Lehman. Freddie [FRE] and Fannie [FNM] the Government's Enron
Off Balance Sheet Finance
Freddie and Fannie are (were) an off balance sheet shelters for the federal government. Just like Enron, which created special twits, turns and special units off its books, our government did the same.
Call it a subsidized PUT option on the US housing market. Washington wrote this PUT 30 years ago and took a larger position earlier this year by allowing FRE and FNM to increase their buying. They wrote this put to create a more liquid and orderly market for the citizenry to purchase houses. Can we say politicians giving handouts? But this is worse. The politicians did not understand what risks they were accepting, all they saw was an asset class that nationally almost never went down. They were lowering the cost for a mortgage for no money out of the treasury. This sounds perfect for a congressman, a they get to give their constituents a handout for accepting a massive liability that someone else will have to pay some day. What is worse they accepted the risk of an entire asset class without a modicum of hedging or setting aside a reserve for when they may have to make good on that risk. They handed a 16 year old they keys to the car and didn't take out insurance.
What would cause housing prices to go down, only some unforeseen catastrophe which would simultaneously put strain on our economic system and treasury making it more imperative that congress set aside a lock box. Does this sound familiar? Does this sound like other federal liabilities? What other blackswans are out there like a credit crush (credibility crunch). Every observation said housing prices would not never decline, until it did. What other impossibilities are very possible?
Instead of letting the creative energies of the citizenry solve this problem they created artificially low risk/reward ratio for residential real estate. Mortgages, for the last 30 years have not been priced efficiently. And since the government wrote the largest PUT ever, we are on the hook. Thank god they didn't back autos. Just think if they guaranteed SUVs. The bubble popped in that asset class this year too. GMAC took massive billion dollar write downs as leased SUVs became worth 40% over 6 months thanks to $140 barrels of oil.
By backing the debt of FRE and FNM it allowed the entities to borrow and leverage to the hilt. The problem is what is possible is inevitable. When one takes risk, on a long enough time line there will be collapse. FRE and FNM leveraged up even higher so that even smaller shock waves of housing prices going down 10% nationally spells doom. Think about it. Can you imagine a 50% drop? Didn't oil just drop 40% in a few weeks?
They created Frankenstein's monster, a federal subsidy to every home owner that is now to big to fail. It has come full circle as those same home owners will have to pay for every risk assumed.
Again, credibility, trust and transparency are trigger points for all crises. FRE and FNM were not transparent to the risk of catastrophic problem. The federal government was not transparent to the risks of backing all of these GSEs.
LEH
Lehman Brothers [LEH] is also in its death throws with a massive real estate portfolio, 1/3 of its portfolio in residential real estate and tons of Teir 3 (hard to value) assets. Not so much of because they leveraged so much and took to much losses. If that was the case they would have no problem taking on additional capital. They can't raise capital because no one knows how to value the assets on their books. It is not transparent. The number one rule of investing: Only invest in what you understand. Since their balance sheet is intelligible, no one can know.
Investment banks have become hedge funds that perform banking services. If I wanted a hedge fund I'd get a prospectus and have limits to my exposure. What are your limits with LEH's traders & bankers? I have no idea. If I wanted a hedge fund I'd invest in one. The ibanks should return capital back to shareholders. Performing banking services comes with enough risk.
Lessons, Potential Areas to Invest.
This problem is transparency. Goldman Sachs [GS] receives well over half of its revenues from proprietary trading. What is in its black box? No one knows. Other hedge funds that do not disclose. How about arbitrage funds? Long Term Capital was brought down by a shift in liquidly of their assets. Companies that have written to many puts for income. Admittedly this is a tough area because its trying to predict blackswans. However, let us learn that where ever we have lack of transparency (sunshine) there will be problems.
I still don't see the worst behind us in financials. Many traditional banks are already in trouble and their failure will cause systemic failure (ie market risk) via panic and general distrust. All finance is based upon trust. For that matter all business is based on trust. With panic and fear there is no trust and no business.
Also, most of the profits of ibanks were cause by leveraged investing. Even if ibanks return to some kind of normalcy they will not leverage up to produce the same kind of profits they had before. Therefore, do not expect them to return to their old highs (diluted per share basis).
Freddie and Fannie are (were) an off balance sheet shelters for the federal government. Just like Enron, which created special twits, turns and special units off its books, our government did the same.
Call it a subsidized PUT option on the US housing market. Washington wrote this PUT 30 years ago and took a larger position earlier this year by allowing FRE and FNM to increase their buying. They wrote this put to create a more liquid and orderly market for the citizenry to purchase houses. Can we say politicians giving handouts? But this is worse. The politicians did not understand what risks they were accepting, all they saw was an asset class that nationally almost never went down. They were lowering the cost for a mortgage for no money out of the treasury. This sounds perfect for a congressman, a they get to give their constituents a handout for accepting a massive liability that someone else will have to pay some day. What is worse they accepted the risk of an entire asset class without a modicum of hedging or setting aside a reserve for when they may have to make good on that risk. They handed a 16 year old they keys to the car and didn't take out insurance.
What would cause housing prices to go down, only some unforeseen catastrophe which would simultaneously put strain on our economic system and treasury making it more imperative that congress set aside a lock box. Does this sound familiar? Does this sound like other federal liabilities? What other blackswans are out there like a credit crush (credibility crunch). Every observation said housing prices would not never decline, until it did. What other impossibilities are very possible?
Instead of letting the creative energies of the citizenry solve this problem they created artificially low risk/reward ratio for residential real estate. Mortgages, for the last 30 years have not been priced efficiently. And since the government wrote the largest PUT ever, we are on the hook. Thank god they didn't back autos. Just think if they guaranteed SUVs. The bubble popped in that asset class this year too. GMAC took massive billion dollar write downs as leased SUVs became worth 40% over 6 months thanks to $140 barrels of oil.
By backing the debt of FRE and FNM it allowed the entities to borrow and leverage to the hilt. The problem is what is possible is inevitable. When one takes risk, on a long enough time line there will be collapse. FRE and FNM leveraged up even higher so that even smaller shock waves of housing prices going down 10% nationally spells doom. Think about it. Can you imagine a 50% drop? Didn't oil just drop 40% in a few weeks?
They created Frankenstein's monster, a federal subsidy to every home owner that is now to big to fail. It has come full circle as those same home owners will have to pay for every risk assumed.
Again, credibility, trust and transparency are trigger points for all crises. FRE and FNM were not transparent to the risk of catastrophic problem. The federal government was not transparent to the risks of backing all of these GSEs.
LEH
Lehman Brothers [LEH] is also in its death throws with a massive real estate portfolio, 1/3 of its portfolio in residential real estate and tons of Teir 3 (hard to value) assets. Not so much of because they leveraged so much and took to much losses. If that was the case they would have no problem taking on additional capital. They can't raise capital because no one knows how to value the assets on their books. It is not transparent. The number one rule of investing: Only invest in what you understand. Since their balance sheet is intelligible, no one can know.
Investment banks have become hedge funds that perform banking services. If I wanted a hedge fund I'd get a prospectus and have limits to my exposure. What are your limits with LEH's traders & bankers? I have no idea. If I wanted a hedge fund I'd invest in one. The ibanks should return capital back to shareholders. Performing banking services comes with enough risk.
Lessons, Potential Areas to Invest.
This problem is transparency. Goldman Sachs [GS] receives well over half of its revenues from proprietary trading. What is in its black box? No one knows. Other hedge funds that do not disclose. How about arbitrage funds? Long Term Capital was brought down by a shift in liquidly of their assets. Companies that have written to many puts for income. Admittedly this is a tough area because its trying to predict blackswans. However, let us learn that where ever we have lack of transparency (sunshine) there will be problems.
I still don't see the worst behind us in financials. Many traditional banks are already in trouble and their failure will cause systemic failure (ie market risk) via panic and general distrust. All finance is based upon trust. For that matter all business is based on trust. With panic and fear there is no trust and no business.
Also, most of the profits of ibanks were cause by leveraged investing. Even if ibanks return to some kind of normalcy they will not leverage up to produce the same kind of profits they had before. Therefore, do not expect them to return to their old highs (diluted per share basis).
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