The Fannie, Freddie Takeover and You

   

Congratulations — it’s a boy, and a girl! And their names are Fannie Mae (FNM) and Freddie Mac (FRE). Whether you were expecting their arrival or it was a complete surprise, either way, they’re yours now.

Just like Britney Spears’ father was named her conservator till she gets straightened out, so too did the government take over its problem children. This means that if you are a U.S. taxpayer, you are now the proud owner of about $5 trillion in mortgage debt. Hey, it’s diversified — what ever could go wrong?!

By now you’ve heard the news about the U.S. government buying (or, bailing out) the nation’s largest mortgage lenders, Fannie and Freddie.

Today I’m going to talk about how to profit from the bailout, but first — very quickly — here are the basics.

‘FANNING’ THE FLAMES OF THE CREDIT CRISIS

Most people who have had a mortgage end up making the monthly payment to a different bank than the one who originally gave them the loan. Sound familiar?

A loan is a bond and, when your mortgage lender changes hands, the banks are basically trading a bond created based on your debt.

Fannie Mae and Freddie Mac purchase home mortgage loans from banks and repackage those loans as mortgage-backed securities by pooling a large number of loans together, thus reducing the risk of default of any single borrower.

They either hold the loans on their books, or they sell them to investors around the world. Together, Fannie Mae and Freddie Mac own about $5 trillion in home loans — about half the nation’s total.

fannie freddie chris rowe chart The Fannie, Freddie Takeover and You


WHAT’S THE SIGNIFICANCE OF THE GOVERNMENT’S BUYOUT/BAILOUT?

When banks — which are used to selling over half of their loans to Freddie and Fannie — suddenly don’t know if either one will be able to buy loans that the banks write, then the banks will be reluctant to lend money.

Therefore, they will require a higher interest rate from the borrower (homebuyer) to compensate for their incurred risk or they won’t be willing to make home loans at all.

When the money doesn’t move around, banks lose money due to less activity and housing prices go down, as it becomes more and more difficult to borrow enough money to buy a home.

On the flipside, when the bank is able to sell the loans they made (to home buyers) to Fannie or Freddie, they are able to get their money back to make more loans, which in turn keeps the money moving through a healthy system.

That’s the “lower half” of the equation in the chart above. Here’s the “upper half” of the story.

YOU DID A GOOD DEED AND DIDN’T EVEN KNOW IT!

Because the government is backing up Fannie and Freddie, investors are more willing to buy debt issued by the two. That is, they’re more willing to buy their bonds. In other words, it means they’re more willing to lend Fannie and Freddie money which they, in turn, lend to homebuyers in order to capture a spread on the interest rate.

Again, this is important because if institutional investors are less willing to buy debt backed by Fannie and Freddie (without the government backing) they will require the two to pay a higher interest rate to compensate for the risk of default, or they will simply stop buying Fannie’s and Freddie’s debt. This trickles down to the homebuyer who would have to pay higher rates to their mortgage lender.

So because the government is now backing the debt, you can expect the net effect to be reduced mortgage rates because, basically, the government is the one lending the money.

Foreign investors own about $1.5 trillion of the debt issued by Fannie and Freddie, so the news sent overseas markets ripping higher as confidence was restored that they won’t get the short end of the stick.

(By the way, that means you — if you are a U.S. taxpayer — are the one lending the money. Isn’t that nice of you? You are helping to bail out people who made bad investment decisions.)

So just remember, when your tax dollars are there to bail out those who don’t want to take responsibility for their own actions, people run wild and make big messes. Hey, don’t worry, because everyone else will clean it up for you, right?

This is a hard pill to be force-fed, folks, but the alternative is obviously much worse.


SO, WHERE ARE THE PROFITS IN THIS FOR US?

I know what you are thinking. You think I’m going to tell you to play real estate stocks somehow, or perhaps an Exchange-Traded Fund (ETF) of some sort.

Well, you are right.

The market is at a critical point right now. We appear to have bounced off of a very important support level.

The bears are closing out their bearish (short) positions. Then they’re turning around and trying to short-sell the market while nervous bulls start selling long positions. But THEN, strong bulls keep buying stock while nervous bears exit their bearish positions, causing a great big rally in U.S. markets. It’s crazy!

This is happening on strong volume, confirming the market’s recent bullish reversal pattern. That means the overly aggressive bears (which add selling pressure to an advancing market) as well as nervous bulls (who also add selling pressure to an advancing market) were just shaken out.

This is great for bulls … for now.

IS THE HOUSING MARKET HOME TO FUTURE PROFITS?

Don’t think for one second that this stabilizes the housing market. We still have nearly a year’s worth of inventory, record foreclosures and rising unemployment to deal with.

(Imagine if taxes are increased by our next president at a time like this? Geesh, the timing would be awesome — just as long as you are 100% bearish — profiting from large downside moves!)

Either way, Tycoon Report readers can profit; so election SHMELECTION.

Don’t think the stock market has put in a long-term bottom, either. Maybe it has (though I doubt it), or maybe it hasn’t, but that is irrelevant to me. I look for confirmation first and I don’t make assumptions until I see it.

Finally, this isn’t very surprising to investors (the institutional ones that move the stock market). Everyone knows the two mortgage giants are government-sponsored and knew the bailout was imminent when the Federal Housing Finance Agency was created by Congress this summer to regulate Fannie and Freddie.

This tough pill to swallow is probably just a painkiller the stock market gobbled up like Pac-Man. But the ghosts won’t take long to start flickering and then the chase will be on once again.

Want to run after the ghosts and gobble up as many as you can? It’s a risk, but here you are …

REAL ESTATE COMPANIES THAT LOOK DECENT

  • Annaly Capital Management (NLY)
  • Boston Properties (BXP)
  • Kimco Realty (KIM)
  • Public Storage (PSA)
  • Simon Property Group (SPG)
  • Vornado Realty Trust (VNO)

I can’t give exact buy recommendations (entry or exit prices) here because it wouldn’t be fair to members of The Trend Rider. But I can say that I would wait for a slight pullback to buy any of the stocks mentioned above.

I would also remind you that when it is time to get bearish (or exit bullish positions), you should do it with zero emotion whether you are up or down.

As for my expectations for the overall market, I am bullish only in the intermediate term, but bearish on the long-term trend.



Chris Rowe is the Chief Investment Officer for Tycoon Publishing’s The Trend Rider. To learn more about him, click here to read his bio.


Article printed from InvestorPlace Media, http://investorplace.com/2008/09/what-fannie-mae-freddie-mac-takeover-means-to-you/.

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