By William Patalon III
Money Morning/The Money Map Report
We've been warning you since the start that the subprime crisis would have some real staying power.
Indeed, every time optimistic prognosticators have predicted an end to this global financial debacle, we've had the same response: Don't you believe it.
Again just recently, after several big banks announced yet another round of major write-offs – all of them related to the subprime crisis, albeit indirectly – analysts, and even some banking-industry executives, said the write-downs were coming to an end.
Once again, we advised readers to avoid losing their heads over such heady optimism. And again, we were right.
The latest victims of the subprime crisis – mortgage giants Fannie Mae (FNM) Freddie Mac (FRE) – will be in the spotlight this week as investors, economists, bankers, mortgage brokers, homeowners, and politicos alike monitor the fate of these institutions. And here are the questions that will be asked – and hopefully answered – in the process:
- Are these government-sponsored enterprises (GSEs) too big to fail?
- Are their capital positions not as dire as some claim?
- Will the government nationalize them (at the taxpayers' expense)?
- Will residential borrowing costs shoot through the roof?
The answers will go a long way toward determining how much longer we have to tell you "don't you believe it" each time some analyst says the subprime crisis is over.
And some of those answers could well come today (Monday), especially after reports surfaced yesterday (Sunday) morning, stating that the U.S. Treasury was working on a rescue plan for the two government-sponsored mortgage firms. [For a related story detailing the Fannie and Freddie debacle in today's issue of Money Morning, please click here].
Investors also will have to turn at least some of their attention to earnings season (remember that?) as some key financial companies report: US Bancorp (USB.L) (Tuesday), State Street Corp. (STT) (Tuesday), Wells Fargo & Co. (WFC) (Wednesday), Merrill Lynch & Co. Inc. (MER) (Thursday), JP Morgan Chase & Co. (JPM) (Thursday), and Citigroup Inc. (C) (Friday).
Even earnings season poses some questions related to the subprime crisis:
- Will these results lead to more write-downs and additional capital infusions – further fueling the subprime crisis?
- Are those foreign sovereign wealth funds still looking for more American investments?
- Will the high-tech sector be able to offset some of the financial-sector pain, as it has so many times over the past couple of years?
Investors get another look into the inflation picture as both June Producer Price Index (PPI) and Consumer Price Index (CPI) are released. Have the higher energy costs started to work their ways into other sectors of the economy? Are companies passing along these costs to the ultimate consumer? (Remember, the so-called "core" data – which excludes volatile food-and-energy prices – is useful, but check out the full inflation picture for a change).
Finally, June retail sales may look promising as those government checks will be reflected in the data, but don't be fooled. This month, consumers are back out on their own.
And then panic set in. It's one thing for The Bear Stearns Cos. Inc. (BSC) with all of its interconnected relationships to be close to failing and require a "bailout." But what about two government sponsored entities (GSE) which own or guarantee $5 trillion in mortgages and serve as the backbone of that entire industry?
Surely, Freddie Mac and Fannie Mae have made news in the past (accounting irregularities, ineffective management) and have long been targets of certain politicos who have warned about a "too big to fail" mentality. Well, after losing a combined $11 billion (as of March 31) and raising $20 billion to shore up balance sheets, both entities face another major liquidity crunch and are in dire need of new infusions.
Lehman Brothers Holdings Inc. (LEH) analysts (like they have room to talk) and St. Louis Fed President William Poole were among the "experts" who implied both GSEs were on the verge of collapse without an immediate capital investment. Fannie and Freddie shares plunged to their lowest levels in more than 16 years and firms with significant mortgage holdings (investment-related and REITs) fell in lockstep. Though the Office of Federal Housing Enterprise Oversight (OFHEO) and Treasury Secretary Henry Paulson offered their best political spin by claiming the GSEs are "adequately capitalized," investors were not buying (literally) as some awaited news of a government "bailout." A lonely, optimistic voice in the crowd emerged Friday as Citigroup (as if it doesn't have its own problems) stepped forward and made the statement that "we expect cooler heads to prevail…we believe the recent sell-off in the shares of Freddie and Fannie is overdone."
The Freddie-Fannie news overshadowed virtually every other business story of the week. Staying within financials, Merrill Lynch is close to raising more capital of its own (possibly new write-downs on the horizon?) as it looks to reduce its investments in BlackRock Inc. (BLK) and Bloomberg LP. Likewise, Citi is selling its German banking unit to France's Compagnie Financiere du Credit Mutuel SA for more than $7.5 billion.
Outside of financials, Dow Chemical Co. (DOW) is acquiring Rohm and Haas Co. (ROH) for $15 billion in a cash deal, and General Motors Corp. (GM) will be handing out more pink slips (so what else is new?) as it reevaluates most of its brands. Oh yeah, earnings season kicked off last week with Alcoa Inc. (AA) beating estimates and General Electric Co. (GE) affirming its profit forecast for the year. Thomson Reuters predicts that Standard & Poor's 500 companies lost 13% in the 2nd quarter, with financials leading the slide with related earnings falling by more than 65%.
Oil prices ended a highly volatile week on a very negative note. After tumbling more than $9 a barrel in two days, crude once again soared to record levels as Iran threatened the world (or, at least, Israel) by test-launching a few missiles. After starting the week around $145, prices plunged to $136 on Tuesday before rallying again (to $147 at one point Friday).
The Dow Jones Industrial Average and the S&P 500 struggled as negative news from financials and the late week oil-price spike brought out the bears (again). The Dow even fell below 11,000 for the first time in two years before closing slightly above that level. Meanwhile, the S&P 500 hobbled into "bear" territory, as the index has reached a point that was down 20% from its October 2007 highs. As the weekend began, some investors speculated that U.S. Federal Reserve Chairman Ben S. Bernanke, Treasury Secretary Paulson and others might participate in more "round the clock" meetings over this Freddie-Fannie fiasco.
Is it time to panic yet?
Dow Jones Industrial
10 yr Treasury (Yield)
No rest for the weary. Just because the economic calendar was light last week doesn't mean the Fed officials were taking any time off. Instead, a "power-hungry" Bernanke was pushing for the central bank to get more regulatory authority over the financial markets. He believes that such a move would help ensure damage control in case of future potential failures (as we saw with Bear Stearns, and may soon see with the dynamic duo of Freddie and Fannie).
In congressional testimony, Bernanke spoke of the Fed's continued creative moves to assist in the current financial crisis (this entire mess stems from the subprime crisis); he suggested that investment firms should be able to borrow from the discount window beyond the mid-September deadline (and into 2009). Late into the week last week, the week, reports claimed that Freddie and Fannie likewise would have access to the Fed's discount window. Whether that will be part of the rumored Treasury Department bailout we mentioned remains to be seen.
Across the pond, European Central Bank President Jean-Claude Trichet implied that his policymakers stand prepared to raise rates further should threats of inflation continue to rise across Europe.
Last week, retailers reported "same-store" sales data (stores open at least a year) for June and the results were not half bad (at least, not for discounters). Wal-Mart Stores Inc. (WMT), Costco Wholesale Corp. (COST), and BJ's Wholesale Club Inc. (BJ) each reported better-than-expected sales as consumers went "crazy" with those government rebate checks (or as crazy as a $300 to $600 refund will allow).
Children's Place Retail Stores Inc. (PLCE) also reaped the benefits of the government's generosity, though traditional mall-based stores like Limited Brands Inc. (LTD) and The Gap Inc. (GPS) failed to capitalize.
After struggling through a poor June, Nordstrom Inc. (JWN) warned that its 2nd quarter results might not meet prior forecasts. Analysts have grown concerned that the rebate checks were like a tailwind that temporarily filled the sails of some of the big store chains, enabling them to navigate some of this slowdown – but that these checks will ultimately leave the store chains becalmed going forward.
On that note, Morgan Stanley (MS) reduced its earnings forecast for the entire retail sector for 2009.
Weekly Economic Calendar
Consumer Credit (05/08))
Slightly better than expected increase in credit card debt
Initial Jobless Claims (07/05/08)
Initial claims fell, though continuing claims rose
Balance of Trade (05/08)
Record exports led to best showing since March
The Week Ahead
Retail Sales (06/08)
Industrial Production (06/08))
Fed Policy Meeting Minutes
Housing Starts (06/08)
Initial Jobless Claims (07/12/08)
News and Related Story Links:
- Money Morning Financial Analysis:
Avoid the 'Resurgent' Homebuilding Sector and Go Global for Profits.
Government Sponsored Enterprises (GSE).
- Money Morning News Analysis:
Freddie Mac and Fannie Mae Rocked by Liquidity Concerns.
- The BBC:
Yahoo rejects new break-up offer.
- Money Morning News:
Dow Makes $18.8 Billion Offer for Rohm and Haas.
- Forbes/Thomson Financial News:
U.S. Treasury Working on a Rescue Plan For Fannie Mae and Freddie Mac – Report.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.