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UPDATE 5: Going into
the opening in Asia (with electronic markets and Sydney already open), gold
is up around $12 and silver is up 40 cents, while the U.S. dollar is off 40
basis points on the Dollar Index. It will be interesting to see how things
develop as each market opens after this stupefying weekend.
UPDATE 4: Chris
Ciovacco would like to welcome
American taxpayers to the mortgage business. Among his many excellent
insights is the following:
“Financial markets are always looking forward,
albeit only about three weeks in the current trading-oriented markets. The
markets have looked forward to Fed rate cuts and government bailouts since
the credit crisis began. Now that the Fannie and Freddie news is out,
I’m not sure what the markets have to look forward to.”
Meanwhile, in a rare
episode for Jim Sinclair, he is speechless. Not only that, his initial
reaction to the F&F Farce is playing second fiddle to the Storm in the Gulf:
“Now that it
has been made public that the US Treasury (the US Government) has taken over
Freddie and Fannie let us see exactly what “taken over” means. A
cursory look at the takeover suggest to me that the National Debt could rise
by more than $5 trillion. Not even the government can be that stupid - or can
they be?
Let’s get more information
before opining further.”
Alas, I think the
only additional information that is forthcoming for now is how the various
markets will perceive this largest ever financial engineering in the
history of the world. How long will it take the Wall Street geniuses and
their hack economists to figure out that we have just witnessed the largest
crowding out of the private sector ever? When will they realize that a
primary effect of such crowding out is to cause or exacerbate a business
downturn, which can (at least theoretically) only be mitigated by printing
money? Assuming they do achieve a basic understanding of the situation,
should we suppose they might even conclude (correctly) that the size of the
money printing operation must be commensurate with the size of the crowding
out? Nah. And even if they do, they won’t admit it publicly.
“It” being that the only truly safe assets left in the world are
gold and silver.
UPDATE 3: The
nationalization program has now been announced.
It consists of 4 parts: (1) A conservatorship (”temporary”
takeover of control); (2) a purchase of up to $200 billion in special
preferred shares that also gives the U.S. Treasury a warrant to acquire 79.9%
of the common shares of both GSEs; (3) an unlimited mortgage-backed
securities (MBS) purchase program (limited only by the national debt
ceiling); and (4) an unlimited credit facility extended to the GSEs (limited
only by the national debt ceiling).
Although it could
have gone even further, the U.S. government intervention still amounts to a
nearly complete and direct backing of GSE agency debt and agency MBS. Here is
the statement from Treasury addressing this:
“Investors have purchased securities of these
government sponsored enterprises in part because the ambiguities in
their Congressional charters created a perception of government backing.
These ambiguities fostered enormous growth in GSE debt outstanding, and the
breadth of these holdings pose a systemic risk to our financial system.
Because the U.S. government created these ambiguities, we have a
responsibility to both avert and ultimately address the systemic risk now
posed by the scale and breadth of the holdings of GSE debt and mortgage
backed securities.” [Emphasis mine]
Note something
interesting. The Treasury states that (in the past, presumably, the past
being as recent as this Friday) there was only a perception of
government backing of government sponsored enterprises. Presumably that
perception has been tweaked over this weekend. Yet the Treasury does not
unambiguously state that the ambiguities are being removed. Instead, the
Treasury is “merely” fulfilling its responsibilities to avert
and ultimately address the systemic risk. The reason for this waffling
language is that an Act of Congress would be required before an explicit
guarantee can be made. But let’s be realistic here, it is fairly
certain that some sort of Act will be passed before December 2009 that fully
nationalizes Freddie and Fannie. In the meantime, “[t]hese
agreements will protect the senior and subordinated debt and the mortgage
backed securities of the GSEs“, according to the U.S. Treasury. To
boil it down to its essence, the U.S. government has just enacted a new New
Deal and America is now on a crash course to becoming one of the most
socialistic economies in the world.
More importantly (if
that’s possible), what has just taken place is the largest financial
engineering of all time. It is the largest intervention by an order of
magnitude considering that more than $5 trillion of assets is being impacted.
By comparison, the LTCM bailout in 1998 involved a mere $4 billion. And so
far, the entire Federal Reserve bailout of the financial industry (via credit
term facilities) has amounted to $300 billion. Here, I would note that the $5
trillion of assets currently yield a substantial spread to
“risk-free” U.S. Treasuries. That spread will shrink
substantially, perhaps in an instant. The result will be falling yields and
higher asset values. For example, if yields on GSE debt and MBS were to fall
50 basis points across the board (I suspect this might be plausible), those
$5 trillion of agency securities could appreciate in value by $250 billion
more or less. That is no chump change and we could very well see a tsunami of
fund flows and reallocations being unleashed next week. Such a huge
repositioning of funds could easily overwhelm even the largest market in the
world, foreign currencies. What it could do to/for a relatively small market
like gold or silver is downright scary. Alternatively, we could see yields
rise on U.S. Treasury securities. That could cause some equally violent
havoc.
Nonetheless, here are
some potentially positive considerations for the monetary metals. First, the
commercials at COMEX have done a lot of short covering in the past couple of
weeks, especially in silver. The open interest is not at an extreme low, but
it is low enough to suggest that there isn’t a multitude of big players
with inside knowledge who are ready to “cash in” on the
Freddie/Fannie nationalization. Second, the basis in SLV and GLD, the big
silver and gold ETFs, changed from discount earlier on Friday to a premium
toward the end of the day. Moreover, there wasn’t a lot of action in
the after-hours electronic gold and silver markets. Third, Freddie and Fannie
rallied during the regular session on Friday along with the rest of the
financials. And while the GSEs fell hard in after hours once the
nationalization rumors started to spread, the financials did not rally very
hard in after hours (although they did rally). Fourth, the multi-pronged
nature of the Treasury’s Freddie/Fannie package indicates that the
market may actually react to this news by shunning GSE securities, not
rushing in to buy them. In particular, why did the Treasury feel the need to
announce a plan to purchase MBS securities directly if the other funding
mechanisms (preferred shares and credit facility) were enough to restore
confidence in the GSEs?
I’d like to
make another important, if not obvious, observation here. Given a fiscal
deficit, the only way that the Treasury will be able to enact its “bold
plan” to stabilize the GSEs is to issue U.S. Treasury securities on an
incremental basis. Specifically, if and when the Treasury buys a Fannie or
Freddie MBS, the funds to do that will come from the sale of Treasury securities.
In other words, the U.S. Treasury will earn the spread between Treasury
securities and MBS. That is a potentially lucrative business as long as the
total difference between the two sets of interest payments (the
Treasury’s payment of interest on Treasury securities and its receipt
of interest on MBS) more than offsets the defaults on MBS loan principle. By
way of example, if we suppose that an MBS has a duration of seven years and a
spread to Treasuries of 2.5%, then theoretically up to 17.5% (7 times 2.5%)
of defaults can be absorbed before taxpayers are on the hook. Yes, I know
this is an extremely simplistic way of looking at this but it works for
illustrative purposes. It also demonstrates some of the moral and fiscal
hazards of such a plan. For example, a spike in mortgage defaults will tend
to drive spreads apart and the U.S. Treasury may find itself having to either
chase interest rates higher to “protect” homeowners OR let the
spread widen in order to “protect” taxpayers. Another example is
actually more of a question: what makes the government think that it can be
effective as both the main price maker and main risk taker in the credit
markets? I would venture that the answer is going to be spectacularly
disastrous.
In conclusion, it
needs to be said that the Treasury’s GSE bailout plan is a monstrously
massive crowding out of private debt by public debt in the credit markets. In
fact, President Lyndon B. Johnson privatized Fannie Mae in 1968 (Freddie
didn’t exist yet) to get GSE liabilities off the government’s
books in order to better manage U.S. finances in response to the budgetary
demands of the Vietnam War. To think that reversing such a step during an
even more challenging but similar period (not only do we have the Iraq War
but a housing mess that we didn’t have in 1968) is going to turn out a
Cinderella story is the height of folly. That, of course, won’t stop it
from being spun as a positive development, even a miracle, by the mainstream.
Jim Cramer got the ball rolling on Friday, proving once again that intelligence
and common sense are sometimes mutually exclusive. Spin aside, I’m
afraid the U.S. dollar is now officially a dead man walking.
UPDATE 2: The latest
Federal Reserve Factors Affecting Reserve Balances report
shows the Fed has up to $354.349 BILLION of assets other than Treasury
securities on its books to back the Federal Reserve Note (FRN). This is 44.3%
of the almost $800 billion of FRNs outstanding. For those who don’t
understand what this means, Federal Reserve Notes are the actual pieces of
paper fiat currency ($1, $5, $10, $20, $50 and $100 bills) that are the
liabilities of nobody other than the central bank, and ultimately the U.S.
government. All other forms of “U.S. dollars” (this includes
checking accounts, savings accounts, certificates of deposit, money market
accounts, etc. but excludes Treasury Bills, Notes and Bonds) are actually the
liabilities of individual financial institutions. And what exactly are these
$354.349 BILLION of other assets held on the Fed’s balance sheet? Why,
I would imagine most of them are Freddie Mac and Fannie Mae
“agency” securities. In other words, a perverted way of looking
at the nationalizations of Freddie Mac and Fannie Mae is that the
“safety and security” of the U.S. dollar has actually been
strengthened as a result. Perhaps this is one of the reasons why the U.S.
dollar has rallied over the past couple of months since Congress approved the
“twin F’s” bailout. And why it is entirely possible that
the “black = white” reaction to this weekend’s $5 trillion
rescue could be more strength from the dollar and more weakness out of the
monetary metals.
On the other hand, a
direct guarantee of Freddie and Fannie securities by the U.S. government
makes them arguably just as good as U.S. Treasury securities, which would
mean that the global pool of U.S. dollar priced “risk-free”
interest earning assets could have just doubled over the weekend. Assuming no
equivalent increase in demand (i.e., instantaneous doubling by $5 trillion),
this much paper could simply be too much for the world’s no-risk
appetite. This tends to argue for the value of the dollar to take an instant
haircut of up to 50%.
On the other foot,
given the recent rate differential of nearly 100 basis points between U.S.
Treasuries and agency debt, there could be a huge amount of jockeying and
chasing a better “risk-free” interest rate during the next week.
If a significant number of players want, but are unable, to swap Treasuries
and agency securities directly, they may have to go to the currency markets
to obtain dollars so they can make the switch. That, in turn, could create a
short-lived but extremely strong demand for U.S. dollars.
So which hand or foot
is it going to be? Darned if I know, but I’m thinking some amputations
might be in order.
UPDATE 1: Bloomberg reports that House Financial Services Committee Chairman
Barney Frank has confirmed that a plan is in the process of being hammered
out this weekend between Fraidy Mac, Fanny Mae and the United States
Department of the ?Treadsurely? (to which Paulson replies, stop calling me
Shirley). U.S. Dollar, welcome to the jungle!
ORIGINAL: Media
reports proliferated Friday night carrying the rumor that Freddie Mac and
Fannie Mae will be taken over by the Treasury–a de facto
nationalization–over the weekend. As many of you remember, my first
impression of the “rescue plan” passed by Congress in July was
that it was in fact a nationalization. But even I didn’t think it would
be consummated just a few weeks later. While the takeover has not been
confirmed as I write this, it does appear that retail bullion investors might
be asleep at the wheel. What do I mean? Well, something like this has the
potential to turn gold and silver prices around in a hurry. In fact, I
wouldn’t be surprised to see gold and silver open gap up in Asia on Sunday night if some sort of plan is announced on Sunday. Then again, it
wouldn’t surprise me either if the monetary metals take another plunge
on what is possibly the most bullish news for bullion during this entire bull
market. After all, the Russian invasion of Georgia at the opening of the
Summer Olympics (also over a weekend) was a significant, bullish
geo-political event for gold and silver, yet bullion reacted by actually
plunging to new lows the next week.
In any case, those of
you who are the betting type have the opportunity to take advantage of the
potential gap up before Asian markets open. How? Well, you can buy gold and
silver bullion, that’s how. And please no belly aches about
availability. I just spoke with Mr. Hannes Tulving at www.tulving.com and he has
decent stocks of gold bullion as well as 90% junk bags of silver along with boxes
of silver Eagles and a few other items. And unlike most Internet dealers, he
takes orders over the weekend. So, if you are a gambling man or woman, there
is your craps table.
Getting back to
“asleep at the wheel”, Mr. Tulving reports that he has not seen a
major spike in orders today. This means one of the following: (1) retail
bullion investors don’t get the significance of what could be happening
this weekend; (2) retail bullion investors feel that the takeovers will be
spun as being positive for the U.S. dollar and therefore negative for
bullion; (3) retail bullion investors don’t know what to think given
all the false flags and crazy boolsheet that have pervaded the gold and
silver markets over the past couple of months.
Frankly, I myself am
not going to take a gamble this weekend, so I can’t blame anybody else
for “not getting it”. But I did feel it was important to report
my observations. I’d be curious to hear what some of you think.
Tom Szabo
Silveraxis.com
Tom Szabo was born in Hungary
during the Communist era and escaped to the West with his family, eventually
settling in California. After graduating from the University of California at Berkeley with a Bachelor’s Degree in Business Administration, he spent 8
years as a financial statement auditor with Deloitte & Touche, focusing
on financial institutions. He has co-founded several
precious metal related businesses and investment funds, invests for his own
account and runs the website at www.silveraxis.com. His specialty is
original, controversial, unpopular and contrarian thinking.
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