Tuesday, November 20, 2007

Striken Bond Portfolios Enter Earn-Out Period

I did a little looking at Freddie (FHLMC), who rocked the financial markets, today.


The big picture runs ... o.k.

  • Big mortgage bond holders, like FHLMC, probably move into a period of "work out" in 2008. It's likely that there will be more credit losses to go. But these portfolios are still making money. Earnings will offset remaining credit losses, leaving flat income for the year.
  • The return to sanity of the pricing of risk will lead to some market-based losses. However, if the Fed eases some more (huge amounts, not required), then these will be ... mostly manageable, a moderate net drag.
  • If the peak of problems with foreclosures and workouts occurs in 2009 (or sooner), the markets will be looking beyond that, most likely, in late 2008 or early 2009, at the first signs of positive news.

From this point, the risk one is getting paid for is that the housing markets end up worse than than expected, because 'what is expected' got baked into the numbers today. Freddie, who are as good as any, I guess, are estimating that things end up worse than the last downturn (1991), so they are hardly being rosy. For them to turn out "wrong" from here on out would mean a fairly quick and radical worsening of the home markets.

Housing hasn't simply stopped nor has lending.

However, the high oil prices could put strain on the low-end of the market, for sure and dull economic growth enough to create a one-thing-leads-to-another problem. In short, bumpy is not out of the question.


Congress ought to remain vigilant, keeping on top of the regulators to make sure that all significant institutions have adequate capital plans.

Forcing almost everyone to shrink their balance-sheet all at once is not a great idea. (You'll notice that some of the thrifts appear to have skipped the problems and will benefit from that handsomely).

Some temporary relief of capital requirements is in order, coupled with other means, in a sort of 50-50 partnership to keep the credit market from 'standing still', rather than growing, if there is business to do.

I know that sounds weird, but it works. And it doesn't really let anyone off the hook for bad decisions. It just makes coping with them easier.

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