Avoid Fannie and Freddie Like the Plague

7/11 - "Truthfully, the government can't afford to take over Fannie and Freddie because their outstanding debt would more than double the federal government debt outstanding, which would further deteriorate the dollar on international markets. Fannie and Freddie own or guarantee about $5.2 trillion dollars of U.S. home mortgages, or nearly half of those outstanding.

Stock investors are running from the company, but bond investors are not. According to the Wall Street Journal this morning, Bill Gross, chief investment office of PIMCO, bought a large amount of Fannie Mae debt on Thursday. He told the Journal, a default would set off "a firestorm of intolerable proportions."

"Howard Shapiro, a New York based Fox-Pitt analyst told Bloomberg Fannie would need to lose $40 billion immediately and Freddie would need to lose $37 billion to be considered insolvent. For this to happen, the housing market would need to decline 40% and delinquency rates would have to increase to 12% to reach critical capital levels."

"Analysts think there are a number of alternatives short of conservatorship that could shore up both companies so critical to the U.S.. housing market and economy:"

7/11 - "The blowhards and bluff artists and the Gang of Four -- Ambac (NYSE: ABK) (Cramer's Take), MBIA (NYSE: MBI) (Cramer's Take), MGIC (NYSE: MTG) (Cramer's Take) and PMI (NYSE: PMI) (Cramer's Take) -- truly have blood on their hands for this moment...The whole apparatus stinks and we are now seeing the unwinding, but I think that the false assurances created by the Gang of Four and their insistence to not worry made everyone way too complacent. Their glib promises as well as the incredibly lax work of the ratings agencies, S&P and Moody's, enabled the whole edifice to be propped up.

And once it was clear to them that they needed more capital, they chose to forgo the window and attack the shorts. Had they raised the capital they needed and had the ratings agencies said they can't bless any more of this junk, we might have never been in this spot."

"Today, as we ponder the unthinkable, the nationalization of Fannie and Freddie, we have to recognize that it ISN'T the default rates that are doing it. It is the lack of a small amount of capital relative to the huge amount of guarantees, almost all of which aren't even an issue except the last three years of them...And it is those guarantees that are being stressed, because the personal mortgage insurance that Fannie/Freddie insist upon to make their loan that they securitize "less likely to default," is being obliterated as surely as MTG and PMI's stocks are being obliterated."

7/11 - "The recent pressure on the shares of FRE (FRE.N; US$8.00; 1H) and FNM (FNM.N; US$13.20; 1H) reflect market concerns/confusion surrounding potential future dilutive capital raises. While the question of capital adequacy has surrounded the GSEs (government-sponsored enterprises) for a while, given their relatively high leverage versus banks, the timing of recent "noise" has been particularly challenging given the recent 2Q-end and the company quiet period ahead of 2Q reporting. Note: OFHEO has publicly stated that both GSEs currently have adequate amounts of capital."

"We believe the main market fear is in the risk of the GSEs being forced to raise large amounts of capital. We spoke with FRE management this morning and they indicated that there has been no significant change in their financial condition during 2Q beyond prior guidance, and that they remain on track to gain SEC registration soon and pursue their $5.5 billion commitment to raise new capital (half common and half straight preferred) at an opportune time."

"...we believe the market needs to be reminded that the GSEs were structured as shareholder owned institutions for a reason - to provide non-federal capital support for the U.S. housing and mortgage markets, and that the GSE structure has worked in the past (such as during 1998) and continues to work today. We believe that no one in Washington desires for a nationalization of the GSEs, which would bring the burden of providing mortgage access and liquidity on to the shoulders of taxpayers."

"Remain Buys - Thus, since we expect cooler minds to prevail as regulators fully comprehend the important role of the GSEs, we believe the recent sell-off in the shares of FRE and FNM is overdone."