Bill Fleckenstein

Contrarian Chronicles7/21/2008 12:01 AM ET

Feds can't fix Fannie and Freddie

The mortgage giants aren't short of cash. They're stuck with bad loans that aren't going away. Also: Short sellers didn't bring down the lenders -- the lenders did it themselves.

By Bill Fleckenstein

As the Treasury prepares to ride to the rescue of Fannie and Freddie, it's worth noting one little detail: That so-called plan is in reality just a concept.

Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs) do not have a liquidity problem that can be solved by the Federal Reserve or even by an injection of Treasury capital. It's a solvency issue. Short-term cash isn't the real problem. Over time, the mortgage giants' liabilities are quite likely to swamp their assets. Thus their assets are contingent, but their debts are forever.

Further, if the Treasury is the only entity left willing to buy shares to shore up Fannie and Freddie, what will happen to other troubled financial institutions? Between now and the year's end, more mortgages will percolate through those institutions' balance sheets, creating losses that will force them to seek capital as well.

As for access to the Fed's discount window, even if Fannie and Freddie use it, that won't change much. Lehman Bros. (LEH, news, msgs) has had access to the discount window, and that has done Lehman little good. Nor has it healed Washington Mutual (WM, news, msgs), Bank of America (BAC, news, msgs), Citigroup (C, news, msgs), etc.

Standing single file . . . and in fear

The rapidly growing disaster the country faces, in addition to the financial one, is a recession that's worsening -- a reality depicted in widespread images of depositors lined up at IndyMac (IDMC, news, msgs) bank. (A friend of mine known as Mr. Mortgage has also noted lines at multiple locations of Washington Mutual.) I suspect that as this process moves forward, many regional banks will experience modest runs, because fear becomes contagious at some point. And fear eventually leads to panic.

This is all part of the next-time-down thesis that took forever to arrive, due to monkeying with the financial system by Wall Street and the government. But it is finally here.

As the process plays out, it will further hamper people's ability to make mortgage payments. That will impair mortgage assets, with a feedback effect on housing prices. Of course, our currency will continue to be undermined by what the Fed and the government want to do. You can quickly see how intertwined the real-estate market, stock market, economy and currency are.

As far as the stock market goes, fear has not yet morphed into panic, but I think we will get to that point. On the upside, folks often forget that markets are ruled by people -- who, at the end of the day, are ruled by their emotions. There can never be a new era because human nature remains the same.

Complacency: A Greenspan legacy

For now, fear has not reached panic levels. In fact, I am amazed by the complacency of so many stock operators, who act as though their greatest fear is missing the next rally. I guess that's how former Fed Chairman Alan Greenspan's policies over the past 25 years have conditioned financial muscle memory -- to believe that nothing ever goes wrong for long.

Turning to wrongheaded finger-pointing, I found it interesting that Securities and Exchange Commission Chairman Chris Cox wants to amend rules for naked short selling (though his proposals are much ado about nothing, as it is already illegal), specifically in the cases of Fannie, Freddie and certain brokers. I know I've said this before, but since there's been so much chatter about short sellers, let me once again try to make this perfectly clear:

Short sellers didn't create the housing bubble, which is what caused the unfolding disaster. Nor did they make the bad loans now going sour. Short sellers do not ruin companies, and they are incapable of driving a company's stock price lower for more than a brief moment. If unscrupulous manipulators decided to pressure a stock lower, that would be a recipe for losing money unless they were extremely quick, not only to sell but also to cover the short position.

Video on MSN Money

Mortgage crisis © Creatas/Photolibrary
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Likewise, short sellers didn't cause Bear Stearns to collapse. That was a do-it-yourself job, executed by the arrogant chieftains who let themselves get wildly over-leveraged.

And someone might tell Cox that short sellers didn't ruin Fannie Mae. That was the handiwork of former CEO Franklin Raines and the rest of management (as well as the regulators), whose Enron-like greed caused me to name the company "Fanron" on Feb. 23, 2005. As I wrote in my daily column on my Web site that day:

"Problems there definitely matter, since Fannie has been one of the primary engines that finance the housing ATM. In yet another turn for the worse, OFHEO stated that it has 'identified (additional) policies that it believes appear inconsistent with generally accepted accounting principles.' When I read this morning's OFHEO headlines (concerning Fannie's 'held for sale' loans and 'use of FAS 140' hedge accounting), I thought this smells, just like Enron, ergo, my new nickname for Fannie -- Fanron."

This business of blaming short sellers for lower stock prices (and speculators generically for high oil prices) is getting ridiculous, especially when the real perpetrators suffer minor consequences as they walk away with giant piles of money.

At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column.

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