Fannie Mae, Freddie Mac: The Dumbest Idea Ever

Yesterday in my post Simply Insane I listed all the economic releases that came out on Tuesday and explained just how bad they were… and why the market was simply insane. Allow me to continue that train of thought:

Durable Good Orders fell 5.3%, more than expected and the previous month was revised downward to a gain of 4.4%. These numbers are particularly terrible because inventories increased to a new high.

New Home Sales dropped 2.8% to an annual pace of 588 000, the fewest since February 1995. The median price slumped a record 15.1% as prices dropped from $254 400 to $216 000. Worse yet, inventories climbed to 9.9 months, the most since 1981.

Fannie Mae reported a shattering loss of $3.80 a share or $3.55 billion in the fourth quarter alone. Triple analyst estimates.

The market was holding onto recent gains, flat on the day, when another ridiculous piece of news hit the wires:

Fannie Mae, Freddie Mac Portfolio Caps Will Be Lifted (Update3): “U.S. regulators removed limits on the combined $1.5 trillion mortgage portfolios of Fannie Mae and Freddie Mac, enabling the companies to increase financing for the slumping housing market.”

The market loved this news, with the S&P spiking from 1374 straight to 1390. Allow me to explain just how retarded this is:

“Unconstrained by portfolio limits, the government-chartered companies may buy more loans and bonds, replacing buyers who fled the market amid the collapse in subprime mortgages.”

So, the removal of the cap allows Fannie and Freddie to expand their portfolios. That is, buy more mortgages.

First of all, both companies are barely keeping it together worrying just about their current portfolios. Fannie reported yesterday, and it was devastating. Freddie reported this morning and it was just as devastating.

Second, forcibly replacing ‘buyer who fled the market’ is never a good idea. When rational, selfish actors voluntarily flee any market it is because the risk reward profile really, truly sucks. When the most speculative of players exits stage left, then conditions are or will become truly horrendous. Remember, these players are motivated solely by the profit motive and often don’t even have the downside risk of blowing through their own capital since they are investing yours.

Third, raising the caps concentrates the market. Two uber large players are taking an ever increasing concentration of market risk. Simply put Fannie and Freddie are taking on the entire systemic risk of the US mortgage market. They are doubling down into a declining, maybe crashing, market. As traders, what have we learned about averaging into a massively offside position?

Why the market would rally on this crap is anybody’s guess. I used the time prices spent above 1385, as a chance to re-establish my short positions.

This morning, Freddie Mac reported ‘doing their ass’ as well.

Freddie Mac Has Fourth-Quarter Loss Amid Housing, Credit Slump: “Freddie Mac, the second-largest source of money for U.S. home loans, posted a record $2.45 billion loss for the fourth quarter as rising mortgage defaults sent credit costs soaring.

The net loss, which amounted to $3.97 a share, widened from $401 million, or 73 cents, a year earlier, the McLean, Virginia- based company said in a statement.

Government-chartered Freddie Mac and the larger Fannie Mae, which account for 45 percent of the $11.5 trillion residential home loan market, are posting their biggest-ever losses as home foreclosures and tumbling housing prices increase costs on the mortgages they buy and guarantee. Chief Economist Frank Nothaft told investors in London yesterday that home prices will slide through 2009 and a recession is more likely.”

More importantly, Fannie Mae had true financial weapon of mass destruction buried in it’s 10Q filing. Hat tip to CubGuy99 over on the forums at Market Ticker.

“The total number of loans we purchase from MBS trusts is dependent on a number of factors, including management decisions about appropriate loss mitigation efforts, the expected increase in loan delinquencies within our MBS trusts resulting from the current adverse conditions in the housing market and our need to preserve capital to meet our regulatory capital requirements. For example, we recently introduced a new HomeSaver Advancetm initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases.”

Drop EVERYTHING. Let me make this crystal clear. This is what Fannie has just done:

1) You take a secured loan, in this case your mortgage.
2) You stop making payments on it, because you can’t afford to make payments.
3) You accumulate a couple of months of unpaid principal and interest.
4) Instead of having you default, as you should, Fannie turns your accumulated missed payments into an unsecured loan.
5) You carry on, apparently making payments on BOTH your mortgage and the unsecured loan.
6) Clearly, the dumbest idea ever.

When you take a secured loan and turn any missed payments into an unsecured loan you’ve just turned a higher quality loan into a lower quality loan. WTF?

Irrespective, the homeowner stopped payments on the loan because they could not afford to make them. How does turning those missed payments into yet another loan help? How can a reasonable person even entertain this idea? Again, WTF?

Turning a secured loan into an unsecured loan for the explicit purpose of not having to repurchase the bad paper, and thus avoid taking the mark to market loss is just insane. That loss is inevitable. Just take it dammit! Unbelievable.

The worst crimes EVER, are apparently LEGAL.

Freddie Mac Has Fourth-Quarter Loss Amid Housing, Credit Slump: “Freddie Mac, the second-largest source of money for U.S. home loans, posted a record $2.45 billion loss for the fourth quarter as rising mortgage defaults sent credit costs soaring.

The net loss, which amounted to $3.97 a share, widened from $401 million, or 73 cents, a year earlier, the McLean, Virginia- based company said in a statement.

Government-chartered Freddie Mac and the larger Fannie Mae, which account for 45 percent of the $11.5 trillion residential home loan market, are posting their biggest-ever losses as home foreclosures and tumbling housing prices increase costs on the mortgages they buy and guarantee. Chief Economist Frank Nothaft told investors in London yesterday that home prices will slide through 2009 and a recession is more likely.”

Durable-Goods Orders in U.S. Fell More Than Forecast (Update2): “Orders for U.S. durable goods fell more than forecast in January as a slowing economy prompted companies to reduce spending.

The 5.3 percent decrease in bookings for goods meant to last several years followed a revised 4.4 percent gain in December that was smaller than previously reported, the Commerce Department said today in Washington. Excluding transportation, demand dropped 1.6 percent, the third decline in four months.

New-Home Sales in U.S. Decreased More Than Forecast in January: “Purchases of new homes in the U.S. fell more than forecast in January as lending restrictions and plummeting prices kept buyers away.

Sales dropped 2.8 percent to an annual pace of 588,000, the fewest since February 1995, from a 605,000 rate the prior month, the Commerce Department said today in Washington. The median price slumped a record 15.1 percent from a year earlier.

The housing report showed the median price of a new home decreased to $216,000 from $254,400 a year earlier.

A decline in inventory failed to keep pace with the drop in demand. The number of homes for sale fell to a seasonally adjusted 482,000, and the supply of homes at the current sales rate jumped to 9.9 months' worth, the most since 1981.”

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Fannie Mae: Another Shoe Drops
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