No one really believes the 'well capitalised' statement anymore

Today was a bad day for financials. So, what else is new, you ask?

WAMU came out with a statement, saying it's "well capitalised". Their stock took a 35% beating today....then rose 10% in extended trading hours after 4pm EST.

National City today said that they maintain one of the highest Tier 1 capital ratios among large banks. (Tier 1, by the way, is basically the cash value of all the company's stock put together) These comments were during the middle of the worst trading day for Nat City ever, with shares dipping down below their June 1984 levels, utlimately losing 15% on the day.

Just 2 months ago, Indymac Bancorp (which has since failed) was "well capitalised".

While the Fed didn't say Fannie Mae and Freddie Mac were 'well capitalised' last week (OFHEO did back in March), they did say they "support them at their current levels". Additionally, Freddie said their capital levels were "strong". Then, a couple days later, into the weekend (so traders couldn't immediately react) the Treasury Secretary Henry Paulson gave these two GSE's an unlimited line of credit to pay their obligations and meet reserve requirements, and sought authorisation from Congree to buy Fannie and Freddie stock, keeping it solvent.


So, the question is, who really believes whom anymore? I'm afraid that all these overstatements of "well capitalised" will affect the same event of the boy who cried wolf. Eventually, a bank will actually be well capitalised, but no one investor will believe them because they will grow accustomed to so much truth-spinning, etc.

What else is new, you ask? Well, who knows, WAMU might actually be well capitalised, but they won't benefit from their comments today. No one is going to believe any financial institution for now.

Those saying otherwise are largely naive, towing the company line and don't have the benefit of being able to think for themselves, or are looking for a sure profit backed by the taxpayer's dime.

Indymac Bancorp fails. What next?

As many of you already know, and some have followed intensely throughout the week, Indymac Bancorp, headquartered out of Pasadena, CA fail yesterday evening and was received into the arms of the FDIC. There were approximately 1 billion in uninsured deposits, held by 10,000 customers. They will get approximately half back over the weekend, through an advance dividend. The FDIC is working hard to make sure insured deposits are mediated in a timely manner so customers have access to funds immediately.

First, Bear Sterns fails. That didn't affect the day to day activities of, say pulling money out of your ATM card. Now, Indymac fails due to the asinine loans they piled on top. Interestingly enough, Indymac was starting by the same man who founded Countrywide, Angelo Mozilo...the apple doesn't fall to far from the tree now, does it?

But seriously, what next?

I'm sure you've seen the rumours that Fannie Mae and Freddie Mac are insolvent (according to a Fed president's comments a few days ago). Of course, current regulators were quick to counteract these comments, but didn't Democrat Schumer out of New York say that he was 'concerned' about Indymac potentially failing due to their extremely poor lending standards? And, he was dead on target. But, after these comments, fed regulators were quick to tell the democrat to mind his own business, and basically quit trying to warn the public ahead of time.

Ultimately, look for Fanne and Freddie to get a huge accounting standards exemption, so they don't have to fully disclose the entirety of their mortgages on their balance sheet. If this doesn't happen, they will go the way of the Mac.

Additionally, Lehman will likely fail if it doesn't get a generous dosage of Sovereign Wealth Funding...or some more fed stimulization.

After that, it could be Wachovia, if they don't clean up their absurd Option Arm portfolio.

It's going to be bigger than we think, a longer and deeper prolonged pain due to our poor, greedy, and foolish lending practices. The fall will be prolonged and hard. Then, a new set of regulators and lenders will take the reins. Would to God that they actually concern themselves with the validity of their lending standards and the livelihood of their customers.

But we can only wait and watch. What do I know? I don't have any insignia behind my name, like CPA, MBA, JD, BS, etc...

Do Fannie and Freddie need new capital or not? A strategic look at OFHEO's recent statement...

Recently, shares of Fannie Mae and Freddie Mac took severe hits. Freddie Mac took an 18% hit yesterday, and Fannie Mae a 16% decline, in New York Stock Exchange trading.

Why?

This was due to an analyst at Lehman Brothers who stated that the two mortgage giants may need to raise additinal capital to keep weathering the current credit crisis.

We then got a quick response today from the Office of Federal Housing Enterprise Oversight (OFHEO thereafter). James Lockhart, the director, went on the record as saying, "An accounting principle should not drive a capital decision by a regulator.". Essentially, he is saying that the change of an accounting rule shouldn't drive capital requirement changes at a lending institution. The Lehman analyst was basically saying that Fannie and Freddie would need to put more money in reserve to keep their loans afloat...that is, having another capital raising.

Here's a chart showing the immediate decline Notice how the shares dropped right after the Lehman analysts comments Monday morning (7/7/08), and then notice how they are struggling to increase after Lockhart's recent statement this morning, Tuesday (7/8/08).

But, isn't something odd here? Why would a government institution make direct comment on a company's stock performance?

Here's why.

Friday, June 27th, Senator Charles Schumer, a Democrat from New York, sent a letter to various federal lending institutions (amongwhich was OFHEO) stating IndyMac Bank "may have serious problems with its current loan holdings, and could face a failure if prescriptive measures are not taken quickly." See here for the full article. Here's the chart.

After the letter, regulators from the Fed came out and slammed the senator, asking him to please--shut up! See here for a good read. Basically, the belief is that Schumer, since he's on the board of the Federal Reserve and knows things not public, let the cat out of the bag in his letter. Interestingly enough, with hindsight being 20/20, Indymac Bank closed down all mortgage operations yesterday and fired more than 50% of it's workforce!

Back to Fannie and Freddie.

So, you see that there is this apparent veil of reality in government regulators ensuring the already-skittish John Q. Investor to keep his capital in these lending institutions. Indymac Bank already accused Schumer of essentially causing a bank run...however this is quickly debunked by looking at their YTD stock performance.

The OFHEO is simply trying to stave off a massive selloff of Fannie and Freddie shares. Will they be successful?

Let's take a look at the 'new accounting rule' that caused such concern with the analyst in the first place.

The 'new accounting rule' is simply a revision of the Financial Accounting Standards Board Rule #140. This revision would include eliminating the QSPE's! Why is this HUGE? For starters, what is a QSPE?

A QSPE is a 'qualified special purpose entity'. Examples of QSPE's are, you guessed it, Fannie Mae and Freddie Mac. Essentially, these companies are able to originate loans and move the assets off their balance sheets, which increases the return on equity and assets. This, in turn, makes investors like their stock due to the ROE and ROA ratios, which pushes the stock price up further and further.

Lehman analyst Bruce Harting also said in his July 7 note that the very size of the impact on Fannie and Freddie probably means they would be exempted from having to comply. "We think it's likely the GSEs will be granted an exemption because a literal interpretation of their minimum capital requirements would suggest that the GSEs would become significantly undercapitalized, and it would be very difficult for them to raise the capital needed," Harting said in his note. (A GSE is a "Government Sponsored Enterprise) Quote taken from this article.
Interesting. Here's the logic. You don't have enough resources to comply, so we won't make you comply...wow. Essentially, Harting is saying that Fannie and Freddie don't have enough reserves...but he's saying it 'without saying it'.

So, I leave you with this.

1. Will regulators continue to try to reassure the public?

2. What should you as an investor do if they do reassure the faith in the system (sell or buy)?

3. Will we see a revision of the current accounting system, but more exemptions for entities

with off balance sheet assets?

What's your action plan?

10/9/2002 Dow closes at 7286.27

When discerning amidst volumes of information, media, and general punditry we need to remember to use wisdom. Remember the past, let it help you understand the principles of the future.

As we are into our "official bear market" due to the DOW closing down 20% from it's most recent high (in the last 52 weeks), we need to remember where it closed only 6 years ago.

...7286.27...

Isn't it ironic that the DOW closed at that level on Oct. 9th 2002, then reached the most recent all time high last October, 9th 2007? Additionally, Black Monday, the largest percentage drop in the DOW's history was 10/19/87. Lastly, the 2nd and 3rd largest percentage drops in history were 10/28/29 & 10/29/29 respectively. It appears as though October is a volatile month...

The DOW would have to plummet another 36% to reach those levels.

While I'm not saying it's impossible, look at what happened next. We rode the next 6 years on a bull track, topping out in the 14's.

There's still much more of the credit crises to be address. We now are dealing with global inflation. Our currency is needing a good bolstering, but if we do that, we crush a fragile economy. Food & Energy costs are soaring, which is providing an excellent podium for political candidates this Fall. The war question is still out there...dragging on...and on...and on. The commercial real estate markets are signaling an end to the bull as vacancy rates rise, crunching the strip malls. Unemployment rates are stepping up the pace, and the government extends benefits 16 weeks for the unemployed. Acqusition & development on construction permits are virtually nonexistent. In other words, people are cutting back...and well they should.

Our environmental policies will change once enough get hurt by the increasing energy costs. People will get fed up, replacing the current electorate with a different flavor. Bankruptcies, foreclosures, and delinquincies will soar, forcing banks to run dry on reserves, some to implosion, some to receivership under the FDIC, and some to acquisition.

But, in the end, 4 years from now (I believe this will all blow over by 2012), the dust will settle, and the bear will go into hibernation.

Until then, cash is king, shorting stocks are the prince, and options are the aristocracy. The hedge will thicken as the claw trumps the horn...but only for a time.

An official bear market?

The Dow is currently trading at 11221.78 (morningish Pacific Time). Should the DOW close down 20% (and it will) or more from its peak in October (Oct 9, 2007: 14,164.53), we will see headlines tonight and tomorrow morning:

"DOW IN OFFICIAL BEAR MARKET"

"Dow Jones Industrial Average confirms Bears over Bulls"

or whatnot...

My question is this. Why does a -20% decrease from a previous high equal a bear market? I don't think you'll see any convinving arguments on why it should rather be -10% or -25% or maybe -16.645%???

Look for the DOW to go down to the mid-10's and even further.

The point here is, folks, not to allow fear tactics to mess with your investor mindset. If they are, take a break before you decide to make any type of trade!