US Treasury Plan to Inject $15 Billion Into Ailing Freddie and Fannie for Special Shares Class

Its liquidity, but its just not enough, so even if we do get a bounce on the news on Monday we will consider selling it.

The Sunday Times
US Treasury rescue for Fannie Mae and Freddie Mac
Treasury secretary looks at $15 billion cash injection for crisis-hit mortgage lenders
Iain Dey and Dominic Rushe
July 13, 2008

US TREASURY secretary Hank Paulson is working on plans to inject up to $15 billion (£7.5 billion) of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms.

The two companies lost almost half their market value last week as rumours of a government bail-out swept the stock markets, hammering share prices around the world.

Together, the two stockholder-owned, government-sponsored companies own or guarantee almost half of America’s $12 trillion home-loan market and are vital to the functioning of the housing market.

The capital-injection plan is said to be high on a list of options being considered by regulators as a means of restoring confidence in the lenders. The move would protect the American housing market, but punish shareholders in both companies.

Under the terms of the proposed move, the US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.

The potential rescue comes as investors are braced for more bad news from the financial sector. Citigroup is expected to reveal further writedowns of at least $8 billion with its second-quarter results, and Merrill Lynch is forecast to reveal writedowns of some $4 billion.

Both banks are expected to post sizeable losses for the second quarter, and reveal plans to sell off billions of pounds worth of assets.

A number of US regulators and politicians have been attempting to restore confidence in the two mortgage agencies.

Paulson and President George Bush stepped in to give vocal support to the two firms on Friday. “Freddie Mac and Fannie Mae are very important institutions,” said Bush, adding that he had spoken with Paulson who had “assured me that he and Ben Bernanke [the Federal Reserve chairman] will be working this issue very hard”.

Paulson killed off speculation that the government would renationalise the two agencies, a move that would have pitched the US public accounts into a new state of crisis.

However, Paulson pledged to support the two companies “in their current form”. He is said to have been concerned about the prospect of a rescue plan benefiting shareholders.

The capital injection would also see both lenders granted permission to use the Federal Reserve’s discount window - a short-term emergency funding source.

Freddie Mac has a $3 billion short-term funding line that comes up for renewal tomorrow. The short-term debt is one of the hundreds of funding lines that the two agencies use.

The funding lines allow Freddie and Fannie to buy mortgages from America’s commercial banks, which it then sells on to bond investors through securitisations. A government guarantee on the company’s debts allows it to raise money cheaply, making mortgages cheaper to finance for US banks.

Some in Wall Street believe a rescue plan may be announced ahead of tomorrow’s US market opening to calm nerves and support the debt auction.

Howard Shapiro, a Wall Street analyst at Fox-Pitt Kelton, said: “I think it will happen over the weekend. There will be government action but it will be far short of the dire scenarios that people are envisioning.” He said there was “no question” that the two firms were fundamentally sound.

He added that Paulson would have to move in order to “change the psychology” of the market and put Fannie and Freddie back on a stable footing.

David Buik, partner at BGC Partners, said: “These agencies are the backbone of financial society in the US. They simply cannot be allowed to fail, and the government won’t allow them to fail. Whatever the solution is to this problem, I can’t imagine it will be good for shareholders.”

He added: “In London we may see a dead-cat bounce on Monday, especially if we get a rescue. But that’s all it will be - shares may pop up 50 points or so, but then they will head down again.”

In the UK markets, HBOS will this week complete its £4 billion rights issue in a move that could see underwriters Morgan Stanley and Dresdner Kleinwort lumbered with more than £1 billion of the bank’s stock.

More than 13% of the HBOS shares in issue have been sold short by hedge funds - a bet that the bank’s share price will fall.

Bradford & Bingley will also put its lifesaving £400m rights issue to a shareholder vote.

Robert Parkes, UK equity strategist at HSBC, said: “It’s a seller’s market - we’re generally advising clients to sit on the sidelines until all the current issues blow over.”

Periods of Financial Distress: the Swinging Dow

Periods of Financial Distress are also periods of significant swings in market price and sentiment, often intraday. Here is a list of the largest intraday swings in the Dow Jones Industrial Average by points and by percents.

We can vividly recall one day in July 2002 when the Dow was down over 600 points and a short term bottom was made, when the money honey herself Maria Bartiromo bared her milky neck and pursed her lips to say 'capitulation,' at which point the Dow turned right around and we had a buying panic rally that took us back into the green in the period of about an hour.

Here is a chart of that period, that significant market bottom.



Here is a view of the same market bottom showing the two month lead into it.



Here is the 2000-2002 bear market shown with an SP 500 chart, from the second high in September 2000 which the SP made after the initial 2000 decline



Here is the list of the biggest intraday swings in the DJIA which we received from Barry Ritholz.



For reference, here is the decline in the SP 500 from the recent market top in October 2007

Periods of Financial Distress

As regular readers will remember, we have a mathematical model of 'periods of financial distress' called CrashTrak. We bring it out in market moments in which we have had a long ramp up to a decided market peak, and then a decline that achieves at least 10 percent. We gave an initial nod to the developing crash scenario which we are now in back in January of this year.

Crash: the Rally that Fails as a Hallmark of Major Market Dislocations

Market 'crashes' are low probability events that are notoriously difficult to predict accurately. CrashTrak did predict the tech crash of 2000-2. Unfortunately we were not able to forecast the great stock market reflation of 2003-2007 which the Fed had engineered until it was well underway.

This points out the weakness of using technical analysis in forecasting markets priced in fiat currencies that can be used to mask the actual market dynamics of real values, especially if the deflators and actual rates of inflation have also been rendered opaque. Simple models that worked in the past may not work in this environment of economic obfuscation.

Nevertheless, it can be used successfully if one couples technical analysis with fundamental analysis. The movements on a stock chart are an abstraction that represents an underlying marketplace of individual transactions. There are other ways to assess these transactions to obtain enough data to forecast a 'crash,' again reminding the reader that forecasting a low probability event is notoriously difficult. The flow of money in the market is one of these tools which we use, and is listed on a number of the charts which we provide almost every day.

We will be publishing updates of CrashTrak now that we have reached a second threshold of probability with the dip of the major indices below the -20% decline from the top level again.

The underlying mechanics of crashes is interesting and informative. Here is one of the best descriptions of how a crash happens that we have found, quoted in a paper by Barkely Rosser. For those of you who are students of market dislocations, Charles Kindleberger is a 'must read.'

Falling from the Period of Financial Distress into the Panic and Crash

In 1972, Hyman Minsky described the "period of financial distress," in a paper in a journal that no longer exists (Reappraisal of the Federal Reserve Discount Mechanism, vol. 3, pp. 97-136), "Financial Instability: The Economics of Disaster."

Charles P. Kindleberger picked up on this and followed Minsky's analysis in his famous book, Manias, Panics, and Crashes: A History of Financial Crises... The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revivial, but finally giving up in the final collapse.

According to Appendix B of Kindleberger's 2000 edition, 37 of the 47 great historical speculative bubbles exhibited such a period before the final crash...

Federal Regulators Take Over IndyMac After a Run on the Bank

Reuters
Regulators to run IndyMac until buyer found
By John Poirier and Rachelle Younglai
Friday July 11, 8:10 pm ET

WASHINGTON (Reuters) - Banking regulators on Friday swooped in to take over mortgage lender IndyMac Bancorp Inc, the second-largest bank failure in U.S. history and the fifth bank to close this year.

The Federal Deposit Insurance Corp estimated the cost of the California-based bank's failure to its $53-billion insurance fund at between $4 billion and $8 billion and will run the bank while it looks for a buyer.

The takeover of IndyMac capped a tumultuous day for U.S. financial markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac's primary regulator, the Office of Thrift Supervision, blamed comments by New York Democratic Sen. Charles Schumer for causing a run on the deposits at the largest independent publicly traded U.S. mortgage lender.

Schumer responded quickly on Friday, blaming the OTS for not doing its job and for letting IndyMac's loose lending practices continue.

The OTS said depositors have been withdrawing cash at an elevated pace since late June, when Schumer questioned IndyMac's ability to survive the housing crisis.

In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts, the OTS said.

"This institution failed today due to a liquidity crisis," OTS Director John Reich said. "Although this institution was already in distress, I am troubled by any interference in the regulatory process," he said.

The successor bank run by the FDIC will open for business on Monday. Over the weekend, depositors will have access to their funds by ATM, other debit card transactions, or by writing checks. They will have no access via online banking and phone services until Monday.

Earlier in the week, IndyMac said it was unable to raise new capital, would slash staff by 60 percent and had stopped making home loans. Its stock slid precipitously in the past week and last traded at 28 cents on the New York Stock Exchange, down 95 percent from the beginning of the year.

The FDIC insures up to $100,000 per deposit and up to $250,000 per retirement account at insured banks.

At the time of closing, IndyMac had about $1 billion of potentially uninsured deposits held by about 10,000 depositors. The FDIC said it would pay those depositors an advance dividend equal to 50 percent of the uninsured amount.

OTS told a conference call with reporters that it did not expect significant market impact from IndyMac's closure as the firm is not a systemic institution and does not have numerous counterparties. Reich also said he did not expect a larger thrift to fail.

Former FDIC official Ann Graham said it was not unprecedented for the FDIC to start running a bank after it fails. "It happens when they need to move more swiftly with the closing than they can move with a potential sale," said Graham, a law professor at Texas Tech University.

"They don't have to sell the institution over the weekend," she said. "They have the time to shop around." (Put it on Craigslist - Jesse)

Graham said the FDIC has the authority to operate an institution for two years but expected the agency will dispose of it much sooner than that.

(Reporting by John Poirier, Karey Wutkowski, Rachelle Younglai; Editing by Toni Reinhold and Braden Reddall)