The Invisible Hand of Foreclosure Prevention

“These are complicated instruments” they say. We have thousands of bits of mortgages spread over billion dollar pools known as CDOs. Trying to value, or more importantly reconstruct, a mortgage is like trying to build a sandcastle in a hurricane. Let’s accept the premise that the current system is broken beyond repair - and move forwards. While Congress was busy grandstanding, I was trying to figure out a solution.
When a company needs money to purchase assets, it can go to the bond market and issue debt. This debt trades at some value and can usually be bought back below par. Imagine a company issues $50MM at par, and the very next day, a black swan visits Wall Street causing a crash. On this day, the bonds start trading at 80 cents on the dollar. Barring some debt indentures, this company can now repurchase its own $50MM of debt for only $40MM. When the home owner needs money to purchase assets, he or she goes to the lender. Regardless of the economic situation, the home owner is always asked to pay back his debt at par plus accrued interest. There is no reason this practice should continue.
Merrill Lynch sold its mortgage debt portfolio for 22 cents on the dollar. I can imagine almost every single home owner will to pay 23, or more, cents on the dollar for their own mortgage, or for that tranche of their mortgage.
Mortgages should be traded on an exchange where home owners can buy securities that they can later tender in for their mortgage. If we had this system, there would be no issues with transparency, no guessing of values, and stabilize foreclosure rates due to mortgages being under water.
We can use parts of the options trading model to help do this. Each mortgage type will trade within its own category. The following list is not exhaustive but should help clarify my plan.
• By Length of Mortgage (10,15,30 year)
• By Type (Fixed vs. Arm)
• By interest rate ( 5.75%, 5.875%, 6.00%, etc…)
• By FICO Score of Borrower (In 10 point Increments)
• By Geographic region (Midwest vs. Northeast – or maybe even more specific)
• Conforming vs. Jumbo
It would be hard to argue that one 30 year, 5.00% fixed conforming mortgage from a Midwest borrower with an 800 FICO score should be valued different from another. Therefore, if today such a mortgage was trading at 95 cents on the dollar, the individual who was responsible can be rewarded. At the same time, California sub-prime home owner would a choice between foreclosure and trying to repurchase their mortgage below Face Value, preventing mass foreclosures. Lenders could write in specifics to which securities they will allow as tender for the mortgage to protect themselves.
The current system is broken and should not be continued in the future. Let’s replace it with a transparent system that will allow the market to price the value of this debt, like it does so with corporate debt.

Back in Business

Hello everyone,

I know it has been a while since I have last posted some thoughts. I have been busy with school and building a more professional website.

My next home will be www.Sentimist.com

I will be sharing this website with a fellow investor, Tomasz Dzien.

We plan on posting our thoughts regularly while also offering educational sessions.


Let me also take this time to offer some more current thoughts.

Currently, I am SHORT Best Buy (BBY), First Solar (FSLR), and the Nasdaq 100 (PSQ).

Today's poor retail numbers indicate to me that retailers will continue struggle just to survive. At the same time, I believe that lack of access to credit coupled with very low energy prices are axing alternative energy. My general market outlook is negative. I believe that Technology is the ultimate discretionary spending made my corporations-which is why I am long the PSQ.

More to come.

Oil Plummets Again- This time to $91

Oil is clearly crashing. This sell-off in oil has been more fierce than anyone thought likely. Oil seems to have been hit by the perfect storm.

Luckily, I recommend that short about $50 ago

DUG is currently at 47.60, which is 46% higher than my original call.

Oil looks right now looks to be easily headed to $80. I think it will near it but I would prefer to take some money money off the table because the inventory reports will come out today. It is likely that Hurricane Ike did affect short term supplies.



I would also like to add that its prudent to buy companies severely affected by high oil prices such as FDX, PG, and KMB

Lehman (LEH) Files for Chapter 11 - Can't find a Buyer

Here are the thoughts of Brad Hintz

Lehman Brothers Holdings was not sold. Barclays pulled out of the negotiations, apparently concluding that conservatism is the best course of action in today's uncertain credit market conditions, and Bank of America found a better partner in Merrill Lynch.

The US Treasury decided that it will not provide credit support of a Lehman Brothers acquisition beyond the funding support what it is already being provided through the Fed discount facilities. Therefore, The Street spent part of the weekend making preparations for a worst case outcome. ISDA has produced a legal document in an attempt to facilitate the orderly unwind of the Lehman derivatives book in preparation of a potential bankruptcy filing by the firm.

Having survived the weekend without being acquired, LEH apparently concluded that an attempt to open for business this morning in New York was futile. Even with a strong liquidity position and access to the Fed discount window, management realized that it would not be able to raise more equity capital given its stock price and that issuance of long term debt would be problematic. We believe its ratings were about to be taken down by Moodys and it was unlikely that counterparties would accept Lehman settlement risk; therefore, the company would be forced to pre-fund its trades.

And although the $600 billion balance sheet of the firm would provide plenty of sources of immediate cash if the firm began to liquidate its securities inventories, management apparently concluded that the plan Lehman Brothers presented last week was impossible to complete with LEH's stock price more than 90% down and an orderly liquidation strategy would only prolong the inevitable. So the firm filed Chapter 11 this morning.

Oil Nears $100

Oil Continues Slide
10:30a ET September 11, 2008 (Briefing.com)

Oil futures made a brief spike into positive territory before receding back into negative ground. Oil is currently down 1.0% to trade near $101.50 per barrel. Curde is now up just 5.8% year-to-date. Oil exploration and production companies are currently down 2.1% this session, the worst in the energy sector (-1.4%). However, oil and gas refiners (+4.8%) are faring quite well. Many refiners are curtailing operations as hurricanes threaten their facilities, which eases demand for crude oil. That scenario helps build crude inventories, but makes gasoline and other consumable fuels shorter in supply. Softer fuel prices bode well for stocks since they reduce input and operating costs. However, uncertainty related to the global economy and the threat of continued weakness in the financial sector (-3.2%) has promoted traders to act largely independent of oil prices during recent sessions.

Taking more Profits on this Momumental Day

Google GOOG: 427

I want any short positions based on my recommendation to be down to 25%. We had a very dramatic move from GOOG and a bounce is inevitable.



First Solar FSLR: 222


Home Depot HD: $30.10


Jim Cramer is now bullish on HD. I still love this stock for another 2 years but we have seen about a 50% run from the bottom.

HUGE NEWS: US Government takes over mortgage giants

US Government seizes control of mortgage giants Fannie Mae and Freddie Mac WASHINGTON (AP) -- The Bush administration's seizure of troubled mortgage giants Fannie Mae and Freddie Mac is potentially a $200 billion bet that it will help reverse a prolonged housing and credit crisis.

The historic move announced Sunday won support from both presidential campaigns, but private analysts worried that it may not be enough to stabilize the slumping housing market given the glut of vacant homes for sale, rising foreclosures, rising unemployment and weak consumer confidence.

Officials announced that both giant institutions were being placed in a government conservatorship, a move that could end up costing taxpayers billions of dollars. Treasury Secretary Henry Paulson said allowing the companies to fail would have extracted a far higher price on consumers by driving up the cost of home loans and all other types of borrowing because the failures would "create great turmoil in our financial markets here at home and around the globe."

Mark Zandi, chief economist at Moody's Economy.com predicted that 30-year mortgage rates, currently averaging 6.35 percent nationwide, could dip to close to 5.5 percent. That's because investors will be more willing to buy the debt issued by Fannie and Freddie -- and at lower rates -- since the federal government is now explicitly standing behind that debt.

"Effectively, the federal government has now become the nation's mortgage lender," he said. "This takes a major financial threat off the table."

Futures on all major stock indexes rose about 2 percent in electronic trading Sunday night, another sign of investor relief about the takeover plan

The companies, which together own or guarantee about $5 trillion in home loans, about half the nation's total, have lost $14 billion in the last year and are likely to pile up billions more in losses until the housing market begins to recover.

The Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke, in exchange for senior preferred stock. Treasury will immediately be issued $1 billion of such stock from each company, which will pay 10 percent interest. Further purchases of preferred stock will be triggered if quarterly audits find that the companies' capital cushion is below prudent standards.

The government, which will receive warrants representing ownership stakes of 79.9 percent in each company, is hoping that its moves will reassure nervous investors that they can continue to buy the debt of the two companies.

In a statement, President Bush said, "Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction and are critical to returning the economy to stronger sustained growth."

Democratic presidential nominee Barack Obama issued a statement agreeing that some form of intervention was necessary, and promised, "I will be reviewing the details of the Treasury plan and monitoring its impact to determine whether it achieves the key benchmarks I believe are necessary to address this crisis."

Republican presidential nominee John McCain also voiced support while his running mate, Alaska Gov. Sarah Palin, said that Fannie and Freddie "have gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help."

The conservatorship will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie, a move taken at the same time that Congress greatly expanded the power of the Treasury Department to make loans to the two companies and purchase their stock.

The executives and board of directors of both institutions are being replaced. Herb Allison, the former head of the TIAA-CREF retirement investment fund, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Paulson was careful not to blame Daniel Mudd, the outgoing CEO of Fannie Mae, or Freddie Mac's departing CEO Richard Syron for the companies' current problems. While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

Fannie and Freddie both purchase home loans from banks and then repackage those loans as mortgage-backed securities which they either hold on their own books or sell to investors around the globe. This process provides banks with more money to make more home loans, greatly expanding home ownership.

The impact of the government takeover on existing common and preferred shares, which have slumped in value in the last year, will depend on how investors react to Paulson's assertion that they must absorb the cost of further losses first. Under the plan, dividends on both common and preferred stock would be eliminated, saving about $2 billion a year.

After the Treasury Department's announcement, credit rating agency Standard & Poor's downgraded Fannie and Freddie's preferred stock to junk-bond status, but reaffirmed the U.S. government's triple-A rating.

The Federal Reserve and other federal banking regulators said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."

The Fed released a letter from Fed Chairman Ben Bernanke to James Lockhart, the director of the Federal Housing Finance Agency, in which the Fed chief said he concurred in Lockhart's decision to take control of Fannie and Freddie saying the action "will help ensure the safe and sound operation of the enterprises."

Analysts were split on how much the takeover could eventually cost taxpayers although they all agreed the up-front costs will be substantial, possibly hitting $100 billion as the Treasury is called upon to bolster the capital cushions at both institutions.

However, if the plan does the trick of stabilizing the housing market and home prices stop falling and rebound, then the assets of both Fannie and Freddie should rise in value and the government should be able to sell off the companies and recoup its investments.

But it could take a long time to work through that process given all the headwinds facing housing at the moment from the plunge in home prices to soaring defaults on mortgages which are dumping more homes on an already glutted market. The weak economy has pushed unemployment to a five-year high of 6.1 percent, further reducing demand for homes.

"I think the government will end up having to put in far more money then they are planning right now (given all the problems facing housing) but the important thing is the agencies have been taken over by the government," said Sung Won Sohn, an economics professor at California State University Channel Islands. "That means there will be less panic in financial markets."

Under government control, the companies will be allowed to expand their support for the mortgage market over the next year by boosting their holdings of mortgage securities they hold on their books from a combined $1.5 trillion to $1.7 trillion. Starting in 2010, though, they are required to drop their holdings by 10 percent annually until they reach a combined $500 billion.

In addition, officials said the Treasury Department plans to purchase $5 billion in mortgage-backed securities issued by the two companies later this month, the first of a series of purchases planned by the government in an effort to bolster for these securities, which was badly shaken a year ago when the credit crisis first erupted with soaring defaults on subprime mortgages.

Paulson said that it would be up to Congress and the next president to figure out the two companies' ultimate structure and the conflicting goals they operated under -- maximizing returns for shareholders while also being required to facilitate home buying for low- and moderate-income Americans.

"There is a consensus today ... that they cannot continue in their current form," he said.

Members of Congress will be watching in the coming months to see how the takeover works, but more housing legislation appears unlikely until next year given the few weeks remaining both Congress quits to hit the campaign trail.

Sen. Charles Schumer, D-N.Y. said the intervention was sparked by worries within the Bush administration that foreign governments would stop holding Fannie and Freddie's debt. "This was the prudent course to take," he said.

Senate Banking Committee Chairman Chris Dodd, D-Conn., announced his committee would hold hearings on the takeover to address a number of unanswered questions so that the American people will know "if this unprecedented proposal will help keep mortgages affordable, stabilize the markets and protect taxpayer interests."

Lockhart said that all lobbying activities of both companies would stop immediately. Both companies over the years made extensive efforts to lobby members of Congress in an effort to keep the benefits they enjoyed as government-sponsored enterprises.

Sunday's actions followed a series of meetings Paulson had with Bush and other top administration economic officials with Bush relying heavily on the judgment of Paulson, who was the head of investment giant Goldman Sachs before he joined the Cabinet in 2006.

"It is really an assent to Hank's direction, guidance and judgment," said a senior administration official, who spoke on condition of anonymity to discuss behind-the-scenes deliberations.

Associated Press Writer Ben Feller in Washington contributed to this report.

http://biz.yahoo.com/ap/080907/mortgage_giants_crisis.html