 Queer Eye For The Bond Guy:
Fanny Mae as the
Bond Canary
Jim Willie
CB
Archives
Jan 13, 2005
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Fanny Mae deservedly
receives a tremendous amount of criticism. It has become the
mortgage industry poster boy for uncontrolled inflation, accounting
fraud, executive pilfering, and collectivism for home ownership.
More could be said about probably the largest wellspring of funneled
theft in the history of the United States, as much as $3400 billion
from 1988 to 2000, but that is another story, and besides, I
value my health, freedom, and well-being too much to document
such claims. Where massive cash flows, fraudulent siphons divert
money.
In all likelihood
Fanny Mae is downright insolvent and bankrupt. The Dept of Treasury
has taken over their hedge book in the past summer months. The
financial press failed to properly report what happened. How
about a column title "Fanny Mae Bankruptcy" ??? No
no no, that would make for a negative story on a wonderful device
to enable home ownership to over 65% of our public. The Dept
of Treasury punted to the Security & Exchange Commission,
which will merely force accounting restatements, and probably
punt back to Trez. A ping pong game will ensue. It cannot be
permitted to stop, since publicity of the formal announcement
of bankruptcy would again make for bad press. The centrifuge
must continue. The game must perpetuate without end, so as to
avoid that day of reckoning. In movement comes no final determination.
In effect,
the USA is in the process of repeating the error committed by
Japan late in the 1980 decade. The USA is gearing its entire
mortgage finance structure to over-priced housing property, inflated
by perhaps 40% to 50% in value. Whereas Japan suffered bank damage
from underwater mortgages, scattered in its bank under-writing
across the terrain of the Land of the Rising Sun, inside the
USA suffered damage will occur in a localized manner with Fanny
Mae and the other Govt Sponsored Enterprises (i.e. Freddy Mac,
Federal Home Loan Association). To be sure, the debris of potential
under-water mortgages is scattered across countless Savings &
Loans and mortgage banks inside the US Economy. Talk about a
weapon of mass destruction! And Asian central banks hold the
button for detonation. We no longer have control, either with
the internal accounting or foreign influence.
This essay
is not an attempt to fully analyze the paper pyramid known as
Fanny Mae, nor to fully document its fraudulent game, nor to
fully articulate its risk. My purpose is to propose the Fanny
Mae stock (FNM) share price as a leading indicator of the upcoming
bond bubble breakdown, and a leading indicator of bond derivative
events. FNM will herald the future bond bear market. We have
already experienced our first derivative event with Fanny restatement
from hedge book corrosion. However, it has so far been contained,
much like a nuclear power station enclosed by a 10-foot (3-meter)
cement containment module. Our federal banking officials are
venting radioactive gas every single day, every single week from
the receivership containment module. Such is the nature of
monetized Fanny debt.
First, some
background so readers can benefit from some measure of information
on its controls, auditing, accounting, risk management, and foreign
credit reliance.
INADEQUATE CONTROLS
To be sure,
Fanny Mae and Freddy Mac stand as the centerpiece to a grand
mortgage finance centrifuge system which dispenses mortgage funds
to agencies and banks in a monstrous recycle. New mortgages are
approved and funded by agencies of all kind, only to sell portfolios
to Fanny Mae, to receive the funds right back, and to repeat
the grant of new mortgages. Firms which manage new loan creations
earn nice origination fees (points). The risk management and
accounting problems cited for this spewing machine are many.
Banking authorities such as the Federal Reserve cannot seem to
contain or control the growth of money from this system. Perhaps
25% of new money supply growth in 2003 and 2004 was traceable
to Fanny Mae and the other federal pools of mortgage supply.
INADEQUATE QUALITY
AUDITS
Audit controls
are a ridiculously funny joke with Fanny. Agency held mortgage
portfolios can legally be audited only in the aggregate, so bad
loans are easily buried and hidden. That is the law, designed
as a large wide patio sliding door for fraud. A rash of patterned
under-capitalized loans cannot be identified. A scad of grossly
over-valued properties cannot be identified. A raft of loans
with kickbacks cannot be identified. Worse, a funnel of systematic
(see the HBO Sopranos) criminal fraud loans from shell corporations
cannot be identified either. In fact, Fanny itself manages
a recycle game which is possibly complicit to the scam with "Reperforming"
loan portfolios, and sells bonds to back them up. They label
certain loans as defective, recycle the faulty parts into another
aggregate package, and sell the defective product to the public
at a discount. Their quality is uncertain, but certainly sub-par.
Would you purchase 100 televisions if you knew 10% were defective?
How about at a discount?
INADEQUATE REQUIREMENTS
Agency held
mortgages entail minimal requirements for qualification. Applications
are routinely accepted with 5% down payment, closing cost rebates
under the table, and worse. Appraisals are widely regarded to
be a joke. If an appraisal professional offers reasonable and
lower estimated values for properties under application, he or
she will quickly be excluded from the grand game. The inspection
process has been undermined, since the centrifuge will spin out
funds even for properties with problems. Remember the "Reperforming"
products? Inspectors are subject to similar pressure to comply
and play the game. Mortgage insurance, no problem.
INADEQUATE ACCOUNTING
The recent
SEC decision to require restatement of $9 billion in Fanny Mae
losses highlights the exposure of the fraudulent nature of this
massive shell game of a centrifuge, with attached funnels. They
have systematically put aside hedge book disasters into the nether
regions of amortized losses, or else have hidden them into accounts
to be reckoned with at later dates. Games have been played
to delay loss reporting so that executive stock options were
redeemed with profit, fully reported last May by Barrons.
This is where public scrutiny and outcry will possibly result
not only in criminal trial, but also in cancellation of millionaire
pensions for the perpetrators. Be assured that somebody in Fanny's
executive ranks will be prosecuted and will sport an orange prison
jump suit, probably not well connected politically, possibly
a past whistle blower, perhaps even an official who wears the
wrong colored political party coat.
DANGEROUS RISK MANAGEMENT
Fanny Mae has
the unenvied task of managing a gigantic mountain of bonds, with
different interest rates, different lengths of maturity, different
loan size, different regional markets, and different income levels
of borrowers. Their business plan might not be possible to
execute successfully without a deity in charge of risk management.
If mortgage rates fall, the "refinance" movement wreaks
havoc with their accounting, as pre-paid bonds plummet in value.
Refinanced funded proceeds usually are devoted to Treasury bond
recycle, which used to push rates even lower from sheer magnitude.
Proper hedging is a careful craft, not easily achieved, and Fanny
might have fallen way short in its success. While falling rates
render portfolios of bonds as rising in value, the lost income
from cash flow in refinances could render operations totally
drained in liquidity. In other words, the business would run
out of money to maintain operations. If mortgage rates rise,
then bond portfolios could quickly crater, especially with leverage.
Worse, they might be forced to sell into their bond futures
portfolio to raise required cash, which accelerates rising long-term
interest rates. This is called "mortgage convexity."
Derivatives are at work to contain the Ponzi Paper Mountain with
US Treasury Bonds (i.e. bond futures contracts). There is more,
as Real Estate Mortgage Investment Conduits (REMIC) are employed
to contain the mountain attached to the centrifuge with Mortgage
Backed Securities (MBS). These are leveraged contracts on mortgage
bonds. A mistake in a declining rate environment, and they are
dead. A mistake in a rising rate environment, and they are dead.
There are many more devices employed, such as interest rate swap
options (called swaptions). There are strips which remove payment
to principal. There are floaters, which balance against international
prevailing rates. Enough, getting a headache here. Oy oy oy.
FOREIGN CREDIT RELIANCE
It is estimated
that 25% of all official Agency bonded debt is purchased and
held by foreigners, such as Asian central banks. Not only are
foreigners the major credit suppliers to keep the USGovt funded
on deficits (45% share), but they are also major credit suppliers
to mortgage funding. Of course, they gobble up corporate debt,
like 25% of it. What better way to keep US homeowners able to
borrow endlessly against their increased home equity, for the
typical consumer purchases, room additions, and maintained lifestyle.
Does that mean Asian bankers will eventually own a large swath
of American property titles? Hmmm.
WEAKEST LINK IN THE
BOND STRUCTURE
The financial
markets constantly seek out simple indexes, worthy indicators,
and other measures to aid in reading complex markets. Given
the overwhelming characteristics of financial weakness, which
any rational thinking person cannot deny, the Fanny Mae stock
can be placed in the fish bowl for view as the best indicator
of approaching disaster. Stock prices typically forewarn
of fundamental distress and trouble over the horizon in 3 to
9 months time. If mortgage bonds are to suffer a horrible fate
in future months, the FNM stock price will surely take a nosedive.
Or at least, imminent "recognized" insolvency might
be tipped off by a bearish chart pattern. To date, no such warning
can be put up for view. My analysis has long accepted FNM as
the crack in the housing foundation from a financial perspective.
In my view, the cracks are widening, the cracks are growing in
length, water is leaking, and new cracks appear periodically.
My conclusion is that the future will bring the bond bubble bust,
the great anticipated bond bear market, the crash to do unspeakable
damage to the US Economy, AND FANNY MAE STOCK PRICE WILL PROVIDE
THE BEST AND MOST RELIABLE WARNING.
Some might
disagree and look for siren signals from mortgage agencies, from
title trusts, from home builders. These public companies are
often shielded by Fanny Mae itself, since they offload risk to
Fanny themselves. These firms are not part and parcel to foreign
central bank portfolios. No, the real bond decline will come
when foreigners shed their US bond holdings. Their mortgage agency
debt securities are the most likely initial dumping ground. If
trade war erupts, the first Asian salvo will surely be mortgage
bonds. They contain much more risk, and are more insecure than
Treasury securities.
Let's examine
the above FNM chart. The mortgage congame stock price seems safely
bound between 65 and 75 per share. There is a possible rounded
top pattern (emerging
in red),
which might alert investors of imminent decline. The roof to the Fanny
chart house seems tilted downward, but hardly any severe listing
to prevent the liquidity to drain inside to sleeping or living
quarters. Some measure of confidence might even be garnered from
the upward tilting lower support in the current trading range.
Together with a tilted rooftop, the building base indicates a
time of resolution in the coming months, or else just a more
dangerously narrow range. As the range tightens, the tolerance
for swings is removed, adding to the risk of breakdown. Watch
for the rounded top, and whether it continues to exert pressure
downward.
Four events
can be identified in the FNM chart. Some correlation can be seen
with the TNX chart, which corresponds to the 10-yr Treasury Note
yield. They do not perfectly coincide though, since Fanny contains
much more risk on its own demerit. Event A marks a quick swoon
in FNM over 20% in value, from 78 to 60 during the late summer
of 2002. At that time, the US Economy was showing early signs
of recovery (whether real or not), bonds were rotating into stocks,
and the first of several bond revolts occurred. Event B marks
from January to March 2003 the misfortune which befell Fanny,
as the stock from 70 to 60, almost a 15% decline. St Louis Fed
Governor Poole provided impetus for the climax selloff. He had
warned that the mortgage finance giant was grossly under-capitalized,
its derivative book had insufficient core funds, its accounting
was suspect, and its failure could cause a meltdown to the US
Economy as a systemic risk. Well put, Poole! It is a wonder he
was not fired from federal service like former Treasury Secretary
O'Neill.
Event C marks
in midsummer 2003 some more fibrillations (heart attack) from
yet another bond revolt. Its stock fell from 75 to 61, almost
a 20% decline again. At this time, much publicity had circulated
that Fanny and its mortgagor sisters had lost control, and had
run amok beyond what reins the Federal Reserve could pull. Reports
cited over 25% of all new money in the banking system had been
generated from mortgages. The usual suspects of Treasury bonds,
corporate bonds, commercial loans, credit card extension, and
financial sector carry trades now had a new member in the Grand
Inflation Financial Engineering Club. Much talk swirled around
stories of Fanny insolvency and critically wounded hedge books.
Event D coincided
with reports that Fanny Mae was exposed and cited for financial
accounting fraud, executive option fraud, and likely earnings
restatements of the severe downward variety. The reports soft-pedaled
the story of bankruptcy and entry into receivership to the Dept
of Treasury. Can't have that! The stock fell as precipitously
as it did in the summer 2002, as shares fell in value from 78
to 67, hardly a crash.
Rumor is rampant
that Fanny Mae stock and her gargantuan backside haunches of
fatty debt is the beneficiary of an historically unprecedented
massive remedial rescue LIPOSUCTION project. The Federal Reserve,
administered by the Dept of Treasury, is printing money (monetization)
and purchasing Fanny paper in order to prevent its collapse.
If Fanny were subjected to free market forces, it would quickly
enter bankruptcy court, see FNM go to 35 cents per share, and
cause a tsunami wave with other private agency bankruptcies.
Even if somewhat contained, such a development would surely cause
the long-awaited decline with awesome momentum in the US housing
sector.
To date, FNM
shows no signs of a bond breakdown, a bond bear market, or liquidation
of the bankrupt Fanny Mae corporation. Is it a corporation, or
a federal agency, or just a financial engineering madcap apparatus
whom nobody will lay claim to ownership down the road? It is
clearly on life support, with large intravenous infusions being
administered on a daily basis. The proper accounting probably
can be found offshore. Fanny's inevitable fate might be a
formal socialist basket case like Social Security Trust, which
also was stolen dry, but in full view.
FANNY MAE STOCK
(FNM) SERVES AS THE CANARY IN THE BOND COAL MINE. WHEN IT GOES
INTO DECLINE, BE PREPARED FOR A BOND BEAR MARKET. GOLD REQUIRES
SUCH A BOND BEAR TO TEAR DEEP WOUNDS IN FALSE MONEY. WE ARE NOT
THERE YET, BUT A NARROWING RANGE MAKES FOR A CHALLENGE.
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Jim Willie
Archives
Jan 12, 2005
Jim Willie
CB is the editor of the "HAT TRICK LETTER"
website: Golden
Jackass
subscribe: Hat
Trick Letter
Jim Willie
CB is a statistical analyst in marketing research and retail
forecasting. He holds a PhD in Statistics. His career has stretched
over 23 years. He aspires to thrive in the financial editor world,
unencumbered by the limitations of economic credentials. Visit
his free website to find articles from topflight authors at www.GoldenJackass.com.
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