Without a bailout of Fannie and Freddie, Commercial banks will be in deep trouble

Commercial banks
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Banks and thrifts are in the business of making loans, and there is no bigger loan the U.S. consumer will take on than a mortgage. If banks can’t sell these loans to Freddie or Fannie it would follow that the trickle of failures today would accelerate into a flood. Without buyers, big mortgage lenders such as Washington Mutual Inc. (WM) , Bank of America Corp. (BAC) and Wachovia Corp. (WB)will be in deep trouble — just as B of A.’s Ken Lewis thought he had heard the last of the criticisms of the $4 billion buyout of the nation’s biggest home lender, Countrywide Financial Corp.

Banks and thrifts also hold more than $1 trillion in Fannie and Freddie bonds because they are considered as good as cash. Without a bailout, banks and thrifts would have to raise more capital because GSE debt would have to be written down or sold.”

Debt markets
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Believe it or not, residential mortgage-backed securities are still being underwritten and sold. Volume is down 81% year-to-date from the same period last year, but through Aug. 18, 280 RMBS deals valued at a combined $161 billion had been issued, according to Dealogic. Even at those bare minimum levels, RMBS volume represented about 11% of all debt capital market issuance through July 31. The research firm also points out that $33.9 billion of those bonds will mature by yearend, a third of that amount in December alone.”

“There will be Blood”

Something just occurred to me after reading Weidner’s great article that dealt with new implications of socialisation of the two big F’s: Hank Paulson et al. are market men. Just like Daniel Day Lewis in “There will be Blood” called himself an oil man.

Hank in particular is an investment banker, and so by definition reveres the market. He may do good and bad things within the market context (such as lying to main st about how bad things really are, to name but one thing off the top of my head), but at heart the market is what he idealises. I know this because that is my ideology, and I know where he used to work. I need not know anymore.

So what I’m trying to say is that he will only nationalise Freddie and Fannie if his hand is forced, as the implications for the market is something that Weidner touched on in this article, but is in fact far worse than anything he alluded to. The reason being is that idealogically, it would be admitting such a large part of the market has failed, that at this current juncture, the sanctity of the markets operating AT ALL (let alone well) would be thrown into question. The question being should there even be a market in this current financial climate/turmoil.

If Paulson’s hand is forced, which now seems almost inevitable given their recent share price declines, I’m not sure how it will play out. What I am sure of is that it will be a watershed moment, and if it’s taken badly by markets, could provide the beginning of an actual bear-market. One that is quite different to the make-believe, feel-good semi-bear market we’ve seen since Bear Sterns collapsed.

This will be different to Bear Sterns or anything else we’ve seen so far. $5 trillion in brand new nationalised, and increasingly unservicable mortgage debt could be the rather large straw that breaks the massive-deficits-government and market’s collective backs. It will then truly be time to bid farewell to the USA dollar and it’s former buying power, and hello to a forced savings plan, courtesy of bankruptcies on mass from well-underwater mortgages which means losses ultimately to all parties involved: but especially the consumer (proportionally.)

One last important question: What’s worse, you’re individual bankruptcy or you’re country’s? Think about it.

Seriously, no bailout?

First of all, this is not a bailout of FNM and FRE. It’s a bailout of the credit ratings of GSE and U.S. government debt. The feds cannot afford to allow foreigners to lose confidence in bonds guaranteed by the govt, either implicitly or explicitly. That’s because the government can’t keep operating without the foreign subsidy of budget expenditures.

Second, “the number of defaulted loans is about 2%” is utterly misleading. The default rate is increasing exponentially month by month, and prime mortgages are now defaulting at a much higher rate than subprime, while Alt-A recasts will not peak before 2010. Furthermore, defaults are being under-reported because banks are not willing to foreclose. Countless mortages are six months and more in arrears, yet the banks continue to allow the homebuyers to stay in the home for free because a foreclosure will create a big loss the bank does not want to book. Why? No capital to move to Loan-Loss Reserves.

Third, “at the GSEs where lending standards are much higher” is another red herring. GSE standards have been relentlessly lowered to make it possible for FNM and FRE to take on as much as possible of the failing banks’ decaying mortgage pools. Fannie and Freddie are not being bailed out! They are being used as dumpsters to rescue the insolvent banking system.

Fannie and Freddie’s stock will go to near zero. Why? Because the Fed will re-capitalize them with new preferred shares, and old preferred and common stock will be subordinate, meaning they have no claim on assets in the coming meltdown. Fannie & Freddie bonds and other liabilities will be laid on the backs of taxpayers.

This “bailout” of GSE debt will not help the equity value of other financials. Both Fannie and Freddie need $50 billion in new capital right now, and several hundred billion at least in coming months. The other financials are holding shares of the GSEs, which will be worthless, and they’re also holding GSE bonds that are coming into question.
The bottom is a long ways away.

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