Fannie and Freddie Melt Down, National City Bank in Trouble, and Poland Signs a Missile Deal

August 20

The stock of Fannie (FNM) is down -30% as I write this. There are rumors that the CEO of FNM is headed over to the Treasury for some ‘discussions.’ I am shocked that the US stock market (currently up on the day) is simply shrugging its shoulders at the complete capital destruction of the largest financial company in the world.

I am further shocked that the US dollar is holding up. I know that the foreign central banks feel a bit trapped, and that they have to support the dollar, but sooner or later it is going to sink in; the US fiscal deficit is about to get a whole lot worse due to the taking-on of $5 trillion of FNM and FRE mortgage debt. Both the fact of the blow-up and the apparent market responses to this are simply shocking to me.

Free markets? No, not any more. We now have socialized markets, and we got there without any sort of serious discussion by Congress. Note also that, even as recently as a week ago, Hank Paulson was still (publicly) proclaiming that it was “very unlikely” that FNM or FRE would require any public money. Either our leadership is fantastically out of touch with reality, or it thinks nothing of telling lies to the public. Of the two, which is worse?

Reliving the S&L Meltdown (August 20 - WSJ)

It was the worst of times -- or maybe not so bad. Such was the tale of three conference calls. Merrill Lynch sold $30 billion of subprime mortgage-related debt to a hedge fund for 22 cents on the dollar. Does that mean the houses underlying these debts (assuming an improbable 100% default) are worth only one-fifth of what owners paid for them?

Whereas Freddie Mac and Fannie Mae avoided any big writedowns of their dodgy "Alt-A" mortgages, on grounds they don't need to sell these to any hedge funds and will hold them to maturity, when they will be seen to have paid off after all.

In effect, we are reliving the S&L crisis, with two giant S&Ls gambling on survival with taxpayer funds while politicians summon the will to act. Fannie and Freddie have started lending new money to delinquents to avoid foreclosures; they're dangling cash incentives in front of loan servicers to delay recognition of hopeless cases.

On the one hand, we find that a pool of mortgages sold into the open market took a 79% write-down (loss), but on the other hand we see that Fannie and Freddie are steadfastly maintaining that their mortgages are deserving of a 0% write-down. On the one hand, we have an open and transparent price discovery process, and on the other we have to take word of FNM/FRE executives at face value. In short, FNM leadership is asking us to trust the same leadership that did not see this crisis forming, expanded aggressively into it to reap profits, and cashed out hundreds of millions in stock options right before the troubles started. Further, and most eggregiously, the CEO of FNM recently gave this statement to the Washington Post:

"In 2006 and early 2007, the industry, many analysts and market observers were generally not predicting a downturn in the housing and credit markets to the magnitude of what has since emerged, and outlooks for particular market segments at that time varied significantly."

Note to Mudd (<-- actual name of FNM CEO), there were LOTS of observers who were calling for massive pain as far back as 2004. To claim that there was some confusion as ot the direction of the housing market even as late as 2007 is especially bad form for the CEO of a mortgage company.

National City Bonds Show Defaults KeyCorp Can't Deny (August 20 – Bloomberg)

Never have regional banks been so disrespected by bondholders.

National City Corp. Chief Executive Officer Peter Raskind says Ohio's biggest lender is the ``best capitalized of all major U.S. banks'' after raising $7 billion this year, yet its bonds show it's at risk of default. Cleveland-based National City's bonds have plummeted as much as 17 cents on the dollar since June and yield more than 10 percentage points above Treasuries, similar to Ford Motor Co. debt. KeyCorp, Comerica Inc. and Fifth Third Bancorp have also tumbled, falling as much as 14 cents.

The declines underscore growing speculation among investors that the more than $500 billion of credit losses and asset writedowns sparked by the collapse of the housing market are nowhere near ending, and there is little Federal Reserve Chairman Ben S. Bernanke or Treasury Secretary Henry Paulson can do.

"I've been at National City for 30 years and a month and for 29 of those we've seen nothing like it," Thomas Richlovsky, National City's 57-year-old treasurer, said in a telephone interview. "In past cycles certainly lending, or credit, has gotten more difficult. The cost of credit would go up. In this particular phenomenon of the last year it's not like you can borrow money and the price went up. No, the market's closed."

The current crisis is a credit crisis. Period. I don’t really care if the stock market is trying to signal a bottom, or help keep confidence up; the real problem is that we have a debt-based money system in which the engines of debt have stalled out. Bernanke and Paulson are furiously pulling on the starter cord, but so far they’ve only been rewarded with a few sputters. Also, if you have any money at National City, GET IT OUT. It’s now very high on the list of “banks least likely to succeed.”

Sometimes geopolitical events warrant a comment or two. This is one of those times. With things still quite unsettled in the Russia-Georgia conflict, it would seem like a good time to take a deep breath and let some subtle diplomacy do its work. Unfortunately, this approach is well outside the of the skill set of the US executive branch.

Let’s check two articles separated by only 3 days time.

Russia threatens nuclear attack (August 17 - Au.com)

RUSSIA warned Poland yesterday it faced a nuclear attack if it accepts a US missile interceptor base on its soil.

The ominous rhetoric came as Moscow signed a treaty to stop the fighting in neighbouring Georgia, another US ally which is seeking to join NATO like Poland.

US, Poland sign missile shield deal amid Russian opposition (August 20 - AFP)

Warsaw and Washington signed a deal Wednesday to deploy a US missile shield in Poland, in the face of deep anger and threats of retaliation from Moscow.

"This will help us to deal with the new threats of the 21st century, of long-range missile threats from countries like Iran or from North Korea," said US Secretary of State Condoleezza Rice shortly before inking the accord with Poland's Foreign Minister Radoslaw Sikorski.

This clearly provocative move comes at a very puzzling time, if your intent is to stabilize an explosive situation. Of course, if your intent is otherwise, then perhaps this move makes more sense. There is a lot of evidence (and a fair bit of speculation) concerning the role of the US and Israel inside Georgia prior to the onset of the conflict. If you have not looked into this conflict and wish to know what happened, I would strongly urge you to read outside of the US press for your insights. Briefly, Georgia initiated the conflict on August 7th and barraged a completely civilian town in South Ossetia with indiscriminate rocket and artillery fire, killing between 1000 and 2000 civilians and provoking a Russian response.

In the face of this, the US decided to rush through a missile defense pact with Poland, who needs protection from missiles like a rugby player with the ball needs protection from spectator insults.

One thing that amuses me here is the impression that the US political leadership isn’t even trying anymore. If they were, they’d have spent more time coming up with a more plausible reason for the anti-missile installation than helping Poland to deal with “long-range missile threats from countries like Iran or from North Korea.”

I mean, seriously. Poland? Under threat from North Korea and Iran? Say what?

They just aren’t even trying anymore. I doubt the speech writer even bothered to stub out his or her cigarette before submitting that one. Taken another way, this gives us a pretty clear insight that US intentions in the region have nothing at all to do with the safety and security of Poland, who is now a pawn in a much larger game. For my money, I cannot imagine that the prize in this game is anything other than energy. Although exactly how provoking Russia furthers that interest is a point well outside of my grasp. I will continue to monitor developments, and I wish Europe a very calm and warm winter.