The Heat is On: Fannie Mae (FNM) and Freddie Mac (FRE)

Lost in this month long Kool Aid rally off the July 15 lows is the danger that is Freddie Mac (FRE) and Fannie Mae (FNM). Just a month ago we had one of those emergency Sunday evening announcements that now comes every quarter as we reward risk taking institutions with our tax dollars [Jul 13: And Here We Go]. When things go well, they keep the gains and CEOs laugh to the bank. When things go bad, we cannot let any major institution fail - hi Bear Stearns (BSC). This is one time when the inability to short is really going to cost us - while one could argue Bear was a surprise in how quickly it happened this one has looked increasingly obvious for 4-5 months - I think a 100% gain is very probable in Freddie Mac as I oppose Bill Miller on this trade and say it goes to $0. [Aug 13: Bill Miller Continues to Boggle Me - Increasing Stake in Freddie Mac] What has been hilarious is how the politicians have been layering these 2 staggering drunks with more drinks as the financial situation worsened at both. But then again their timeline is "fix the fire today and we'll worry about the next fire in a few months".

We've been on this case for a long while and I originally thought this day would come maybe mid 2009 but in this age when all time is compressed, it looks like the pressure valves are spouting and it's becoming increasingly clear that "socialism 101" will be happening in America (again) and I'd venture sooner rather than later. It seems like ages ago but just last month [Jul 10: Whose Bottom Will this Be? Lehman Brothers (LEH) or Fannie/Freddie?]

Here are some warnings we touched on

1. [Nov 20: Freddie and Fannie Trading Like Chinese Small Caps]
   
2. [Feb 27: OFHEO Increases Allowance for Fannie Mae] Instead of limiting risk, to "save" the mortgage market the regulators told these companies they will allow them to take even more risky loans
   
3. [Mar 10: Barron's Cover Story - is Fannie Mae the Next Government Bailout?] Even Barron's saw the writing on the wall - politicians of course, could not
   
4. [Mar 19: Fannie, Freddie Layered with MORE Risk] We bemoaned the "solutions" the politicians were coming up with for the housing problem - all of which added even more systematic risks on the back of these 2 institutions
   
5. [Apr 15: Could the US Lose It's Triple A Rating] We discussed the United States of Subprime losing its Triple A rating if it had to bail out these 2 institutions - think our dollar is a joke now? Just wait.
   
6. [May 7: Some Things I'm Reading] 2 articles from Wall Street Journal and NY Times warning about this

• Alan Greenspan usually surrounds his opinions with caveats and convoluted clauses. But ask his view of the government's response to problems confronting mortgage giants Fannie Mae and Freddie Mac, and he offers one word: "Bad."
• The former Federal Reserve chairman also said he expects that U.S. house prices, a key factor in the outlook for the economy and financial markets, will begin to stabilize in the first half of next year.... he cautioned that even at a bottom, "prices could continue to drift lower through 2009 and beyond."
• At the Fed, Mr. Greenspan warned for years that the two mortgage giants' business model threatened the nation's financial stability. He acknowledges that a government backstop for the shareholder-owned, government-sponsored enterprises, or GSEs, was unavoidable. Not only are they crucial to the ailing mortgage market now, but the Fed-financed takeover of investment bank Bear Stearns Cos. also made government backing of Fannie and Freddie debt "inevitable," he said. "There's no credible argument for bailing out Bear Stearns and not the GSEs."
• His quarrel is with the approach the Bush administration sold to Congress. "They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted -- with necessary taxpayer support to make them financially viable -- as five or 10 individual privately held units," which the government would eventually auction off to private investors, he said. (this is how they hopefully end up - this way none is "too big to fail" in the future - let them all run as independent competitive bodies and if 1 of the 10 fails the entire global financial system is not set on it's knees - of course anyone following along the past decade could tell you that but as always we are REACTIVE not PROACTVE - only when the emergency happens do "solutions" start popping up)
• Instead, Congress granted Treasury Secretary Henry Paulson temporary authority to use an unlimited amount of taxpayer money to lend to or invest in the companies
• But a similar critique has been raised by several other prominent observers. "If they are too big to fail, make them smaller," former Nixon Treasury Secretary George Shultz said. Some say the Paulson approach, even if the government never spends a nickel, entrenches current management and offers shareholders the upside if the government's reassurance allows the companies to weather the current storm.