have been considered - and if it was, no federal official or representative seems to have been bothered by it.

Fannie and Freddie were encouraged to buy dicier loans, particularly Alt-A. Even some subprime loans started showing up on their books. Together these loans accounted for as much as 20% of the total debt they backed by the first half of 2008. A similar percentage of loans on their books were for over 80% of the original home price and since housing prices were falling, this percentage for actual home value was not only much higher, but growing rapidly. Caps on the size of a mortgage that Fannie could handle were raised substantially at that time to over $700,000. These actions along with the diminished role of banks in mortgage lending wound up creating a de facto nationalization (the de jure nationalization would come later) of the American mortgage market. In the last half of 2007, Fannie and Freddie backed 90% of mortgages in the United States and 81% in first half of 2008.

As a consequence of government policies, the condition of these already financially weakened and corruption plagued companies deteriorated even further. The leverage, calculated as liabilities divided by shareholder equity, that Fannie Mae was utilizing rose to an eye popping 78 to 1, more than double the 33 to 1 leverage that caused Bear Stearns to implode overnight. This huge leverage was made possible with the complicity of Fannie and Freddie's regulator (OFHEO) who kept lowering the capital surplus requirements the companies needed to maintain, first from 30% to 20% and then to 15%. This allowed Fannie and Freddie to continually state to the press that they had much more capital on hand than the minimum amount set by their regulator and thereby imply that they were in a sound financial state, even though they were not.

In fact, by the first quarter of 2008, Freddie's liabilities exceeded it assets by $5.2 billion. Based on the basic principles of accounting, it was an insolvent company. While this information was public, other than the New York Investing meetup, few seemed to notice this obvious fact. Only when a former Fed official made a public statement pointing out that the emperor had no clothes in July 2008, did the problems with Fannie Mae and Freddie Mac suddenly receive major press and government attention.

NEXT: Exposing Fannie Mae and Freddie Mac - The Bailout

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - Corruption

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=q5ho_OAJIU8.

There are probably few institutions in the United States that are as corrupt as Fannie Mae and Freddie Mac. Both are dumping grounds for political hacks from the major political parties and their Wall Street cronies (Wall Street firms do a considerable business in selling Fannie and Freddie's bonds). Powerful lobbyists from all points on the political spectrum are on their payrolls. Ex-congressman are known to get lucrative consulting contracts with them. And all of this is subsidized by the U.S. taxpayer.

The government support provided to Fannie and Freddie is supposed to be used to expand home ownership for lower income Americans. Not much of it winds up being spent of that purpose however. Instead, it has been estimated that at least 50% of their government subsidies, go to pay for dividends for their stockholders and to pay inflated bonuses for their top management. Both Fannie and Freddie had major accounting scandals in the early 2000s. Fannie alone had to spend a billion dollars for the audits to redo its books. The audits and other investigations showed that Fannie and Freddie purposely altered earnings to increase the amount of executive bonuses. They also indicated that Fannie and Freddie's operations were permeated with fraud and mismanagement. It was found that they overvalued assets, under reported losses, falsified signatures on accounting records, changed earnings records in their databases, misclassified securities on the books, and misused tax credits. Furthermore, it was revealed that they didn’t use generally accepted accounting principle (GAAP) to determine their earnings.

Government subsidies also went to pay for the $200 million in 'lobbying activities' that Fannie and Freddie spent in a several year period. This taxpayer supported lobbying was used to pervert the American political process. When Representative Cliff Stearns held a hearing investigating Fannie and Freddie and announced he would be holding more in the future, jurisdiction was promptly removed from his house committee. It was given to the apparently more compliant Mike Oxley, who then benefited from 19 political fundraisers sponsored by Fannie. When Representative Paul Ryan held town hall meetings in his district criticizing Fannie, Fannie subsequently called all mortgage holders in his district making false claims about his positions. He got into a lot of trouble with his constituents as a result. Perhaps ever more outrageous, when the head of OFHEO (the government appointed regulator for Fannie and Freddie) issued a report in 2003 indicating that the excess leverage that Fannie and Freddie used could prove to be financially calamitous (something that is now proving to be true), he was soon thereafter fired by the Bush administration. It was quite obvious at that point, that anyone who attempted to put any control whatsoever on Fannie or Freddie would promptly be gotten out of the way.

Where was the American media when all of this was taken place? Generally, they had been intimidated into silence. When the Wall Street Journal did an expose on Fannie and Freddie's operations in the early 2000s, they received a slew of ongoing condemnation from Wall Street and Washington. Even they seemed surprised by the extent that the politically powerful and well-healed benefited from the Fannie and Freddie tax-supported gravy train. It seemed that there were few people that Fannie and Freddie wouldn't attempt to bribe and no one that was too powerful that they wouldn't attempt to silence.

NEXT: Exposing Fannie Mae and Freddie Mac - The Subprime Crisis

Daryl Montgomery
Organizer New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - Origins

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.


Our video for this posting can be found at: http://www.youtube.com/watch?v=Ennn4Qq8MUY.

After the market close on September 4th, 2008, it was announced that the U.S. government would likely be taking over mortage giants Fannie Mae and Freddie Mac in what would be the biggest financial bailout in U.S. history. Congress had already passed a bailout bill a month earlier making this action possible. The New York Investing meetup had already predicted that the need for the bailout the previous fall. This topic was raised in the December 2007 meeting and in the April 2008 meeting, Fannie Mae and Freddie Mac were on our list of the dirtiest dozen financial companies.

The origins of Fannie and Freddie were innocent enough and didn't presage their ultimate blowup many years later. New Deal mortage progams actually started with the FHA, which was created in 1934 to insure mortgages that had less than a 20% down payment (most mortgages in the 1920s had much higher down payments). Fannie Mae was then established in 1938 to buy FHA mortgages, creating a secondary mortgage market. For the first 30 years of its existence Fannie Mae had limited impact on the U.S. housing market because it had acess to little credit and significant restrictions on the size and type of mortage it could back. All of that changed around 1970 however.

That year, the U.S. government ranamed the existing Fannie Mae, Ginnie Mae, and then created a new Fannie Mae that would be a quasi-govenment backed company that could purchase riskier mortgages (Fannie's charter allowed it buy even 100% mortages as long as the amount over 80% was insured). The reason for making Fannie Mae a publicly traded company was the government wanted to provide expanded mortgage services, but didn't want the debt on its own books. In tandem with Fannie Mae's creation, Freddie Mac was also created as a GSE (government supported enterprise). Its purpose was to package mortgages into bonds, known as mortgage backed securities (MBSs) and sell them to investors thereby recycling the capital available for mortages. Freddie didn't become a fully traded public company until 1989.

The scope and extent of Fannie's operations expanded greatly in the 1980s and 90s. In 1978, Fannie was allowed to back mortgages for multifamily dwellings. In 1981, it added adjustable rate mortgages to its operations and in 1983, even riskier second mortgages. At the same time, the maximum amount of a mortgage that Fannie could back was also rising going from
$108,300 in 1980 t0 $252,700 in 2000. After 2000, this amount increased at a much faster clip, reaching $417,000 in 2006 and $730,000 for awhile in 2008. By raising the mortgage caps repeatedly, the U.S government created a bubble feedback loop that made the U.S. housing bubble possible - housing prices went up; the amount of a mortgages that could be gotten by a homebuyer went up; housing prices went up again; and the amount of a available mortgage went up again and so on and so on.

Between 2001 and 2007 alone, the amount of mortgages backed by Fannie Mae went from 2.5 trillion to $5.0 trillion. U.S. housing prices approximately doubled as well during this same period. Most amazingly, all of this took place even though one of Fannie and Freddie's major purposes was to increase home ownership for the poor. Acting to constantly support higher and higher U.S. housing prices didn't seem to be a particularly efficacious approach to accomplishing this goal.

NEXT: Exposing Fannie Mae and Freddie Mac - Corruption

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21