Fannie & Freddie Had A Big Fall

Market Watch Sunday July 13: In a dramatic statement released Sunday, the White House and Federal Reserve moved to give the mortgage giants the capital they need to survive the depression in the housing market and turmoil in financial markets that had left them dangling over a cliff.

Of most immediate importance, the Fed’s board of governors voted to open up its emergency discount window to Fannie and Freddie. In addition, Treasury Secretary Henry Paulson announced that he will seek Congressional authorization to by stock in the two companies and increase the government’s credit line.

At the moment, each company may borrow only $2.25 billion. In return for the capital, Paulson said that the Bush administration would ask Congress to grant the Fed a “consultative” role in the capital standards of the companies.

The housing rescue package that is nearing final approval by Congress would put in place a strong independent regulator for the companies is slowly moving through Congress. Paulson says he wants a new provision allowing the Fed to work hand-in-hand with the new agency. That would be a bitter pill for Fannie and Freddie, which have been at loggerheads with the central bank over the capital issue for years. It is not clear how Congress will react to Paulson’s request. The Treasury secretary said he has been in close contact with the Congressional leadership over the weekend, so his request will not come as a surprise to lawmakers. It would be logical to attach the lifeboat for Fannie and Freddie to the housing rescue measure.

The Senate passed its version of the legislation last week and sent it back to the House of another vote. It is expected to get to President Bush for his signature before Congress leaves town for its summer recess at the beginning of August.

The House Republican leadership vowed to put politics aside to craft legislation. Fannie and Freddie are strange hybrid companies, known as government-sponsored enterprises. They were chartered by Congress but are owned by private shareholders.For years, Wall Street has believed that the government would never allow Fannie and Freddie to default. The companies have been able to sell debt at lower prices than their competition. But the agencies have grown to mammoth size. They own or guarantee $5.2 trillion of U.S. home mortgages.

July 13 Sunday (AFP): US Treasury Secretary Henry Paulson on Sunday unveiled measures to bolster housing finance organizations Fannie Mae and Freddie Mac, stressing their key role in the US housing market.”Fannie Mae and Freddie Mac play an important role in our housing finance system, and they should continue to play this role in their current forms as shareholder-owned companies,” White House press secretary Dana Perino said in a statement.

“This evening, after working with the companies, the Federal Reserve, and other regulators, Treasury Secretary Paulson outlined a plan that we believe will help add stability during this period. President (George W.) Bush directed Secretary Paulson to immediately work with Congress to act on this plan,” she added.

“It is crucial that Congress quickly works to enact this legislation as a complete package along with the strong oversight reform legislation recently passed in the Senate,” Perino added in her statement. Troubled mortgage giant Freddie Mac is aiming to sell off three billion dollars in securities on Monday following last week’s meltdown, in a potentially decisive move to heal shattered investor confidence. The two government-chartered, shareholder-owned giants underpin some five trillion dollars in home loans, and the meltdown in their shares last week raised fears of a government bailout, or a possible worsening of the credit crunch.

July 14 (Bloomberg) — The dollar rose for the first time in four days against the euro after U.S. Treasury Secretary Henry Paulson asked Congress for the authority to buy shares of Freddie Mac and Fannie Mae . The currency also climbed against the yen after the Federal Reserve said it will offer direct loans to the two largest U.S. mortgage finance companies, easing concerns that confidence in housing and financial markets will worsen.

Comments: Should I gloat, nah that would be in poor taste. Surely I cannot be the only one in the world to see Fannie & Freddie were bankrupt before. (For those interested pls read posting “Unconvincing Selling In The US” posted Friday 11 July and “Fannie & Freddie Sat On A Wall” posted on May 8 this year. Technically speaking, Paulson is asking for permission to use American’s public money to bail out Fannie & Freddie - they have to bail them no doubt about that. All things being equal, the bailout would be another solid whack to pummel further the demise of USD. However, Fannie & Freddie seems to be the biggest “obstacle” that the market had been waiting for Treasury/Fed to do something about it. Now that they have finally, sentiment on USD and hence equity prices would swing to the positive side of things. Not all clear yet but I see some light.

The Dow Jones Index Priced In Euros

Came across this very interesting chart while surfing some financial websites. The chart is Dow Jones index but instead of being priced in USD, it was priced in Euro. This effectively reflect how the Dow looked to investors holding Euros. Some observations:

1) In the eyes of Euro holders, the Dow has lost 50% in value sonce 2002. That is a major valuation shakeout.

2) If euro holders were to be getting the funds flow like petrodollars gushing fountain, you can bet that the cross border M&A would have been very aggressive to buy US companies.

3) Still, American listed companies still look “cheap” in the eyes of euro investors. Once they perceive that the USD has finished falling, some rapid M&A activity will signal a possible bottom fishing for cash rich companies flushed in euros.

4) On the same note, the reverse can be true, i.e. American listed companies flushed with USD may find foreign companies a lot more expensive, and may be reluctant to venture abroad to grow their operations via international M&A.

5) The USD and Dow are paying big time for the excessive money supply growth plicies for the past 7-8 years, thanks largely to Greenspan. Bernanke is basically cleaning up the mess Greenspan left behind - not my favourite Fed chairman by a proverbial mile.

6) However, one final point, the chart also reveals that the Euro’s strength has been a bit over the top. If you compare the Euro vs non-USD growth economies’ currencies, the Euro has appreciated more than the latter group as well. The “expensive Euro” may have helped to deal with imported inflation, but international competitiveness has also been affected. The Eurozone could be in for a flattish period of growth, and pricing themselves out of many products and services.

7) What was most significant is that the “cheap value” now had been recorded back in early 2003 as well, where the market subsequently rebounded significantly, are we there yet? Looks mighty close.

GCC To Depeg From USD

United Arab Emirates is lobbying neighboring countries to depeg their currencies from the U.S. dollar to curb inflation.

UAE is calling on all six Gulf Cooperation Council member states to “rethink” their monetary policy amid soaring inflation in the oil-rich region. The GCC members are Saudi Arabia, Qatar, Kuwait, the United Arab Emirates, Bahrain and Oman. All of their currencies are pegged to the dollar except Kuwait, which depegged its currency, the dinar, from the dollar in May 2007 in favor of a basket of currencies.

• Below are some related commentary and opinions on GCC to depeg:
• Economist: Argues GCC should depeg or revalue vs USD but politics forms a high barrier to change. US applied political pressure against UAE de-peg earlier this year, but political winds may be shifting
• ABDPE: Although official statements from the UAE have ruled out a unilateral depeg or reval from the flagging dollar, a government study suggests GCC states should move to a trade-weighted basket of global currencies to fight inflation
• BNY: Despite the best efforts of Saudi Arabia (and the US) to support the USD peg, the pressures for change have not gone away and would certainly increase should the USD start to slide again
• Merrill Lynch: Latest US Treasury report gave tacit approval of revaluation of GCC currencies to alleviate region’s inflationary pressures. UAE, Qatar will probably move to currency basket in next few months, with their currencies appreciating 5% by yearend
• HC: UAE wants to avoid losses on USD-denominated FX reserves
• Jadwa: Revaluation of the riyal would not tackle the underlying causes of inflation but a significant revaluation (15% or more) would have a clear and immediate impact on inflation and would provide some breathing space while supply bottlenecks gradually unwind
• MS: Small step revaluations remain a risk particularly for the smaller open economies within the GCC - UAE, Qatar
• JPMorgan: Saudi Arabia, UAE unlikely to de-peg in 2008. Most inflation not ‘imported’. Revaluation may invite further speculation rather than quell it
• UBS: Bahrain, Oman and Saudi Arabia unlikely to change currency regime as they face less structural or cyclical need to do so
• Khan: Large revaluation risks loss of non-oil competitiveness; modest revaluations (2-3%) and adoption of individual currency baskets more likely
• May 2007: Kuwait switched to basket peg (70% USD); revalued 4th time on Oct 16 to stem accelerating inflation
• NBER: Fixed exchange rate regime becomes unsustainable due to unexpected increase in government spending

Peak Of Oil Demand

Media has been plagued with articles on peaking of oil supply. Let’s have a look at what some others say about the peaking of oil demand. But whats most important is with the fresh developments with CFTC, comments at the bottom.

TD: Overall, crude oil consumption growth so far in 2008 softened to a paltry 0.4%, in line with non-OPEC supply gains and well below overall total world production growth. OECD led the decline, with non-OECD demand growth to slacken further

Bespoke: Even with oil hitting record highs, China’s oil imports during May reached their second highest levels on record

Unicredit: The increase in fuel prices in India, Pakistan, Indonesia, Malaysia will slow oil consumption growth only marginally since these countries account for only roughly 5% of global demand for oil. China may follow suit after the Olympics

Lehman: Market tends to conflate legitimate reasons for demand growth with what is likely a temporary spurt in recent demand for inventory related to Olympics

CIBC: Fuel subsidies breed soaring rates of domestic fuel consumption, particularly in OPEC countries, where gasoline is 25 cents/gal in Venezuela and 50-60cents/gal in Saudi Arabia, Kuwait and Iran. No sign of plans to remove subsidies soon in any of these countries

MSNBC: China’s car ownership, at only 4% of the population, is expected to rise to 10% by 2015. The fuel-efficient Prius costs nearly twice as much in China as in the US

SG: At constant nominal GDP growth rates, oil burden would have to be US$190-200/barrel to drive oil burden index towards 1980 peak

Commonwealth Bank: Though global growth may slow down in 2008-09, economic development in emerging markets should contribute to oil demand in the long run to 2025

As per my call to short the bugget at US$139, one of the major catalyst I was looking forward to was regulatory changes to curb the seemingly unlimited position limits of many speculators. These are referred in the market place as the “London loophole”. The Commodity Futures Trading Commission (CFTC) held talks yesterday with its UK counterpart about the possibility of introducing limits on traders’ positions in London’s oil markets. The belief is that traders are exploiting London’s openess.

CFTC announced that it has created an interagency task force, which will include the Federal Reserve, to study the role of speculators and index traders in London and their trading activities. CFTC requires US exchanges to put in place limits on the size of positions taken by traders to reduce potential threat of market manipulation. The FSA has no such rule. It is hoped that a similar futures contract mirroring WTI traded on ICE Futures Europe would voluntarily impose position limits. Currently ICE does not. The wheels have begun to turn.

Equity Strategy Update

If we are looking at KLCI only, foreign funds had been net buyers since beginning of the year right up till the recent general elections.

In fact, the net inflows were on a rising trend right up till the elections. Following the surprising results, foreign funds took out around USD130m over the next couple of weeks. The other surprising fact was that that amount was almost matching the net inflows from beginning of the year right up till the election. Coincidence?

Since the election results, the biggest weekly net withdrawals by foreign funds had been the first two weeks following the results. Foreign funds had since then been continued net sellers in Malaysian stocks. In fact the last 3 weeks saw net outflow increasing again owing to oil price short squeeze.

The last week saw Tenaga lifting and sustaining the Composite index. The last couple of days were more significant in that the CI managed to stay flat while other Asian bourses were tumbling all around on oil price shock and heightened inflationary concerns, prompting many economies to increase reserve ratio requirement or hinting at raising interest rates. What has changed that caused Malaysian stocks to diverge from the rest? Well, the electricity rate hike and reduction in oil subsidy were viewed positively. The reduction in oil subsidy finally converted some funds to believe that Malaysia is in place to benefit from higher oil prices. Though all knew that Malaysia was a net oil exporter, the removal of subsidy caused a positive rerating on actually benefiting the overall economy with “seemingly better” resource allocation strategy.

Since I am of the opinion that the oil price bubble will come down sooner than later, and that being highly positive to equity markets in general. I have revised my buying level from 1,150 to 1,210-1,220. My view is that oil could very well drop back to US$105-110, in which case the KLCI should be pegged at 1,400 then.