Today's Tidbits

Fannie Mae Financials May Show Record Losses

From Bloomberg: “Fannie Mae may post a record net loss in its first quarterly report since being seized by the U.S. government as Chief Executive Officer Herb Allison writes off bad debts and increases default estimates. The mortgage-finance company may say its third-quarter loss was at least $20 billion, including a previously announced plan to write down most of its tax credits… Washington-based Fannie may post results as early as tomorrow. Allison, installed when the government seized Fannie and the smaller Freddie Mac on Sept. 6, may use the report to slash the value of assets, as well as boost loss provisions and default estimates, said Paul Miller, an analyst at Friedman Billings Ramsey in Arlington, Virginia. Fannie has already posted losses of $9.4 billion in the past year as the worst housing market since the Great Depression increased defaults.

``Right now the market's numb about how bad the housing market is,'' Miller said. ``So why not clean the books out and clean it up.'' Fannie's new management will likely increase reserves for future credit losses from $3.7 billion last quarter and will take a higher-than-expected charge against its $5.2 billion in ``temporary'' losses, Miller said. Fannie also may increase its 2008 credit-loss ratio projection and post losses on its derivatives portfolio. ‘`It's going to be an ugly quarter,'' Shapiro said. Fannie has ``a new management team, it's got a new mission and they really have no stake in running it for profit right now.'' Fannie's writedown of its deferred tax assets, valued at $20.6 billion as of June 30, will potentially cut its book value in half and increases the likelihood the U.S. Treasury may need to pump cash into the mortgage-finance company. If McLean, Virginia-based Freddie follows suit as analysts expect, it would need to write down more than $18 billion, leaving it with a book value of negative $6 billion and triggering the Treasury aid. The Federal Housing Finance Agency placed Fannie and Freddie under federal control and forced out management after examiners found their capital to be too low and of poor quality. Treasury Secretary Henry Paulson pledged to invest as much as $100 billion in each company as needed to keep their net worth positive. The companies will need that money ``sooner rather than later,'' according to Miller. Allison, 65, will likely implement more conservative accounting policies and will need to write down higher-than-expected credit costs, Miller said. …Examiners from the Federal Reserve, who helped FHFA review the companies' books, found that in addition to thin capital, the Fannie and Freddie may have been understating their losses, Dallas Federal Reserve President Richard Fisher said last month. ``When you look at temporary impairments and so on, we found that many of them might not be so temporary,'' Fisher said in response to an audience question after a Sept. 8 speech in Austin, Texas. With Fannie under government conservatorship, Allison isn't as beholden to shareholders as his predecessor Daniel Mudd. Because Fannie and Freddie's market value was nearly wiped out with the federal takeover, Miller said, ``the new management team has no incentive to sugar coat their earnings.'' …Fannie reported a loss of $2.3 billion last quarter, and $1.4 billion in the three months ended Sept. 30, 2007. Fannie has booked $9.4 billion in cumulative losses over the previous four quarters.”

From Reuters: “Foreign central banks' holdings of U.S. agency securities at the Federal Reserve declined again as they continued to favor the safe haven status of Treasury debt, Fed data released on Thursday showed. Their holdings of agency securities fell by $7.24 billion in the week ended Nov 5 to $901.87 billion, following a $8.78 billion fall in the previous week. This brought the cumulative drop in agency holdings among overseas central banks to about $67.4 billion or 7 percent since the beginning of October. A federal measure to guarantee short-term bonds issued by banks has put them on a perceived higher credit standing than securities issued by mortgage agencies Fannie Mae, Freddie Mac and the Federal Home Loan Bank System….Meanwhile, overseas central banks' holdings of U.S. Treasuries at the Fed surged $19.13 billion in the latest week $1.594 trillion, following a $7.91 billion rise in the prior week. The Fed's combined custody of Treasury and agency holdings for overseas central banks increased $11.89 billion to $2.496 trillion in the latest week.”


Some Economic Priorities For President-Elect Obama

From The New York Times: “The credit markets have stabilized in the last few weeks and even improved a bit. But the rest of the economy is deteriorating fairly rapidly. It’s now in danger of falling into a vicious spiral, in which spending cuts by consumers and businesses lead to further layoffs and then more spending cuts. To prevent that from happening, the Obama administration will need to move quickly — before it takes office — to put together some emergency plans for the financial markets and the broader economy. Mr. Obama and his advisers acknowledge that their focus has to shift, but the change is still likely to be challenging, and a bit disappointing. “Unfortunately, the next president’s No. 1 priority is going to be preventing the biggest financial crisis in possibly the last century from turning into the next Great Depression,” says Austan Goolsbee, an Obama adviser. “That has to be No. 1. Nobody ever wanted that to be the priority. But that’s clearly where we are.” Throughout the campaign, whenever Mr. Obama was asked about the financial crisis, he liked to turn the conversation back to his long-term plans, by saying that they were meant to solve the very problems that had caused the crisis in the first place. Back in January, he predicted to me that the financial troubles would probably get significantly worse in 2008. They had their roots in middle-class income stagnation, which helped cause an explosion in debt, and the mortgage meltdown was likely to be just the beginning, he said then.

His prognosis was right — and the pundits now demanding that he give up major parts of his economic agenda in response to the financial crisis are, for the most part, wrong. When you discover that a patient is in even worse shape than you thought, you don’t become less aggressive about treatment. But you do have to deal with the most acute problems first.”

From Steve Roach at Morgan Stanley: “For President-elect Barack Obama, the campaign mantra of “change and hope” will meet a very quick reality test. Courtesy of a wrenching economic and financial crisis, his leadership skills could, in fact, be tested even before he assumes office. Not only would it be appropriate for him to weigh in on the mid-November G-20 summit in Washington, but his views could well be decisive in shaping the post-election efforts of the US Congress to craft another economic stimulus package. In these troubled times, the new leader of the free world can hardly afford to remain silent….core strategy should be to foster a long overdue rebalancing of the US economy. A dysfunctional growth model must be guided away from the asset- and debt-dependent consumption binge of the past dozen years toward a significant increase in long depressed domestic saving. Only then can the US achieve a sustained reduction of its massive current account deficit, necessary to fund sorely needed investments in infrastructure and human capital. Second, Barack Obama needs to move quickly in restoring America’s commitment to globalization. That means repudiating the politically inspired scape-goating of China and other saber rattling on the trade front. To do that, the president-elect needs to tackle a daunting middle-class real wage stagnation problem – the source of economic anxiety that has been the political foil for Washington’s increasingly worrisome protectionist tilt… Third, the newly elected president must provide leadership to the regulatory reform of America’s bruised and battered financial system. There is a very real risk in today’s highly charged political climate that a regulatory backlash goes too far and ends up impeding the efficiency of America’s market-based system of capital allocation. Reregulation must be even-handed, aimed not only at Wall Street but also at the rating agencies, a bubble-prone Federal Reserve, and other regulatory authorities. If President-elect Obama can push early for a principled and judicious approach to financial sector reforms, there is good reason to hope that the new system will be a major improvement from the old one – ushering in an era of transparency, improved disclosure, better underwriting standards, and enhanced oversight. America’s financial markets and institutions would then be grounded in a new sense of discipline, accountability, and stability – capable of providing just the anchor that an all too unstable and reckless world sorely needs.”


“Perfect Storm” for Retailers as Credit Tightens With Savings Low

From Reuters: “Retail chains posted the worst monthly sales data in more than three decades as consumers cut spending sharply in October, stunned by a financial crisis that has derailed the U.S. economy….The ICSC said it pared its forecast for what were already expected to be dismal holiday season sales. It now expect sales in November and December to rise 1 percent…"The great unknown is just how much lower can consumer spending go?" said Piper Jaffray analyst Jeff Klinefelter. "With savings rates at historic lows and constraints on the availability of consumer credit, I just think there's concern that the perfect storm is brewing." Wal-Mart Stores Inc stood out as one of the few bright spots. It posted a better-than-expected 2.4 percent rise in sales at U.S. stores open at least a year…Wal-Mart's results were a sharp contrast to other discounters like Target Corp and Costco Wholesale Corp, which reported larger-than-expected same-store sales drops. Across the sector, department store chains like Nordstrom Inc and specialty clothing retailers like Abercrombie & Fitch were among those hit hardest. Shoppers have pared purchases of discretionary items like clothes or computers and in some cases are carefully planning when they buy the most basic necessities, like baby formula… The crisis crimped spending even among the wealthy. Same-store sales fell 16.6 percent at upscale department store chain Saks Inc and dropped 15.7 percent at Nordstrom”


MISC


From BBC: “The Bank of England has made a shock one-and-a-half percentage point cut in UK interest rates to 3%, the lowest level since 1955. The size of the cut - the most dramatic since 1981 - signals the Bank's concern the UK is heading for a long recession…The cut was followed by the European Central Bank lowering its eurozone interest rates from 3.75% to 3.25%. The interest rate cuts come as the IMF predicts that developed economies will contract for the whole of the coming year for the first time since World War Two. “


From The Wall Street Journal: “Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain. The market for selling such loans -- by packaging, or securitizing, them into bonds -- had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier…”


From Barclays: “Companies have been borrowing very aggressively to buy equities …the credit crunch has removed this buying, one of the reasons why equities have de- rated to lower PE ratios”


From Barclays: “Oil prices have continued to swing wildly across the $60 to $70 range at the front of the curve, while back end prices have stayed above $90 per barrel.”

From The Financial Times: “Over the next 22 years, consuming countries will devote 5 per cent to 7 per cent of their gross domestic products to pay for their oil, up from 4 per cent in 2007. This will have “serious adverse implications for the economies of consuming countries”. “The only time the world has ever spent so much of its income on oil was in the early 1980s, when it exceeded 6 per cent,” the report says. In 1998, when oil traded just above $10 a barrel, the world spent just 1 per cent of its GDP on oil.”


From Barclays: “Comparisons with the Great Depression are an exaggeration…The average annualised GDP contraction in the Great Depression was 14.1% The largest annual GDP contraction in the Great Depression was 23% in 1932.”


From Bloomberg: “U.K. house prices fell at the fastest pace in at least 25 years…The average cost of a home dropped 14.9 percent from a year earlier in October, the most since the index began in 1983… From September, prices fell 2.2 percent, the ninth straight monthly decline.”

End-of-Day Market Update

From UBS: “Central Banks Slash Rates, Stocks Slash Net Worth: There was a downshift in market activity as participants squared up and headed for cover in front of tomorrow's Non-Farm Payrolls (UBSe -250k, consensus -200k) and Unemployment Data (UBSe +0.3%/6.4%, consensus +0.2%e/6.3%e). Markets, rather than taking solace from the dramatic move by the BoE and rate cuts from the ECB, DNB, and SNB, seemed to interpret these actions as confirming that the situation is dire and that lower rates would provide little relief. The UST 2- year gapped to 1.244% on the BoE news, matching the cycle lows of 3/17/08 at 1.236%. The issue traded off for most of the day, but caught a late afternoon bid as stocks swooned. The curve steepened with long rates rising, as US2Y10Y steepened +7 bps to 241 bps. Next week's supply and tomorrow's data provided the rationale for lightening up on positions. There was little outright buying going on in spread markets, which had helped push rates lower in recent days. CRB was 257.10, -10.87. Crude was -$6.48 to $61.46/bbl. Stocks closed -443 at 8,696. Treasury volume was light at -26% of the 30 day mva…. Commercial Paper outstandings rose $50.5B in the week, after a $100.5B gain last week. Presumably this reflects activity at the Fed's CPFF facility. Recapping the day's central bank actions, the BoE cut by 1.50% to 3.0% (more than the 50 bps - 75 bps expected), the ECB dropped by 0.50% to 3.25%, the SNB reduced by 0.50% to 2.0%, and Denmark lowered 0.50% to 5.0%. It is worth repeating part of the BoE statement: "...the risks to inflation have shifted to the downside...the global banking system has experienced its most serious disruption in almost a century" and they observed a "very marked deterioration in the outlook for economic growth." Strong words from a sober group…Spread markets were much quieter today after the recent frenzy of buying. Tomorrow's data, supply, and ugly price action in equities dimmed investor ardour for basis risk. MBS spreads were broadly unchanged, with the current coupon at +167 over the 50/50 weighted 5- and 10- year swaps. The swap desk reported light position squaring with spreads slightly wider across the curve: 2- years were +2.0 bps to 107.25 and 10- years +1.75 bps to 42.25 bps. The agency desk relayed a similar tale, with better buyers in the short to intermediate part of the curve, but 10- year benchmarks were "an island unto themselves." FNMA 2- year benchmarks were 0.0 at 127 bps, 5- years were +0.1 at 121 bps, and 10- years were +8.0 to 125 bps (Bloomberg). It is interesting how "flat" the spreads are across the 2- year - 10- year curve. Volatility traded higher. Central banks left the door open to lower rates and stocks fell through a trap door to lower prices. With short rates probing a break to new lows, volatility hedgers remain on edge.”


From Bloomberg: “U.S. stocks slid, sending the market to its biggest two-day slump since 1987, after jobless claims jumped and the shrinking economy crushed earnings at companies from Blackstone Group LP to News Corp…. The Standard & Poor's 500 Index fell 5 percent to 904.9, extending its two-day loss to 10 percent. The Dow Jones Industrial Average retreated 443.48 points, or 4.9 percent, to 8,695.79. The Russell 2000 Index of small U.S. companies declined 3.6 percent to 495.92. The MSCI World Index of 23 developed markets lost 6.2 percent to 921.87. The two-day tumble wiped out more than half of the S&P 500's rebound from a five-year low on Oct. 27. An industry report showing an unexpected decline in sales at U.S. chain stores in October also weighed on stocks as 25 of 27 companies in the S&P 500 Retailing Index slumped… The S&P 500 is down 38 percent this year, the steepest annual retreat since 1937. The benchmark for U.S. equities has plunged 42 percent since its record in October 2007 as the U.S. economy shrunk in two of the last four quarters… The VIX, as the Chicago Board Opions Exchange Volatility Index is known, climbed 17 percent to 63.88. The measure tracks the cost of using options as insurance against declines in the S&P 500.”


Prices as of 4:45PM (Based on Bloomberg)

Three month T-Bill yield fell 8 bp to 0.30%

Two year T-Note fell 6 bp to 1.28%

Ten year T-Note yield fell 1 bp to 3.69%

30-year FNMA current coupon fell 1 bp to 5.44%

Dow fell 444 points to 8696

S&P fell 48 points to 905

Dollar index rose 1.29 points to 85.89

Yen at 97.7

Euro at 1.272

Gold fell $6 to $734

Oil fell $4.25 to $61