Saturday, February 28, 2009

Warren Buffett's 2008 Letter to Shareholders

“By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.”

Berkshire 2008

Wednesday, February 25, 2009

John Paulson: Distressed Opportunities

Bloomberg News:

Distressed assets offer the best investment opportunities this year as the global recession deepens, billionaire hedge-fund manager John Paulson said.

“The decline in the market has created a very good buying opportunity,” Paulson, 53, whose New York-based Paulson & Co. oversees about $30 billion, said in a speech at a hedge-fund seminar hosted by Societe Generale and Lyxor Asset Management in Tokyo today. “Distressed opportunity in the U.S. is shaping up to be the best opportunity in a lifetime.”

Paulson said he’s focused on assets such as mortgages and debt from bankrupt companies, while in the equities markets he cited the utilities, consumer staples and pharmaceutical industries. Financial stocks remain risky, Paulson said.

In the 15 years since starting its first funds, Paulson & Co.’s one down year was 1998. All his funds were profitable in 2008, with the flagship fund returning about 38 percent, compared with a loss of 19 percent for hedge funds worldwide on average. The 2008 returns came after his funds made more than $3 billion for the firm in 2007 by anticipating the collapse of the U.S. housing market and subprime mortgages.

Investors are chasing distressed assets after more than $1.1 trillion in losses at financial firms globally and frozen credit markets helped drag the U.S., Europe and Japan into their first simultaneous recessions since World War II.

Deep Recession

“In 2009, we expect this recession is going to be deeper and longer than consensus estimates,” Paulson said. “We don’t think we’re through the banking crisis yet. We think that in many cases, losses the banks will experience will exceed their common equities.”

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices, and participate substantially in profits from money invested. Managers typically charge fees equal to 2 percent of client assets and 20 percent of investment profits.

“We’re bearish on the economy, but very bullish on opportunities in front of us,” Paulson said.

Tuesday, February 24, 2009

Merger Trainwrecks

It turns out that the Zell-Blackstone deal, as well as the Blackstone IPO, marked the exact top of their respective markets:

As a general rule, mega M&A deals always tend to mark the top of a market. We saw this in the 1980s with Merger Mania, culminating in the historic $30 billion RJR Nabisco LBO – right in front of the early 1990s recession.

We saw it in early 2000, with the $164 billion AOL-Time Warner deal, one of the greatest value-destroying transactions of all time. The merger agreement was filed in February of 2000, the market's apex. By 2002, the value of AOL was written down by $100 billion.

And, of course, the financials: MBNA and Bank of America in 2006; Bank of New York and Mellon in summer of 2007; and Bank of America buying Countrywide Financial in early 2008, to name a few.

However, the worst may be RBS and Fortis' colossal $100 billion acquisition of ABN AMRO in October of 2007 – again the exact top of the market. Fortis is now defunct and RBS is being propped up by the British government.

By contrast, heavy bankruptcies are a positive sign. And sharply-reduced capacity and inventories, especially when they have been depressed for long periods of time and demand appears to be improving, are signs of a market bottom.

This is probably where agriculture markets are right now. It continues to appear that agriculture may well enter a bull market over the next few years.

Saturday, February 21, 2009

Agriculture Crisis

It looks as if agriculture futures might be in for a ride sooner than I had expected:

Talk about an absolutely killer case of stagflation.

MENDOTA, Calif. — The country’s biggest agricultural engine, California’s sprawling Central Valley, is being battered by the recession like farmland most everywhere. But in an unlucky strike of nature, the downturn is being deepened by a severe drought that threatens to drive up joblessness, increase food prices and cripple farms and towns.

Across the valley, towns are already seeing some of the worst unemployment in the country, with rates three and four times the national average, as well as reported increases in all manner of social ills: drug use, excessive drinking and rises in hunger and domestic violence.

With fewer checks to cash, even check-cashing businesses have failed, as have thrift stores, ice cream parlors and hardware shops. The state has put the 2008 drought losses at more than $300 million, and economists predict that this year’s losses could swell past $2 billion, with as many as 80,000 jobs lost.

“People are saying, ‘Are you a third world country?’ ” said Robert Silva, the mayor of Mendota, which has a 35 percent unemployment rate, up from the more typical seasonal average of about 20 percent. “My community is dying on the vine.”

Even as rains have washed across some of the state this month, greening some arid rangeland, agriculture officials say the lack of rain and the prospect of minimal state and federal water supplies have already led many farmers to fallow fields and retreat into survival mode with low-maintenance and low-labor crops.

Last year, during the second year of the drought, more than 100,000 acres of the 4.7 million in the valley were left unplanted, and experts predict that number could soar to nearly 850,000 acres this year.

All of which could mean shorter supplies and higher prices in produce aisles — California is the nation’s biggest producer of tomatoes, almonds, avocados, grapes, artichokes, onions, lettuce, olives and dozens of other crops — and increased desperation for people like Agustin Martinez, a 20-year veteran of the fields who generally makes $8 an hour picking fruit and pruning.

“If I don’t have work, I don’t live,” said Mr. Martinez, a 39-year-old father of three who was waiting in a food line in Selma, southeast of Fresno. “And all the work is gone.”

In Mendota, the self-described cantaloupe center of the world, a walk through town reveals young men in cowboy hats loitering, awaiting the vans that take workers to the fields. None arrive.

The city’s main drag has a few quiet businesses — a boxing gym, a liquor store — and tellingly, two busy pool halls. The owner of one hall, Joseph R. Riofrio, said that his family had also long owned a grocery and check-cashing business in town, but that he had just converted to renting movies, figuring that people would rather stay at home in hard times.

“We’re not going to give up,” Mr. Riofrio said. “But people are doing bad.”

Just down the highway in Firebaugh, José A. Ramírez, the city manager, said a half-dozen businesses in its commercial core had closed, decimating the tax base and leaving him to “tell the Little League they’d have to paint their own lines” on the local diamond.

The situation is particularly acute in towns along the valley’s western side, where farmers learned on Friday that federal officials anticipate a “zero allocation” of water from the Central Valley Project, the huge New Deal system of canals and reservoirs that irrigates three million acres of farmland. If the estimate holds and springtime remains dry, it would be first time ever that farmers faced a season-long cutoff from federal waters.

“Farmers are very resilient, we make things happen, but we’ve never had a zero allocation,” said Stephen Patricio, president of Westside Produce, a melon handler and harvester. “And I might not be very good at math, but zero means zero.”

While California has suffered severe dry spells before, including a three-year stint ending in 1977 and a five-year drought in the late ’80s and early ’90s, the ill effects now are compounded by the recession and other factors.

Federal, state and local officials paint a grim picture of a system taxed as it has never been before by a growing population, environmental concerns and a labyrinth of water supply contracts and agreements, some dating to the early 20th century. In addition to the federal water supplies, farmers can irrigate with water provided by the state authorities, drawn from wells and bought or transferred from other farmers. Such water may not always be the best quality, said Mark Borba, a fourth-generation farmer in Huron, Calif.

“But it’s wet,” he said.

Richard Howitt, the chairman of the agricultural and resource economics department at the University of California, Davis, estimates that 60,000 to 80,000 jobs could be lost — including in ancillary businesses — and that as much as $2.2 billion in crop and other losses could be caused by restrictions on water and the drought, which he called “hydrologically as bad as 1977 and economically as bad as 1991.”

“You’re talking about field workers, processing handlers, people packing melons, trucking hay, sprayers, people selling tractors, people selling lunches to people selling tractors,” Mr. Howitt said. “And in some of these small west-side towns, it’s going to hit the people who are least able to adapt to it.”

One of the hardest hit areas is the farmland served by the Westlands Water District, which receives water exclusively from the Central Valley Project and distributes it to 600,000 acres in Fresno and Kings Counties. Sarah Woolf, a spokeswoman for the district, said that her 700 members expected to leave 300,000 to 400,000 acres fallow and that some might not come back to farm at all.

“Everyone’s trying to go down fighting,” Ms. Woolf said. “But there will be significant companies that will go out of business, as well as families that have been farming for generations, if it doesn’t get better.”

The outlook for things getting better quickly is dim, despite forecasts of rain this week. Last month, California officials estimated the snowpack in the Sierra, a primary source of water for the state when it melts in the spring, at 61 percent of normal. On Friday, the State Department of Water Resources said it would deliver just 15 percent of its promised contracts, a level it was able to maintain only because of the recent spate of rain. “It’s pathetic,” said Lester A. Snow, the department’s director.

Lynette Wirth, a spokeswoman for the United States Bureau of Reclamation, said water levels in all federally managed reservoirs in California were well below normal, with “abysmal” carryover from the previous year.

“There’s been no meaningful precipitation since last March,” Ms. Wirth said.

Farmers, of course, are also dealing with issues unrelated to rain, including tight credit from banks and recent court decisions meant to protect fish that have limited the transfer of water through the Sacramento-San Joaquin Delta, which feeds snowmelt to farmbound canals. Many farmers refer to a “man-made drought” caused by restrictions.

At the same time, environmental groups say they also fear a range of potential problems, including depletion of the valley aquifer from well pumping, possible dust-bowl conditions in areas of large patches of fallow ground and concern about salmon and other species. “It’s a tough year for the environment, and people,” said Doug Obegi, a lawyer with the Natural Resources Defense Council.

Tuesday, February 17, 2009

Soros on Oil and Agriculture

From Bloomberg News:

George Soros’ $21 billion fund returned 8% last year, which is incredible not only in light of the global crisis, but also given his fund’s size. As you can see, Soros is now betting big on oil and agriculture, outside of the United States.


Billionaire investor George Soros’s hedge-fund firm bought more shares of Petroleo Brasileiro SA and Potash Corp. of Saskatchewan Inc. in the fourth quarter, almost doubling its holdings.

Soros Fund Management LLC bought 16 million shares of the Petrobras’ U.S. traded shares, bringing its stake to 1.45 percent, according to a filing yesterday with the U.S. Securities and Exchange Commission. The New York-based firm increased its holdings in Potash by 2.6 million shares to 2 percent in the fourth quarter. Petrobras and Potash are now the firm’s two biggest reported U.S. stocks.

“As long as you see through the current crisis there are a few compelling reasons to buy,” Hernan Ladeuix, the head of oil and gas research at CLSA Ltd. in Singapore, said in an e-mail. “Oil prices should go up, probably strongly in coming years. Petrobras is the only large international company where you can have confidence that production can grow 5 percent per annum.”

The purchases made Soros the second-biggest shareholder in the U.S.-traded shares of Petrobras, Brazil’s state-controlled oil company. Petrobras preferred shares fell 5.4 percent in Sao Paulo yesterday, the most since Jan. 12, driven by a drop in oil prices to below $35 a barrel.

Potash, the biggest maker of crop nutrients, also fell by the most since Jan. 12, declining 7.4 percent yesterday. Soros Fund is the eighth-biggest holder in shares of the Saskatoon, Saskatchewan-based company.

Best Buy, Wal-Mart

Soros Fund added 9 million shares of Best Buy Co., bringing its stake to 2.3 percent of the electronics retailer. The firm also started a new position in Desarrolladora Homex SA de C.V., the Mexican homebuilder, bringing its holdings to 4.9 percent of U.S.-traded shares, according to data compiled by Bloomberg. The firm bought 5 million shares of R.R. Donnelley & Sons Co., North America’s largest printer, representing a 2.4 percent stake.

Soros’s hedge-fund firm sold 3 million shares of Wal-Mart Inc., bringing its stake in the discount retailer to 0.01 percent. The firm also sold all of its 2 million shares in Research In Motion Ltd., the maker of the Blackberry phone.

Money managers who oversee more than $100 million of equities or more must file, within 45 days of the end of each quarter, a Form 13F with the SEC that lists their U.S. exchange- traded stocks, options and convertible bonds. The filings don’t show non-U.S. securities or how much cash the firms hold.

Soros’s firm oversees $21 billion. Its Quantum Endowment Fund returned 8 percent last year. That compared with an average loss of 18 percent by hedge funds, according to data compiled by Hedge Fund Research Inc. of Chicago.

Monday, February 16, 2009

Michael Reyen: Are You Bullish on The Bear?

Recently, I heard a commentator on CNBC say that he is bullish about Russia, which he claimed to be one of the few countries poised for positive growth in 2009. As a member of one of the ‘BRIC’ countries, Russia has experienced an economic resurgence within the past decade. But is the specter of positive growth enough? There are several alarming trends that demand attention when considering an investment within Russia.

1.) Falling oil prices pose a serious risk to Russia’s ability to balance its budget, prop up the ruble, and maintain complacency among the people. Russia was able to build up a cushion of cash to guard against falling oil prices, estimated in October of 2008 to be the third largest in the world.[1] However, as the economic crisis intensified, Russia has burned through more than 30% of its currency reserves within the past six months while the ruble has tumbled in value by more than a third.[2] Additionally, inflation stands at 13% a year.[3] Although Russia is better poised to resist a repeat of the 1998 default with $388 billion in cash remaining, a defense of the ruble at the promised 41 ruble to euro/dollar basket of currencies may prove unsustainable, with the ultimate devaluation coming at the expense of confidence in the government and its ability to manage the economy.[4]

2.) Government corruption and general disregard of the rule of law are serious problems within Russia. The ruling party of former members of the KGB and state security services, collectively known as siloviki, or hard men, is strategically placed to accelerate the transfer of wealth and assets from the private sector to their control. The nationalization of successful private companies within Russia is not a new phenomenon, with the most glaring example being the nationalization of the petroleum company Yukos and the imprisonment of its owner Mikhail Khodorkovsky. However, the current economic crisis provides a perfect opportunity for the intensification of this type of nationalization under the guise of government aid to distressed firms. These actions could result in the emergence of a “corporatist state” within Russia, consisting of a “highly monopolistic system, based on a peculiar state-private partnership in which the profits are privatised by Kremlin friends and debts are nationalised.”[5]

Unfortunately, the courts offer little recourse for private investors. The Russian legal system is ineffective and fails to provide adequate protection over property rights, which is a pre-requisite for private investment. Judges serve at the mercy of the President and the ruling siloviki. Corruption also permeates the judicial system and society as a whole. Openly acknowledged as a part of doing business in Russia, the country received a 2.1 out of 10 rating on the corruption index (with 10 being a low rate of corruption) while the corruption market is valued at $300 billion or 20% of GDP.[6] Many large Russian companies seek justice in London and the European Court of Human Rights is flooded with Russian cases.[7] Apart from the ineffectiveness of the legal system and the prevalence of corruption, it is also dangerous to be a high profile legal operator within Russia.

3.) Russia has recently seen a rise in ultra-nationalism that has undercurrents of neo-fascism and xenophobia. The most glaring example of the danger of this ultra-nationalism is the recent murder of prominent human rights lawyer Stanislav Markelov. Mr. Markelov was gunned down in broad daylight in central Moscow along with a freelance journalist working for Novaya Gazeta, a Russian newspaper highly critical of the government. Speculation is that he was gunned down by ultra-nationalists for announcing that he would fight against the release of a Russian tank commander who was imprisoned for murdering an 18 year old Chechen woman. The journalist is the fourth Novaya Gazeta reporter to be murdered or die under mysterious circumstances since 2000.[8]

The rise in ultra-nationalism is due in part to the influx of immigrants during Russia’s decade of prosperity, with the number of migrant workers estimated at over 10 million – making Russia second to only the U.S. in immigrant population.[9] These migrants, primarily Muslim and hailing from the former Soviet Republics of Central Asia, live in squalid conditions and endure both attacks from ultra-nationalists (667 attacks and 86 murders motivated by racism last year) and police harassment.[10] Although the migrants are crucial to Russia’s economy and dwindling native workforce (Russia’s population of 142 million is decreasing by 700,000 a year),[11] the economic crisis is likely to exacerbate their hardship while increasing the frequency of attacks against them as the general populace begins to feel economically desperate and resentful of these low-wage workers. Unfortunately, the Russian government’s recent rhetoric has fanned the flames of ultra-nationalism.

4.) Aside from nationalistic rhetoric, the Russian government also uses the economy to further its political goals, specifically its power within the international energy markets. President Putin is highly involved within the country’s energy industry, and has been active in using politics to prevent Central Asia from building a pipeline to Europe that bypasses Russian territory.[12] These actions, involving Russia’s most attractive industry, are likely to come at the expense of private business. The most recent example is the government’s shutdown of a natural gas pipeline to Ukraine that distributes heating fuel to homes throughout Europe. For three cold weeks much of Southeastern Europe was without heat as Russia renegotiated natural gas contracts with Ukraine. Although it superficially involved natural gas pricing, the undertones of this disagreement are Ukraine’s overtures to the West, contemplation of NATO membership, and weapons sales to Georgia.[13]

The Ukrainian episode along with the war in Georgia is part of a larger pattern of increasingly frosty relations with the West. Other concerns include Russia’s recent arms sales to anti-American governments such as Venezuela and Iran, and the use of the promise of aid and loans to Kyrgyzstan as enticement to force the closure of a U.S. airbase crucial to the mission in Afghanistan.[14] Although the base closure is not an explicit condition of the $2.5 billion in Russian aid to Kyrgyzstan, it is suspicious that the Kyrgyzstan parliament is delaying the vote on whether to expel U.S. troops until after it receives the $450 million down payment from Russia.[15]

It is not a foregone conclusion that any of these trends will hurt GDP growth or hinder returns on investments in Russia (the same cannot be said for the global economic downturn). However, these trends do indicate that any investment in Russia should be carefully considered and an appropriate risk premium factored into any expected return.

Michael Reyen is a former bank auditor and graduate of Colgate University. He is currently pursuing his law degree and Masters in Economics at the University at Buffalo.

[1] The anti-West: An Axis in Need of Oiling, The Economist, Oct. 26, 2008, at 72.

[2] Down in the Dumps: The rouble, a symbol of the Kremlin’s power, is looking sickly, Finance & Economics, Feb. 5th 2009, available at

[3] Id.

[4] Id.

[5] Russia: The Long Arm of the State, The Special Report, Nov. 27, 2008, available at

[6] Russia: Grease My Palm, The Special Report, Nov. 27, 2008, available at

[7] Russia: A Matter of Judgment, The Special Report, Nov. 27, 2008, available at

[8] Michael Schwirtz, Leading Russian Rights Lawyer Shot to Death in Moscow, Along With a Journalist, New York Times, Jan. 19, 2009.

[9] Michael Schwirtz, For Russia’s Migrants, Economic Despair Douses Flickers of Hope, New York Times, Feb. 10, 2009, at A11.

[10] Russia: The Incredible Shrinking People, The Special Report, Nov. 27, 2008, available at

[11] Id.

[12] Andrew E. Kramer, Russia and Ukraine Sign Agreement on Gas, New York Times, Jan. 20, 2009, at A11.

[13] Id.

[14] The anti-West: An Axis in Need of Oiling, The Economist, Oct. 26, 2008, at 71; Associated Press, Krygyzstan: Vote to Close U.S. Base Is Delayed, New York Times, Feb. 10, 2009, at A11.

[15] Id.

Sunday, February 15, 2009

Buffett on Hyperinflation

As you can see, Warren Buffett has been loading up on bonds:

"Buffett agreed to buy a combined $750 million in debt from wallboard manufacturer USG Corp., motorcycle-maker Harley- Davidson Inc. and Sealed Air Corp., the maker of Bubble Wrap shipping products, in the past three months paying between 10 and 15 percent.

"Buffett also agreed in September and October to spend $8 billion on preferred shares of General Electric Co. and Goldman Sachs Group Inc. that pay 10 percent annual interest. This month, he agreed to buy convertible notes from Swiss Reinsurance Co. worth 3 billion Swiss francs ($2.6 billion) that pay 12 percent annually."

While Buffett
’s bond investments might be mandated because he is using insurance float, it stands to reason that if he was overly concerned about very high rates of inflation, he would not be doing most of these transactions.

If Buffett was concerned about high inflation or a deteriorating dollar, he would simply do what he did before: forget about yield and invest in foreign currencies. For example, he could simply buy yen forwards or yen bonds if he thought the U.S. currency faced imminent destruction.

Granted, Buffett’s recent Swiss Re position has this dollar-hedge effect. But if Buffett expected hyperinflation, he would be making very different investments. He would be investing in hard assets or securities related to them.

With high domestic inflation, anything interest-bearing or financial is rat poison – yet Buffett has been investing heavily in dollar-based, fixed-income securities. Evidently he isn’t overly concerned about high inflation.

Friday, February 13, 2009

CDO Hell

Here is a chronology of the CDO meltdown, laying bare what true junk ABS-CDOs actually were. Yet, with over 76% of these instruments that were issued at the market's peak currently in default, it stands to reason that we're pretty close to being done with this, or at least that the most intense phase of the crisis is behind us.

From the Financial Times:

Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.

The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.

So-called CDOs of ABS caused huge losses to banks such as Merrill Lynch, UBS and Citigroup, which held large amounts of the supposedly safest, top-rated chunks of them. They have since been damned by bodies such as the Bank for International Settlements as being too complex to risk manage effectively.

CDOs of ABS were used increasingly at the peak of the credit bubble to keep the securitisation machine moving by recycling hard to sell bits of subprime mortgage bonds and other risky tranches into new structures with top-notch credit ratings.

However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Morgan Stanley.

The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.

By their records, the first three years of the market saw less than 100 deals sold per year and less than 10 per cent of those have defaulted. The number of deals done rose to 133 in 2005, less than 20 per cent of which defaulted, and 89 in just the first half of 2006, about one-third of which have defaulted.

However, the real peak of the market saw 147 deals done in the second half of 2006 and 172 done in the first half of 2007 – of which 68 per cent and 76.2 per cent, respectively, have now defaulted.

The way these CDOs have performed has especially hurt the new wave of specialist credit hedge funds, which sprang up in recent years and became heavily dependent from creating and managing such deals. They were drawn to such business by a belief in the sustainability and predictability of the fees it would generate.

However, about one-third of the CDOs of ABS that have defaulted, or almost $105bn worth, have been or are being liquidated – often ­leading to losses for investors and putting further pressure on market prices of the bits of mortgage bonds and other CDOs they are selling.

Wednesday, February 11, 2009

Milton Friedman on Inflation

Given that inflation has come on the radar lately, it is no shock that many armchair economists have come out of the woodwork, making all types of nonsense claims. And given that inflation is a controversial issue among different schools of economics, here is one of the best series that I've seen, with Milton Friedman explaining inflation and how to cure it.

Tuesday, February 10, 2009

Milton Friedman: The Purpose of the Federal Reserve

By Friedman's standard, and what we are seeing in the economy, it looks as if the Federal Reserve has pursued exactly the right approach. The idea of not supporting banks and reigning in the money supply is outrageously foolish at this point.

Government-Sponsored Trainwrecks

Here are the chilling statistics on Fannie and Freddie, the housing market, and what the U.S. government is on the hook for.

Bloomberg News:

Fannie Mae and Freddie Mac, the mortgage-finance companies seized by regulators, may need more than the $200 billion in funding pledged by the U.S. government if the housing market continues to deteriorate, Federal Housing Finance Agency Director James Lockhart said.

The companies’ needs will depend largely on the direction of home prices, Lockhart said in an interview in Las Vegas yesterday. His comments followed statements from Fannie Mae in November and Freddie Mac Chairman John Koskinen last week that the government’s funding commitment through 2009 may fall short of what the companies need to make good on their obligations.

“When we sized the amount in September, we obviously looked at stress tests and what was happening in the marketplace,” Lockhart said. “There’s been some significant events since then that weren’t in our forecast.”

The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth, according to a Feb. 3 report from Following a record boom, home prices are down 25 percent on average since mid-2006 amid a tightening of lending standards and an economic recession, the S&P/Case-Shiller Composite 20-city price index shows.

Freddie Mac and Fannie Mae are the largest U.S. mortgage- finance companies, owning or guaranteeing $5.2 trillion of the $12 trillion home-loan market. The government seized control of Fannie Mae and Freddie Mac after their losses threatened to further disrupt the housing market, and pledged to invest as much as $100 billion into each company as needed if the value of their assets drops below the amount they owe on obligations.

A ‘Hard Look’

Fannie Mae said in a November regulatory filing that “this commitment may not be sufficient to keep us in solvent condition or from being placed into receivership.” Freddie Mac is taking a “hard look” at whether it will need more than $100 billion, Koskinen said last week.

“It’s going to be a close question,” Koskinen said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff.”

McLean, Virginia-based Freddie Mac has taken $13.8 billion in federal aid and said it will need as much as $35 billion more by the end of this month. Washington-based Fannie Mae said it may tap as much as $16 billion in funding.

Lockhart, who was in Las Vegas yesterday to speak before the American Securitization Forum’s annual conference, said Fannie Mae and Freddie Mac’s most recent requests for aid, which were larger than some expected, were driven by temporary market disruptions that may not translate into permanent losses.

“There were some temporary imbalances that made their numbers pretty dramatic,” he said.

Government Demands

Federal officials are now leaning on the government- sponsored enterprises to help stabilize the housing market. House Financial Services Committee Chairman Barney Frank said last week that the companies will be used “very aggressively” to help reduce record foreclosures.

Lockhart said Fannie Mae and Freddie Mac aren’t expected to take a loss “under any program” that requires their involvement. “We would expect them to be writing business that’s profitable at this point, not a large profit,” he said yesterday. “But we would not expect them to be writing business at a loss under any program.”

The Treasury, not the companies, would bear the cost under proposals to use the companies to drive down mortgage rates to about 4.5 percent, Lockhart said. That proposal was under consideration as part of a comprehensive housing-recovery plan being developed by the Treasury.

‘A Hot Idea’

“That was a hot idea for a while: It’s cooled off,” Lockhart said. “But Fannie and Freddie wouldn’t be asked to eat the difference. If it happened, that would be the U.S. Treasury.”

Fannie Mae and Freddie Mac may also be used to provide direct financing to single-family and multifamily residential mortgage lenders, Lockhart said. Currently Fannie Mae and Freddie Mac provide financing by either buying loans from lenders or helping them package the debt as bonds for sale to investors, thus freeing up cash to make more mortgages.

The FHFA is reviewing whether the companies’ congressional charters, which generally prohibit lending directly to the public, would restrict expanding into so-called warehouse financing.

Credit Standards

Mortgage bankers and other companies that have seen their sources of credit dry up in the past year have been pushing for the change, according to Lockhart.

“The problem is that unfortunately bankers have tightened their credit standards and withdrawn from some markets,” Lockhart said. “And as interest rates fall, if we have relatively large refinancings, we’re going to need to have mortgage bankers be able to provide mortgages in the interim before they sell them to Fannie and Freddie.”

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This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.