11/23/2007
This is a follow up to my last
article: 'Subprime
Mortgages Lead to Subprime Currency' (available here) in which I
wrote:
"The curious mind
asks, who holds those $trillions worth of mortgages? Thanks to the genius of
the American banking and marketing machine, just about every sizable institution
underneath the sun with a fixed income portfolio. From Europeans to Asians,
from Banks to Brokerages, from Hedge Funds to Pension Funds, Institution to
Retail, Trusts to Endowments.
Most of those
aforementioned outfits are in a state of shock and have been reluctant to
mark their $trillion+ subprime portfolio to market. Every other day there is
new revelation of substantial subprime loss. First it was New Century in
March, then American Mortgage and Countrywide in September, then it got worse
as Wells Fargo, Bank of America, Credit Suisse First Boston, Citibank (albeit
with a new CEO now) came out of woodworks. Last Friday it was Wachovia (US
4th largest), and on Tuesday it was Etrade. Not one major bank dealing with
mortgages was immune. If there is such thing as systematic risk, we are sure
looking at one, and therefore expect a lot more skeletons to come out of the
closet in the months to come."
In two short weeks, HSBC,
Citibank, Goldman Sachs, Swiss Re, and Japanese outfits have revealed tens of
billions of losses stemming from US mortgages.
I also said:
"At this juncture, the
Fed has no choice but to redeem any and all mortgages at near face value
directly, through GSE, or offshore vehicles. The more the Fed redeems, the
more dollars they print. When you print $1 trillion (10%) a year, people can
reasonably swallow the extra money supply, but when you print a $1trillion in
a hurry and in a conspicuous way, you are directly challenging money
managers' intelligence and you will see a squeeze in gold. It's that
simple".
CNNF kindly explains how GSE's
work and their impending failure.
"Fannie Mae guarantees
mortgages, which have been packaged and sold to investors as bonds. If a
homeowner falls significantly behind on his payments, Fannie Mae has to buy back
the loan from the bondholder. If the mortgage has an outstanding amount of,
say, $100,000 and unpaid interest of $5,000, Fannie Mae would have to pay
$105,000 -- its full value -- to make the bondholders whole. However, the
$105,000 loan may actually be worth less on the market. It is Fannie Mae's
job to estimate the market value, or fair market value, of the loan and to
record that price on its books. So if the fair market value is $80,000,
Fannie Mae takes a loss of $25,000 (the difference between $105,000 and
$80,000). That loss is considered an SOP 03-3 loss -- so named after the
applicable accounting rule.
Until recently, Fannie Mae
included SOP 03-3 losses as part of its credit-loss ratio. But here's the
trick: Fannie insists that, based on past trends, it can recover a large part
of that $25,000 loss by, for example, helping the borrower renew payments. So
it simply decided to stop including SOP 03-3 losses in calculating its
credit-loss ratio.
Fannie Mae's decision to
exclude SOP 03-3 losses coincide with their shocking rise: In the
third-quarter ended Sept. 30, 2007, the company's SOP 03-3 losses came to
$670 million, up from $37 million in the same period a year ago. It's not
clear why SOP 03-3 losses are skyrocketing, but it suggests that Fannie Mae
is having credit problems and is having to buy a lot more bad loans back from
bondholders"
The
reason for the dramatic SOP 03-3 rise is very clear according to the ABX
index below.
The index shows collectively,
that mortgages GSE's (Fannie and Freddie) guarantee are selling at .70 cents
on the dollar. Freddie's $120 billion and Fannie's $42 billion of exposure to
GSE-qualified mortgages means a write-down of over $30 billion and $10
billion respectively. Given that both outfits have about $1 billion in excess
capital, they are now technically insolvent, especially when the ABX index is
showing no signs of reversing. Freddie has hired Goldman Sachs and Lehman
Brothers as advisors to help it raise capital in the very near term, but our
take is that no sane institution will lend money to Freddie. If left to their
own devises by the government, Fannie and Freddie are doomed.
In our last article I also
said:
"No sane foreign
institution is going to finance American home owners, and why should they
when they can finance the Brazilians, Canadians, Thais, Russians, Chinese,
Indians, with an appreciating currency? The dollar reserve status is now
shattered. Mind you, it's not that we are against the dollar in particular,
we just don't think any fiat currency deserves to be the world's reserve
currency.
To those who say gold is
due for a pro-longed correction at $800, they are missing the big picture. To
us gold's run has just gotten started, the Emperor is now naked for all to
see".
Not only are mortgage-backed
securities distressed, but auto-loan backed securities and credit-backed
securities are now beginning to experience pressure. The world had a love
affair with the Dollar, and happily ate up any Dollar-denominated package
that threw a 5% interest at them. This $30 trillion+ affair has ended and the
aftermath is not pretty. To understand why the Fed has to print and bail out
all those banks and funds, we highly recommend that you watch this British
comic strip.
From the banker:
"One thing I learned
is if you are going to cock up something, better cock up big so government
has to bail you out, and if the government does not give me my money back, I
will tell them, it's not my money, its your pension fund money"
Technically gold has just
successfully tested the 50 day-moving-average support. Our 2007 target of
$850 for gold may be too conservative, as once the $850 level is overcome,
gold could rapidly challenge the $1,000 level. Welcome to inflation and
welcome to gold.
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