Debt Rattle, July 12 2008: The 9th Circle

Gustave Doré Satan trapped in the frozen lake Cocytus in the Ninth Circle of Hell
Illustration for Dante Alighieri’s Commedia [Divina]: Inferno

Ilargi: There's not that much need to comment on current events, they are quite clear. Even so, the spin masters are out in full glory, as is to be expected. The FDIC seized Indymac, and their estimate of $4 billion losses from the bank look suspiciously low. They are hoping to sell the assets, or so they say. Good luck finding a buyer for more than pennies on the dollar. And let's not forget that Indymac was founded by Angelo "Al Jolson" Mozilo.

Not surprisingly, I'm not the only one who has cast doubt on Fannie and Freddie's survival by Monday. The risk of a complete collapse of their share values may be seen as too large, and too likely to breed further losses elsewhere in the markets, or even an outright panic.

Their opening, off the bat, on Friday at a 50% loss, even though it was somewhat contained after, must have set off red flags and wailing sirens through the finance community and Washington. Can they risk a repeat of that on Monday morning? What means are still open to boost investor confidence?

As an analyst put it yesterday: "Without Fannie and Freddie, our economy would collapse". And "da boyz" fear that is real. But then again, what is also real is that America's credit rating will not survive an additional $5 trillion in debts and toxic assets in the books. I would guess that perhaps remaining shareholders won't take the risk of Washington seizing Fannie and Freddie; it would leave them with worthless paper. If they sell early, they may still get some return. But it may already be too late. If so, expect an announcement tomorrow.

As for the "deciders" behind the scenes, I must wonder whether they're set to run out of tricks, or whether all goes according to plan, and they've only just started. After all, somebody's about to buy a huge amount of assets for a miniscule investment, a golden deal that will see all of the lost value nationalized and transferred to the event horizon of the bottomless black hole that is the public purse. It's been done before, 75 years ago in the Dust Bowl, and it was a smashing success. Today it would be 100 times more profitable.

Yet, for now first prize goes to the Wall Street Journal, for an op-ed that says:
The losers have been the taxpayers, who will now have to pay the price for this collusion. Maybe the press corps will even start reporting how this vast confidence game could happen.

That sort of cynical attitude, from a former quality paper turned amnesiac cheerleader, it truly is the pits. Maybe the WSJ, in its press corps role, should start reporting on how it could happen that only now it starts to comment on the inadequacy of reporters covering the issues.

And if it were looking for a reason to continue as a going concern, I would strongly advise a look inward, and not a bunch of cheap sneers at other publications. The Journal has been breathtakingly useless in what by definition should be its field and its purpose, what is the heart of journalism: namely, truth-finding.

If it can't or won't do that, it's time to get off the field with all the other cheerleaders: It's time for the first pitch.


America's 'AAA' rating has become a joke

The Dow Jones index has plunged below 11,000 for the first time in two years in a fresh rout of bank shares after US Treasury Secretary Hank Paulson dashed hopes for an imminent bail-out of mortgage giants Fannie Mae and Freddie Mac.

The share price of the two fortress institutions - which together cover half the $12 trillion (£6 trillion) US home loan market - continued their collapse, losing another 20pc in wild trading. Fannie Mae has fallen 87pc since October, shedding $63bn.

The meltdown at the two federally chartered agencies amounts to a heart attack at the core of the US credit system, leaving it obvious that the Bush administration has failed to stabilise the financial system since the Bear Stearns collapse in March. In a terse statement, Mr Paulson said the Treasury was working on a plan to bolster the two agencies in their "current form".

Press reports had suggested an explicit US guarantee of the agency debt, or even a state seizure known as "conservatorship" that would purge management and burn shareholders. The Dow Jones plunged 251 points to 10,977.7 before recovering to close only 128 points down. After the market closed, Freddie Mac said in a statment: "We are not under any mandate to raise capital in the near term. Freddie Mac's liquidity position remains strong."

The events in the US hit banking shares hard in London, and helped drive the FTSE 100 deep into bear market territory, with the blue-chip index down 145.2 points - 2.69pc - to 5261.6. The FTSE 100 has now fallen 1470.8 points or 21.8pc from last June's high of 6732.4.

The dollar also came under pressure, falling more than a cent against the pound to $1.9884 and saw oil prices climb to a record $147 a barrel, before easing back to nearer $145 in late trading. US analysts estimate that Fannie Mae and Freddie Mac would need to lose a further $77bn to fall below the "critical capital level", but the markets are already starting to anticipate even greater losses as US housing defaults soar.

As the fears of a banking crisis gripped Wall Street, Lehman Brothers shares fell 22pc. Investors have been spooked by a filing this week showing that the bank still has $41bn of mortgage debt and other "toxic" Level III assets. Lehman now risks the same spiralling loss of confidence that engulfed Bear Stearns, though the Federal Reserve's emergency lending window for broker-dealers offers a lifeline.

The credit default swaps on Lehman debt leapt 55 basis points to 380, flashing an extreme stress signal. The implosion of Fannie and Freddie is disturbing. Neither has exposure to sub-prime loans. "The situation is far more serious than Bear Stearns," said Bill King, chief strategist at Ramsey King Securities.

Under the US stimulus plan the pair have been deployed as lenders of last resort to the housing market, carrying out a quasi-official rescue mission on behalf of Congress since March. Now the rescuers themselves need rescuing. Charles Schumer, chair of the Senate banking committee, said: "Fannie Mae and Freddie Mac are too important to go under. If they need additional support, Congress will act quickly."

If Washington does take on the liabilities of the two, this would double the US Treasury's outstanding debt load at a stroke and raise serious concerns about the triple-A sovereign rating of the US itself. There may be no choice. Bill Gross, head of the bond giant Pimco, said a default by the two agencies would set off a "firestorm of intolerable proportions".

Standard and Poor's said in a recent report that Fannie and Freddie posed "a large contingent fiscal risk: if the risks were to translate into increased government debt, they could hurt US credit standing". The markets have already begun to sense danger. The cost of insuring against default on 10-year US Treasury bonds surged from 8 basis points to 15 at one stage yesterday.

"America's 'AAA' rating has become a joke," said Peter Schiff, head of EuroPacific Capital. "I believe the losses from Fannie and Freddie alone could reach $500bn to $1 trillion dollars. ''The US government will not be able to meet repayments on its debt once interest rates rise," he said.

Mr Schiff said a big chunk of the agency debt is held by foreigners. A collapse of confidence could set off a dollar exodus. It is unclear if Mr Paulson can delay a state bail-out for long. "There is concern that Fannie, Freddie, and Lehman will not be around on Monday," said one analyst.

Ironically, Fannie and Freddie shares, having halved in value at one stage, recovered slightly after Mr Paulson's comments. Investors were relieved the agencies might yet be spared a state seizure aimed at limiting "moral hazard". This is what occurred in the Nordic financial rescues of the early 1990s, which left shareholders with nothing.

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IndyMac seized as financial troubles spread

U.S. banking regulators swooped in to seize mortgage lender IndyMac Bancorp Inc on Friday after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which specialized in a type of mortgage that often required minimal documents from borrowers, became the fifth U.S. bank to fail this year as a housing bust and credit crunch strain financial institutions.

The federal takeover of IndyMac capped a tumultuous day for U.S. markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac will reopen fully on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision, but tensions ran high as customers at a branch at its Los Angeles-area headquarters read a notice in the window saying it was closed.

At another branch down the road, a man who said he had more than $200,000 in an account -- twice what is normally FDIC guaranteed -- argued with a security guard who was closing up. The FDIC, which will seek a buyer for IndyMac, estimated the cost of the bank's failure to its $53 billion insurance fund at between $4 billion and $8 billion.

"IndyMac is a company that was pretty much 100 percent invested in mortgage assets, and we're in a bad mortgage market, and it had no capital. It's not complicated," said Adam Compton, co-head of global financial stock research at RCM in San Francisco, which manages about $150 billion.

IndyMac joins top bank failures headed by the 1984 collapse of Continental Illinois National Bank & Trust Co.
The Office of Thrift Supervision (OTS) insisted IndyMac's failure was the second-largest bank failure based on FDIC figures. But the FDIC said its data showed it was third behind the collapse of First RepublicBank Corp in 1988.

The OTS, IndyMac's primary regulator, blamed comments by New York Democratic Sen. Charles Schumer for causing a run on deposits at the largest independent publicly traded U.S. mortgage lender. Schumer responded quickly on Friday, blaming the OTS for not doing its job and allowing IndyMac's loose lending practices. "OTS should start doing its job to prevent future IndyMacs," he said in a statement.

Schumer questioned IndyMac's ability to survive the housing crisis in late June, and over the next 11 business days, depositors withdrew more than $1.3 billion, the OTS said. "This institution failed today due to a liquidity crisis," OTS Director John Reich said. "Although this institution was already in distress, I am troubled by any interference in the regulatory process."

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IndyMac Seized by U.S. Regulators Amid Cash Crunch

After peaking at $50.11 on May 8, 2006, IndyMac shares lost 87 percent of their value in 2007 and another 95 percent this year. The stock fell 3 cents to 28 cents at 4 p.m. New York time today.

IndyMac's shutdown may mean regulators will have to raise more money to support the federal deposit insurance program that repays customers when a bank fails, Reich said during a press conference. The failure will cost the fund about $4 billion to $8 billion, the FDIC said in a statement.

About $1 billion of uninsured deposits are held by about 10,000 customers, the FDIC said. Those depositors will get an ``advance dividend'' equal to half the uninsured amount, according to the statement. The FDIC insures $100,000 per depositor per insured bank, according to the agency's Web site. Customers may qualify for more coverage depending on the type of accounts they own, and some retirement accounts have a $250,000 limit.

IndyMac announced on July 7 that it was firing half its employees. The lender agreed to sell most of its retail mortgage branches to Prospect Mortgage, giving the Northbrook, Illinois based-company more than 60 branch offices with 750 employees. IndyMac also has a retail network with 33 branches and $18 billion in deposits, mostly insured by the FDIC.

The company was started in 1985 by Countrywide founders Angelo Mozilo and David Loeb under the name Countrywide Mortgage Investments. In 1999, it converted into a savings institution from a real estate investment trust. That year, Michael Perry replaced Mozilo as chief executive officer.

Under Perry's leadership, profit more than doubled from $118 million in 2000 to $343 million in 2006 amid the housing boom. The stock more than tripled over that stretch.

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Lending, the FDIC and Liquidation Selling

When the FDIC steps in and takes over a bank or thrift, a number of things normally happen.

First, lending is ordinarily greatly curtailed. Loans to insiders are often called in, weak borrowers who could previously borrow are turned away, and new borrowers usually find it's easier to borrow money elsewhere. Most banks go under because of sloppy lending, so the FDIC normally stops this kind of lending right away.

Second, the FDIC normally seeks to clean up the balance sheet by getting rid of collateral on the books that isn't generating any money. This normally involves selling foreclosed houses, commercial property, equipment, etc. Lots of banks and thrifts out there won't say how much real estate they are already holding on their books, since if they did they might already be technically insolvent.

There are no doubt plenty of loans that are non-performing that are being listed as performing, just to make the books look better. The FDIC is in the business of cleaning things up and getting on with business, and, at least in the past, their normal pattern has been to try to sell most of the collateral in target banks for whatever they can get. Also known as liquidation selling.

The problem has gotten so big this time around that it's possible that the FDIC may pursue a different course (due to political interference, no doubt). However, the pattern the last time around--late 1980s and early 1990s--was to go in and clear everything rotten out, liquidate collateral for whatever they could get, for often dimes or even pennies on the dollar.

The FDIC takeover of failed institutions alone will tend to depress real estate prices in parts of the country. Heavy selling of foreclosed houses and commercial property by FDIC-controlled banks and thrifts will make it worse. Understand that the FDIC doesn't have to please the stock market or the shareholders, and they are often trying to clear up problems in a year or so that have been building for most of a decade.

When a bank goes into receivership with the FDIC, what basically remains are the depositor's accounts and the existing book of loans, many of which are rotten. The collateral is often worth a lot less than it's book value in the first place, and the FDIC policy of quick resolution often leads to drastic losses in value, at least locally and on a short term basis.

Liquidation of assets by the FDIC will probably lead to some of the biggest losses (to the previous owners) and the biggest gains (to the buyers who buy at the bottom from the FDIC-controlled institutions). The FDIC will likely be setting the local market price in areas where they do heavy selling, but when the liquidation selling is over, prices will tend to stabilize.

When banks or thrifts are taken over by the FDIC, the local lending climate tends to change, and the local money supply often drops. Even in local banks which are not taken over by the FDIC, in areas where other banks go under FDIC receivership, lending tends to become much more conservative, for a number of reasons.

Commercial real estate is actually a much larger issue for most local banks than residential, but all of the negative news so far has concentrated on residential. Many of the same wild lending practices also went on in commercial real estate, but in this case the loans tend to be held on the books of local banks to a much larger degree, rather than being sold to outside investors.

As commercial real estate enters the train wreck, it's possible that liquidation selling may extend there as well. Additionally, when local banks find that their commercial loans are failing and collateral values are dropping, they will have no alternative but to reduce lending to non-real estate customers.

Many of these local business customers have no other ready source of financing apart from their local banks, so the downturn that begins in real estate will tend to bring down many businesses which would have been able to weather the storm had they had access to other financing.

It's obvious that few cities need more strip malls, more big box stores, more car lots, etc, and that this sector of the economy has become grossly overbuilt in many areas. The most logical outcome is that a long period of liquidation, falling values, and contraction would occur in many parts of the country. Square footage of retail space has roughly doubled in the US since 1990, whereas population and incomes have lagged far behind.

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Washington, Wall Street weigh Fannie, Freddie help

Wall Street and Washington wrestled Friday with how to shore up mortgage giants Fannie Mae and Freddie Mac, two troubled pillars of the economy whose failure would deal a devastating blow to the already crippled housing market.

As investors grew more convinced that only some type of government bailout could rescue the firms, Treasury Secretary Henry Paulson said the focus was to support the pair "in their current form" without a takeover. The government was considering giving Fannie and Freddie access to the Fed's emergency lending program as one option to prop up the firms, said Sen. Christopher Dodd, D-Conn., citing conversations with Fed Chairman Ben Bernanke and Paulson.

A Fed spokeswoman said the central bank had not talked with Fannie and Freddie about the emergency lending program. The spokeswoman declined to discuss any other options being considered. Both companies issued statements late Friday calling their financial positions solid. Freddie Mac said it did not see an immediate need to raise fresh money, and said other options included cutting its annual shareholder dividend, which costs $650 million a year.

Investors drove Fannie and Freddie shares to 17-year lows before the stocks recovered somewhat. The turmoil, combined with a new high for oil prices, helped send the Dow Jones industrials briefly below 11,000 for the first time in nearly two years. The Dow finished down about 1 percent at 11,100.54. Fannie and Freddie were created by the government to provide more Americans the chance to own a home by adding to the available cash banks can loan customers. Shares of both companies are publicly owned.

Their importance to the housing market and overall economy is hard to overstate: Fannie and Freddie either hold or back $5.3 trillion of mortgage debt, or about half the outstanding mortgages in the United States. "Without Fannie and Freddie, our economy would collapse," Piper Jaffray analyst Robert P. Napoli said in a note to clients.

In the mortgage industry, the prospect of doing business without Fannie and Freddie is truly frightening. "The cost of borrowing would go up dramatically," said Steve Habetz, president of Threshold Mortgage Co. in Westport, Conn. "We would be going back to dark ages where a homebuyer would be hoping that a local bank would (have enough resources) to make the loan that it will keep on its books."

Published reports suggested the government was considering taking over one or both of the companies and running them itself. President Bush met with senior economic advisers and said Paulson had assured him that Paulson and Federal Reserve Chairman Ben Bernanke "will be working this issue very hard." Wall Street sent the companies' stocks lower nonetheless. Freddie Mac shares were down 25 cents, or 3.1 percent, to $7.75. Fannie Mae shares were down $2.95, or 22.4 percent, to 10.25.

"I think everybody's just holding their breath in expectation that something substantive from the government will happen today or over the weekend," said Karen Shaw Petrou, managing partner of consulting firm Federal Financial Analytics. Analysts also suggested the problems had as much to do with market perceptions than any fundamental change in the two companies' finances. One report from Citigroup titled "Fear Begets Fear" called the sell-off "overdone."

The government has several options that stop short of a dramatic takeover. The Federal Reserve could provide emergency loans, or take on either company's mortgage-backed securities in an effort to reassure the market. Under a government takeover, operations would continue at Fannie or Freddie, but shareholders would probably see their investments erased, and the companies' ability to support the mortgage market could be reduced.

"Typically when this happens the business is a shell of its former self," said Louisiana State University banking professor Joseph Mason. "Shareholders aren't going to like it, managers and directors aren't going to like it, but it's not about whether they like it."

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President Bush moves in as Fannie Mae and Freddie Mac lose value

President Bush was forced yesterday to wade into the turmoil surrounding the Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Corporation (Freddie Mac) which underpin America’s entire debt infrastructure, saying that his two leading economic lieutenants – Henry Paulson and Ben Bernanke – were “working this issue very hard”.

Fannie’s shares dived 50 per cent and Freddie’s 48 per cent in midday trading as investors fretted that the Government was making covert preparations to support them and would render their stock worthless. The shares did regain some lost ground, as it emerged that Mr Bernanke, the US treasury secretary, was seriously considering extending his central bank’s “discount window” of cheap financing to the two groups to help plug their balance sheet gaps, as an alternative to backing them.

Speaking after a meeting with his economic team, President Bush said that “Freddie Mac and Fannie Mae are very important institutions”, adding that he had spoken with Mr Paulson, the Treasury Secretary, who had “assured me that he and Ben Bernanke [the Federal Reserve chairman] will be working this issue very hard”.

Although the US Government is preparing to rescue Freddie and Fannie if necessary, it is thought to be keen to avoid such action if it can. Mr Paulson attempted to steer investors away from the notion of a rescue by saying that his preference was for Fannie and Freddie to continue “in their current form”. However, he failed to explicitly rule out the possibility of government backing if the situation continued to deteriorate.

The increasingly poor outlook for the American mortgage market pushed down shares in other groups with a large stake in the fortunes of the housing industry. Lehman Brothers was among the worst hit, with the group’s shares falling by 20 per cent at one point, before it recovered slightly to end 16.6 per cent down at $14.43.

A $5 rise in the price of a barrel of New York crude oil, to breach $147 for the first time, rattled investors further. This helped to push the Dow Jones – already in bear territory after a decline of more than 20 per cent since its last peak in October – to below 11,000 for the first time since July 2006. The Dow went on to close down 128.50 at 11,100.50.

The possibility that Fannie and Freddie could access the discount window briefly reassured the market, prompting a rally that was short-lived as fears about the outlook for the housing market, and the damage it could inflict on the broader economy, “quickly returned to spook investors”. Fannie Mae closed 21.70 per cent lower at $21.97 and Freddie Mac ended the day at $7.75, a loss of 3 per cent.

Fannie and Freddie are a crucial component in the housing industry, and the debt markets in general, because they buy mortgages, package most of them into bonds and sell them on to investors, which they guarantee. They collectively own or guarantee more than half of America’s $12,000 billion outstanding mortgages and their failure would have a domino effect that analysts say would decimate the debt markets and, in turn, the US and global economy.

Chris Whalen, of Institutional Risk Analytics, added: “If people thought for a moment that the US central bank would not ultimately stand behind Fannie and Freddie then the entire US financial system would collapse.” Mr Whalen forecasts that the US Government will eventually renationalise both groups and merge them.

The combined entity would find it easier to raise the money needed to fund the tens of billions of dollars of losses they are collectively expected to suffer from the credit crunch if it had the backing of the taxpayer, Mr Whalen said. Even if the Government does not end up rescuing Freddie and Fannie, their shareholders feel doomed. Analysts believe that the two enterprises are so thinly capitalised that they could not possibly raise the capital they need to survive if they continue as public companies.

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Fannie Mae Ugly

Investors continued to flee Fannie Mae and Freddie Mac yesterday, almost as frantically as the political class tried to reassure everybody there was nothing to worry about. Allow us to sort the good (there isn't much) from the ugly.

In the good category, Treasury Secretary Hank Paulson swatted back reports of a government "nationalization" of the companies – which would mean making explicit what has long been an implicit taxpayer guarantee of their liabilities. This would instantly add $5 trillion in liabilities to the federal balance sheet, doubling the U.S. public debt burden and putting America's AAA credit rating at risk. This is the nightmare scenario for taxpayers.

Less reassuringly, Mr. Paulson said, "our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission." This suggests that Treasury thinks the two companies have enough capital, or can raise enough in private markets, to ride out any mortgage losses. We're not so sure, and neither are investors, who have kept bidding Fan and Fred shares to new lows on fears of insolvency.

The most immediate danger is that investors will shrink from rolling over the debt of the two companies, leading to a run a la Bear Stearns. Mr. Paulson is trying to reassure people that the companies are sound, but after Bear everyone has the heebie-jeebies. With so much on the line, we've been suggesting that Treasury and Congress step up now with a public capital injection to help the companies ride out their losses.

Yes, this would mean putting some taxpayer cash up front, but in the cause of avoiding the far greater risk of a collapse or Bear-like run. If the capital injection was made in the form of a subordinated debt or preferred stock offer, taxpayers would get a stake in the companies and some return on their investment once the crisis passes.

We haven't suddenly become socialists. What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized. We're proposing a more honest form of socialism, with the prospect of long-term reform.

In return for putting up the cash, the taxpayers would also need some reassurance that this Fan and Fred debacle couldn't happen again. Thus their regulator would need the power to shrink their portfolios of mortgage-backed securities that have made them such high-risk monsters, and ultimately to wind the companies down. Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or 10 years from now.

Now we get to the ugly: Congress. On Friday, Senate Banking Chairman Christopher Dodd (D., Conn.) declared that Fannie and Freddie are "fundamentally strong," that fears about their capital are overwrought, and that "this is not a time to be panicking about this. These are viable, strong institutions." Yet he also said that one option under discussion is to let the two companies borrow from the Federal Reserve's discount window.

In other words, Mr. Dodd says the companies are so safe that the Fed may have to rescue them. What he really wants to do is to pass the buck – literally – to the Fed so he and Congress don't have to appropriate taxpayer money up front.

Opening up the window would nonetheless be a giant step toward an explicit taxpayer guarantee of Fannie and Freddie debt. It would further poison the Fed's balance sheet, not to mention get it tangled up in the politics of the mortgage markets in a way that would jeopardize Fed independence.

And speaking of ugly, yesterday's markets showed one more nasty side effect of the Fannie Mae panic: fear of rising inflation. Gold popped by $23 an ounce, and at $965 is back at the heights it reached during the March run on Bear Stearns. Oil also bounced up as the dollar fell, a sign that investors think the Fed will react to the Fannie fears by delaying any monetary tightening even longer than it already has.

If there's any other good news in all this, it is that the scandal of Fannie and Freddie is at last coming into public focus. The Washington political class has nurtured and subsidized these financial beasts for decades in return for their campaign cash and lobbying support. Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.

The losers have been the taxpayers, who will now have to pay the price for this collusion. Maybe the press corps will even start reporting how this vast confidence game could happen.

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Fannie, Freddie say they have plenty of capital

Fannie Mae and Freddie Mac said on Friday that their finances were sufficiently sound to withstand the housing crisis as government officials scrambled to restore confidence in the country's two largest mortgage finance companies.

U.S. Treasury Secretary Henry Paulson indicated that a bailout of Fannie and Freddie was unlikely despite financial market concerns that the agencies, which finance nearly half of U.S. homes, may have trouble raising enough money to keep buying mortgages.

A key senator said the U.S. Federal Reserve was considering allowing Fannie and Freddie to borrow directly from the central bank, spurring speculation that the Fed may take action as early as this weekend. Fannie and Freddie shares, after taking a beating, recovered some of their earlier losses but ending lower on the day.

Sen. Christopher Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said he spoke with Fed Chairman Ben Bernanke and Paulson. Dodd said they were looking at various options, including opening access to the discount window, through which the Fed acts as a lender of last resort for the U.S. banking system.

Investors were worried that the mortgage agencies might run short of capital, placing the fragile U.S. economy at even greater risk and deepening the housing slump. Dodd sought to reassure investors about the health of the two companies.

"These institutions are fundamentally sound and strong," Dodd said at a news conference. "There is no reason for the kind of (stock market) reaction we're getting."

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Options expert calls Fannie, Freddie shares 'worthless'

Market analyst Jon Najarian at options research firm OptionMonster Inc. in a research note Friday morning said that, although he believes government-sponsored mortgage giants Fannie Mae and Freddie Mac will continue doing business, "their shares in my opinion are likely worthless."

He said crude-oil prices hitting another record and tough talk from Treasury Secretary Paulson on banks had set the table for a "monster" day in the markets Friday.

"There is no reading between the lines necessary here," Najarian wrote. "I think Freddie and Fannie equity may be toast, which means the government will simply take over both, as [it] can't let $5 trillion in mortgages vaporize."

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Capital Research, Legg Added to Freddie Mac Holdings

Capital Research Global Investors and Legg Mason Inc. raised their stakes in Freddie Mac in the first quarter, only to watch the value of the second-largest U.S. mortgage company fall more than 69 percent since March 31.

Capital Research, a mutual-fund unit of Los-Angeles-based Capital Group Cos., bought 3.98 million shares of Freddie Mac, making it the largest shareholder, with a 10 percent stake, according to data compiled by Bloomberg. Bill Miller's fund unit at Baltimore-based Legg Mason added 35.6 million shares, ranking it second with a 7.8 percent stake.

Value managers such as Miller, who hunt for stocks they consider cheap based on financial measures such as earnings, loaded up on Freddie Mac and Fannie Mae after they fell more than 25 percent in the first quarter. Fannie, the largest U.S. mortgage company, and Freddie are among the top 20 financial stocks held by mutual funds, data from Morningstar Inc. in Chicago show.

"A lot of the value managers are getting hammered this year,'' David Kathman, an analyst with Morningstar said today in an interview. "In the early days of the subprime crisis, Fannie and Freddie were perceived as a safe haven, but when things started to get worse investors took some significant hits.''

About 48 percent of McLean, Virginia-based Freddie Mac's outstanding shares are held by 535 mutual funds, according to Morningstar. Washington-based Fannie Mae is held by 578 mutual funds, which account for 45 percent of the shares.
Capital Concern

Freddie and Fannie have tumbled this month on concern that the worst housing slump since the Great Depression will deplete their capital and require a government bailout. Freddie has plunged 53 percent this month, while Fannie has declined 47 percent.

Capital World Investors, another unit of Capital Group, sold 11 million shares of Freddie during the first quarter, according to Bloomberg data. It was the fourth-largest holder as of March 31. Chuck Freadhoff, a spokesman for Capital Group, declined to comment.

Legg Mason's own stock has been hurt by its holdings of Freddie Mac and of New York-based Lehman Brothers Holdings Inc. Shares of the fourth-largest U.S. securities firm are down 21 percent this month. Legg Mason's Clearbridge Advisors unit bought 5.3 million Lehman shares in the first quarter, making it the second-largest holder with a 5.8 percent stake.

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Putting Their Houses in Order

Are Fannie Mae and Freddie Mac nearly insolvent, as some investors and policy makers fear? Or are the giant mortgage finance companies sound — and good investments, as others contend?

Those questions reverberated through Wall Street and Washington on Friday, when the two companies’ shares fell yet again in a day of wild swings that left investors fearful of what might happen next.

But the questions are difficult to answer with any certainty because of the size and complexity of Fannie Mae and Freddie Mac, companies that lie at the heart of the nation’s housing market and touch nearly one out of every two home mortgages.

Wall Street analysts disagree over how high the companies’ losses will mount as home prices decline further and foreclosures grow, an outcome that depends on the course of the housing market and the broader economy.

Analysts also differ over what would happen if those losses were to overwhelm the companies, possibly leading to a rescue by the federal government that would be paid by taxpayers. “The real problem is that nobody really knows how bad things will get,” said Thomas H. Stanton, an expert on the two companies who teaches a course on credit risk at Johns Hopkins University.

“Everyone thought these guys were the best in the market at evaluating mortgages, so they let them skate by with huge debts and tiny financial cushions,” Mr. Stanton said. “But now it’s less clear they knew what they were doing, and it’s really hard to know who’s right and who’s selling pipe dreams and then hoping for the best.”

Friday’s market gyrations capped one of the most nerve-racking weeks on Wall Street since Bear Stearns collapsed into the arms of JPMorgan Chase in March. In recent days senior Bush administration officials disclosed a plan that would have the government take over one or both of the companies if they faltered.

Minutes after trading opened Friday morning, the companies’ shares plunged 50 percent. The shares then seemed to stabilize before rising and falling in a series of gut-wrenching waves. Freddie Mac ended the day at $7.75, down 3 percent, and Fannie Mae closed at $10.25, down 22 percent, rewarding both investors who bet on and against the enterprises during the course of the volatile day.

Supporters of Freddie and Fannie insisted that the worries over the companies’ future were overblown. In Washington, Treasury Secretary Henry M. Paulson Jr. and members of Congress voiced confidence that the companies were healthy.

On Wall Street, Citigroup broke with the prevailing public view among major investment houses, which mostly recommend that investors avoid Fannie and Freddie shares, and issued a report recommending that people buy them.

Freddie and Fannie buy mortgages from banks and other lenders. Sometimes they keep those mortgages as investment — as of May, the two companies held mortgages worth about $1.5 trillion. Other times, they repackage the mortgages for sale to investors, along with a guarantee that Freddie and Fannie will pay off the loan if the homeowner defaults.

The companies have guaranteed mortgages worth about $3.9 trillion. Among those who see trouble on the horizon, the prevailing concern is that Freddie and Fannie have vastly underestimated how many bad loans they have bought, and that as borrowers default, the companies will start hemorrhaging money.

“Odds are that things are going to get worse, and so far, no one has done a good job of estimating how bad they will get,” said William Poole, the former president of the Federal Reserve Bank of St. Louis. “By some methods of accounting, these companies have already reached zero value, or are almost there.”

The companies themselves acknowledge that they bought many bad loans. In the past nine months, they have reported losses of more than $8 billion, and have estimated that those losses would grow by as much as $24 billion in the next few years. The firms estimate home prices will decline 7 percent to 9 percent over that period.

Skeptics, however, maintain that even those dour forecasts are too optimistic. Ron Torrens, an analyst at the independent research firm BCA Research, estimates the companies’ losses in 2008 and 2009 will total $52 billion. Other analysts have forecast losses in the next two years of as much as $100 billion.

In the worst-case situation, if the housing market were stagnant for years, total losses at Fannie and Freddie could reach $300 billion, or almost five times what the federal government spent on education last year, some analysts have predicted. If taxpayers were ever forced to guarantee the companies’ debts and obligations, they could be on the hook for that money.

“The housing market is going to continue getting worse for years, and the losses are going to build and build,” said Steve Persky, chief executive at Dalton Investments in Los Angeles. Mr. Persky did not estimate Fannie’s and Freddie’s losses.

“Every time someone has tried to put a number on how much mortgage assets will decline, the market has proven that things are worse than they imagined,” he added.

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How Fallout Could Affect Main Street

The stock market swoon over Fannie Mae and Freddie Mac this week has left many consumers scratching their heads, wondering if buying a home is a worse idea than it was seven days ago or whether to take down the “for sale” sign in the yard.

So now is a good time to step back and assess the landscape. Thus far, the biggest damage has been mostly to Fannie’s and Freddie’s investors, though the overall stock market has recoiled as the companies stumbled. In the housing market, consumers are still moving into new homes, and people continued to close on new loans Friday.

But if you are shopping for a home or a mortgage or considering selling a home, you may wonder what will happen next if things get worse for Fannie and Freddie. Will mortgage rates rise, and home prices fall further? Could the troubles affect the rates you are charged for other loans? Answering these questions starts with a brief (I promise) primer on what the two entities do and why they’re important.

In the beginning, there’s a mortgage lender. It can lend you money it has taken in from deposits on checking accounts and certificates of deposit if it wants. But many lenders choose to sell most or all of their home loans once they make them, and then use the proceeds of the sale to make even more loans.

Fannie Mae and Freddie Mac are the buyers for many of these loans, which makes them crucial to the continued ability of companies to lend money to you and me for a house. Freddie likens itself to a wholesaler supplying a retail store: the retail store is a bank selling money.

Once Fannie and Freddie have bought enough loans, they turn many of them into bonds and sell those bonds to investors. Your mutual funds may hold many of them, something many consumers may just be noticing, after letting out a sigh of relief because they were not planning to buy or sell a home anytime soon.

The mortgage financing system hums along until Fannie and Freddie have trouble raising money to buy loans, or it costs them more to raise the money. And that’s what is happening now. “That increased cost must be passed along; it’s the nature of the beast,” says Keith T. Gumbinger, vice president of the financial publisher HSH Associates, where he has tracked mortgage rates for more than two decades.

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Senate passes mortgage rescue plan

A mortgage rescue to help hundreds of thousands of struggling homeowners avoid foreclosure and get more affordable, safer loans passed the Senate overwhelmingly Friday, but it faces a bumpy road amid continuing turmoil in the housing market.

The 63-5 vote reflected a keen interest by Democrats and Republicans to send election-year help to distressed homeowners with economic issues topping voters' concerns. The plan lets homeowners buckling under mortgage payments they can't afford keep their homes and get more affordable mortgages backed by the Federal Housing Administration.

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. It still faces challenges, however, with the House planning to rewrite key details and the White House threatening a veto without major changes.

"It's not the final stop, but it is a major stop in getting this bill done," said Sen. Christopher Dodd, D-Conn., chairman of the Banking Committee. "For those who said this Congress cannot come together in a bipartisan fashion to do something responsible about housing, this bill does that."

Rep. Barney Frank, D-Mass., the Financial Services Committee chairman and an architect of the bill, says the few but significant revisions House leaders are seeking could be made in as little as one week. Dodd said he was expecting minor "tweaks" that could be dealt with quickly. But key players are bracing for intense negotiations to resolve the differences. They hope to smooth over disputes with the White House at the same time, with an eye toward producing a bill President Bush could sign later this month.

The White House Friday renewed its warning that Bush would veto the Senate-passed bill without revisions, citing $3.9 billion in the measure for buying and rehabilitating foreclosed properties it said would help lenders, not homeowners. The measure includes a long-sought modernization of the FHA and would create a new regulator and tighter controls on Fannie Mae and Freddie Mac, the government-sponsored mortgage giants.

It also would provide $14.5 billion in housing tax breaks, including a credit of up to $8,000 for first-time home buyers. Democrats are divided over important elements of the plan, including limits on loans the FHA may insure and Fannie Mae and Freddie Mac may buy. The Senate measure sets them at $625,000, while House leaders -- including Speaker Nancy Pelosi, D-Calif. -- want the cap as high as $730,000.

House leaders also oppose the immediate effective date of the Senate plan, preferring to phase in the new regulations for Fannie Mae and Freddie Mac over six months. "We'd have a hard time agreeing to that," Dodd told reporters Friday. He called a Capitol Hill news conference to dispel fears about the financial health of Fannie Mae and Freddie Mac as their stocks plummeted on reports that the government was considering taking over one or both of them.

Another key point of dispute is the funding in the Senate measure for buying and fixing foreclosed properties. The House's band of conservative "Blue Dog" Democrats oppose the money, arguing that it would swell the deficit unless paired with cuts or tax increases to cover the cost.

But many Democrats, particularly members of the Congressional Black Caucus, are fighting to keep the funding, which they say will help prevent the communities hardest hit by the housing crisis from sliding into blight.

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Weak Dollar Helps Shrink Trade Deficit

The United States trade deficit narrowed in May as exports, including industrial supplies and consumer goods, climbed to records.

The latest snapshot of trade activity, reported by the Commerce Department on Friday, showed that the nation’s trade gap decreased to $59.8 billion, largely because of the declining dollar. That was down 1.2 percent from April’s trade deficit and was the best showing since March.

The improvement came even as imports, including crude oil, rose to records. Many economists had expected the trade gap to widen, and were forecasting a deficit of $62.2 billion, on average, in May. Exports of American-made goods and services totaled $157.6 billion in May, a 0.9 percent increase from April.

The declining value of the dollar relative to other currencies, especially the euro, is helping to make American exports cheaper and thus more attractive to foreign buyers. Growth in exports has been one of the few bright spots for the economy, which has been pounded by housing, credit and financial crises.

Imports of goods and services grew to a record of $217.3 billion in May, a 0.3 percent increase from the previous month. The stronger export figures should help bolster overall economic growth during the April-to-June quarter, which is already shaping up to be better than the grim projections made at the start of the year, when many feared the economy might contract.

Tax rebates also are energizing shoppers, which should help second-quarter activity. “The narrowing trade deficit may be enough to keep second-quarter growth in the black,” said Joel L. Naroff, president of Naroff Economic Advisors. The economy could grow to more than 2 percent, from 1 percent, in the second quarter, according to various projections.

The trade deficit with oil-producing nations, including Saudi Arabia, Indonesia, Nigeria and Venezuela, rose to a record of $17.9 billion in May. The politically delicate trade deficit with China widened to $21 billion in May, from $20 billion in April.

Exports to the European Union totaled a record $24.2 billion in May, helped by the weakened dollar. American exports to Japan totaled $6.2 billion in May, the second-highest on record. Exports to Canada were a record $24.5 billion in May.

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The latest tremor is seismic

This will pass. One day, the world's financial system will be back on a sure footing. One day, banks will regain the confidence to lend to one another. One day, when bankers tell us the extent of their losses, we will be inclined to believe them.

One day, the lurking fear that permeates the financial world and worries banks every time they put a signature to a new commitment will be gone. One day, the world's central bankers will sleep easily again. This will all pass, but not yet. The latest tremor is seismic. That the US Government is mulling a rescue takeover of Fannie Mae and Freddie Mac is simultaneously unnerving and reassuring.

These vast semi-official bodies are at the very heart of the trillion-dollar American mortgage market. Unnerving, because it is unthinkable that institutions of this scale and scope - total debts of $5.3 trillion - have such wobbly foundations that a former senior Federal Reserve official, Bill Poole, could describe one of them, Freddie Mac, as technically insolvent.

Reassuring, because the perceived, but unwritten, guarantee from Uncle Sam looks a bit more explicit when President Bush admits his officials are working hard on the issue. Adding to the gloom, shares in Lehman Brothers were again being spanked last night on fears we still don't know the full nature of its exposures.

This side of the Atlantic, things are not much better. A large chunk of HBOS's £4 billion rights issue looks likely to be left with the underwriters as the market price languishes below the offer price. Bradford & Bingley's latest rescue capital-raising is at an earlier stage but so far is similarly under water. And the first £50billion of liquidity offered to thirsty banks by the Bank of England's Special Liquidity Scheme has reportedly been long since swallowed up.

Bank chiefs were in Threadneedle Street yesterday begging for the tap to remain turned on. Meanwhile, Northern Rock's eagerness to lend homebuyers 125 per cent of property values at the top of the market in 2006 and early 2007 makes ministers' claims that taxpayers will emerge unscathed from the nationalisation increasingly suspect.

Each fall in house prices throws thousands more Rock borrowers into negative equity. The inevitable acceleration in unemployment will seal the fate of many of its already stretched borrowers.

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Mortgage lenders press Bank of England to extend funding

The Bank of England will be lobbied by high street banks today to extend the special liquidity scheme, put in place three months ago to help free up money markets which have been frozen by the credit crunch.

The banks are thought to be keen to ensure that the scheme, which allows billions of pounds to be pumped into the financial system, is fine-tuned as it is not becoming any easier for banks to borrow money on the financial markets. Many need access to funding either from the money markets or from the Bank of England's special scheme in order to offer mortgages to customers and loans to businesses.

The banks are thought to have drawn up a number of suggestions for discussion with the Bank at a routine meeting today. The scheme was rushed into place in April shortly after the near-collapse of US bank Bear Stearns. The rescue of Bear Stearns, orchestrated by the US Federal Reserve, raised fresh fears about the solvency of the banking system and caused financing among the banks to dry up following last summer's credit crunch.

Among the items for discussion at the meeting between the treasurers of the major lenders and Bank officials, is an idea from at least one of the lenders to extend of the type of assets that banks can pledge as collateral in the existing scheme.

The existing scheme, drawn up by the Bank of England governor Mervyn King, has been estimated to be worth £50bn although the governor has made it clear that there is no upper limit to the arrangement. The Bank of England initially agreed to make the special liquidity facility available until October. It refuses to discuss the use of the facility until then and refused to comment yesterday.

It is not yet clear how widely used the facility has been. It allows banks to trade in illiquid mortgage-backed securities in return for high quality government bills which are more liquid and more likely to be traded on the financial markets. The scheme only allows mortgages that were in existence at the end of 2007 to be exchanged for bills, although some lenders believe that more recent home loans should be extended to the scheme.

King had told bankers that he intends to make the special liquidity scheme a permanent fixture, although there is confusion among the lenders as to what this means in practice. In a speech to the British Bankers' Association last month, King said: "We intend to learn from the experience of the scheme to put in place a liquidity facility that works in all seasons - both 'normal' and 'stressed'." He said that the Bank was also to address the problem of the "stigma" attached to banks that use central bank's facilities.

Ben Bernanke, chairman of the US Federal Reserve, said on Tuesday that he would consider extending the emergency lending facilities put in place in the US after the near-collapse of Bear Stearns. His comments highlighted the extent of the US authorities concerns about the continuing strains in the financial markets. The Treasury has also indicated that Britain's liquidity scheme is a crucial part of the armoury to tackle the credit crunch.

But some lenders are thought to be concerned that the government only wants the scheme to be used when banks are in crisis. King has made it clear that the scheme is not a bail-out for lenders who lent too freely during the housing market boom of 2006 and 2007 nor to rejuvenate the mortgage market. Lenders who use the window pay a heavy price - known as a haircut - when they swap their mortgage assets. The haircut is a discount on the face value of the assets being exchanged for the government bonds.

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RBS shares hit by global economy gloom

Royal Bank of Scotland shares fell 9pc after a swathe of bad news about the global economy and a setback to the sale of its insurance business hit the banking giant. Sentiment was also affected by whether the US administration would have to bail out Freddie Mac and Fannie Mae, which stand behind many US mortgages.

Many banks, including UK lenders, have invested in American mortgages backed by the two. A bail-out might not hit the value of these investments but would probably damage sentiment further among investors. Amidst a sea of red in the banking sector, RBS was hit the hardest, closing down 17.2p at 182.7p and below the 200p a share its record £12bn rights issue was priced at.

Analysts said yesterday RBS faced the prospect of not being able to sell its insurance division, whose flagship brand is Direct Line. Zurich Financial Services, seen as the front runner, pulled out of the auction on Thursday. That leaves just Allstate of the US and Germany's Allianz out of a list of eight potential trade buyers.

RBS put its insurance business up for sale when it announced its rights issue in April. Sir Fred Goodwin, RBS's chief executive, only wanted to part with the business, which also includes Churchill and Privilege, at a price of between £6.5bn and £7.5bn.

Sandy Chen of Panmure Gordon yesterday said RBS was more likely to get £5bn to £5.5bn if it does press ahead with a sale. This would net between £1.5bn and £2bn in capital gains, compared to the £4bn RBS was hoping for.

RBS is progressing with other disposals. It is about to sell the Australian business it picked up as part of the ABN Amro buyout. National Australia Bank yesterday announced it was close to striking a deal with RBS. The price could be about £216m.

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Foreign Investors Pile Up More Pieces of Americana

The hunt for the great American trophy asset is on. The global commodities boom and the dollar’s decline have unleashed a wave of big money buys of prized American assets by newly flush foreign investors.

From $100 million mansions in Palm Beach, Fla., to $23 million modern art confections, to multibillion-dollar stakes in once-venerated Wall Street banks, the number of flashy acquisitions by Russian and Ukrainian oligarchs, Qatari sheiks and large government-sponsored funds in the Middle East is growing.

And now Abu Dhabi, which already owns a 4.9 percent stake in Citigroup, has expanded its portfolio of choice American assets to include the Chrysler Building, whose thin spire and Art Deco styling make it an indelible feature of New York City’s skyline.

The government of Abu Dhabi bought a 90 percent stake in the landmark building Tuesday for $800 million from a German real estate fund managed by Prudential Real Estate Investors. The 1,046-foot (319-meter) tower was designed by William Van Alen and completed in 1930 for the Chrysler Corporation and its founder, Walter Chrysler.

The foreign purchases, especially the Chrysler investment and Middle East involvement in the recent sale of the General Motors building in New York, recall a similar financial plunge by Japanese investors into marquee American properties like Rockefeller Center and the Pebble Beach golf course in California in the early 1990s.

That foray ended badly — many of the investments were unprofitable — and a more insular America, just beginning to worry about its stature as a global economic power, reacted with suspicion. Now, with the dollar down more than 40 percent against the euro and the economy hamstrung by a credit crisis, a less-assured America has become increasingly reliant on foreign capital.

While there has been some scrutiny of these investments from Congress, there is also recognition that these funds, which maintain passive investment positions, will perform a crucial petrodollar recycling function.

“This is the natural outgrowth of us exporting a huge amount of dollars through high commodity prices to countries that have to reinvest it somewhere,” said Douglas Rediker, a sovereign fund expert at the New America Foundation, a research and advocacy organization. “These countries have to extend beyond Treasury bills, and that means equities and real estate.”

Abu Dhabi, Kuwait and other gulf countries rich with oil revenue have taken advantage of falling prices to invest in real estate and financial companies around the world. Middle Eastern investors have spent $1.8 billion this year on American commercial property, according to Real Capital Analytics, a New York property research firm.

As with the Japanese, much has been said about the losses incurred so far by these funds. Abu Dhabi’s main fund, the Abu Dhabi Investment Authority, or A.D.I.A., invested $7.9 billion in Citigroup last year when the stock was trading at $31. Now Citigroup trades at $17, and while the fund still has more than two years before its bond converts into stock, Citigroup’s troubles cast doubt on whether the investment will ever be profitable.

Unlike pension funds, hedge funds or mutual funds, however, sovereign funds, and in particular Abu Dhabi’s, do not face any claims on their assets in the form of liabilities, redemptions or domestic investment requirements. As a result, their investment outlook is very long term in nature.

With oil hovering near $140 a barrel, analysts expect countries in the gulf to generate yearly cash surpluses of $300 billion — Abu Dhabi’s share is said to be more than $50 billion — with sovereign funds in this area forecast to reach a size of $15 trillion by 2020.

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A Third of Reef-Building Corals at Risk of Extinction

A third of the world's major reef-building coral species are in danger of extinction, an international team of scientists warns in a study published today. Because coral reefs are home to more than a quarter of all marine species, their loss could be devastating for biodiversity in the world's oceans.

"If corals themselves are at risk of extinction and do in fact go extinct, that will most probably lead to a cascade effect where we will lose thousands and thousands of other species that depend on coral reefs," said the study's lead author Kent Carpenter, a zoologist at Old Dominion University in Norfolk, Virginia.

The rate at which reefs have been besieged is most troubling, the scientists say. Of the 704 corals classified in the study, 231 were listed as "vulnerable," "endangered," or "critically endangered" according to the International Union for Conservation of Nature's Red List. A decade ago just 13 species met the same criteria. The study appears in the online journal Science Express.

Studies around the globe have made the news of coral reef declines distressingly commonplace, the researchers say.
"What we did was use that information about decline to ask the question, What is the consequence of this on the potential loss of biodiversity?" Carpenter said.

"It's easy for people to understand that coral reefs are at risk, but it's gotten to the point now where the risk of extinction is a reality for the actual species that form the coral reefs. That could be devastating to biodiversity in the ocean." Some reef locales are faring worse than others, the paper said.

"Caribbean reefs appear to be the worst off in terms of numbers of important species that have a very high risk of extinction," Carpenter reported. By contrast the "Coral Triangle" region of the Indo-Malay Philippine Archipelago—an area of high marine biodiversity—has the highest number of species appearing on the list, but many are at a lower level of extinction risk.

"It's potentially the next big problem area," Carpenter said. "If conditions worsen, we're talking about the most important marine biodiversity area in the world potentially becoming a big problem." Meanwhile, areas of the Pacific Ocean stood out as regions where corals are faring better. Reefs among the Pacific's tens of thousands of isolated islands are scattered and relatively unaffected by human activity.

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