Three Consequences of Fannie & Freddie, Budget Deficit Soars, An Oversold Commodity, and More!

by Addison Wiggin & Ian Mathias

  • Chris Mayer on the big Fannie and Freddie theme all the papers missed
  • Why “there will be more bank failures” very soon
  • Better know your derivatives… the credit default swap crisis looming on the horizon
  • Is America now more communist than China? One legendary investor says yes
  • Federal budget deficit soars to near record, CBO declares trend “unsustainable”
  • An oversold commodity due for a rebound

  “All of the newspapers have missed something,” Chris Mayer kicks off today, with Fannie and Freddie in mind. “They have all missed this bigger point: This huge trend snakes its way through financial history.

“This action by the U.S. government does not really signify any sea change in financial markets. It’s just another step in a long journey on the same path. If you read financial history, you come to appreciate this overwhelmingly powerful trend. As Freeman Tilden wrote in his 1935 book A World in Debt:

“The whole progress of the legislative attitude toward the debtor, from the Roman Republic to the present day, has been steadily, though with occasional backward lapses, toward making debt easier to incur, lightening the burden of carrying and softening the consequences of default.”

“What does it all mean and how does it all end?” asks Chris. “I suspect we are on a path similar to that of Argentina. One day, we’ll have some major Argentine-style financial crisis. We’ll have Argentine inflation and a similar loss of faith in the banking system and the currency. The government will chew away and destroy a lot of wealth in the process.”

Chris has built an impressive portfolio of tangible assets — oil, gas, metals, minerals and water rights, to name a few — for his Special Situations readers. If you ask us, that’s where you’re going to want to be when these chickens come home to roost. For the next 48 hours, you can access Chris’ latest Special Situations for half off the normal price. Take advantage, here.  

  “There will be more bank failures, and they will happen soon,” adds Dan Denning. While predicting more FDIC takeovers is far from a bold proposition, we understand the note Dan sent over today. The Fannie and Freddie rescue might cause a big wave of busted banks to wash ashore.

According to the FDIC, "while many institutions hold common or preferred shares of these two government-sponsored enterprises, a limited number of smaller institutions have holdings that are significant compared to their capital."

“Translation:” says Dan, “The other losers this weekend are those financial institutions that owned preferred equity in the GSEs.” You might recall Fannie and Freddie’s weekly stock offerings over the past few months… the GSEs issued millions of preferred shares to raise emergency capital. Regional banks all over the U.S. gobbled up these special shares.

Well… you know how this goes. Fannie and Freddie are penny stocks this morning. Their preferred shares are worth diddly. And we suspect there’s more than one already flailing bank out there staring at a big fat loss.

  The Fannie and Freddie rescue “most likely is going to cause a major disruption in the credit default swaps,” adds Chuck Butler. If you’re unfamiliar, CDSes are a way for debt holders to hedge their bets. If you buy a swap, you pay the seller a fee. In exchange for the fee, the seller pays you in the event of default. 

“First and foremost, there’s a question whether the government’s conservatorship constitutes a ‘CDS event,’ which would force the settlement of the outstanding CDS contracts. Fannie and Freddie have roughly $1.5 trillion in debt outstanding… But that’s chicken feed compared with the notional amounts of CDS contracts, which could be multiples of that $1.5 trillion!

“If the gov’t’s conservatorship does constitute a ‘CDS event,’ there won’t be enough debt to settle the contracts, which will lead to a need for cash. And that could lead to major problems, the least of them being the holders needing cash might have to sell other assets to raise the cash needed.”

Confusing? Definitely. Let’s leave it at this: The International Swaps and Derivatives Association meets today to figure this out. If the government seizure is deemed a form of default, potentially trillions of dollars will exchange hands. That sort of thing tends to get ugly.

  “America is more communist than China is right now,” grumbled Jim Rogers on CNBC yesterday. “This is outrageous. Who are these people who are taking our money and doing this and ruining America?”

“You can at least have a free market in housing and a lot of other things in China. And you can see that this is welfare for the rich. This is socialism for the rich. It’s bailing out the financiers, the banks, the Wall Streeters.

“Bank stocks around the world are going through the roof — that’s because they’ve all been bailed out. You don’t see the homeowners in Kansas going through the roof, because they’re not being bailed out.”

   Most stocks “went through the roof” in the U.S. yesterday. The Dow shot up 2.5% and the S&P 500 rose 2%, while the Nasdaq managed a 0.6% gain. Investors were clearly in a buying mood… oh, but you could just taste the trepidation. In fact, you could see it, too:

  The federal deficit will exceed $400 billion this fiscal year, says the Congressional Budget Office. The CBO admitted today what we’ve been forecasting all year: Government spending in 2008 was way more out of control than the CBO anticipated.

When the fiscal year ends this month, the CBO says $407 billion will be on the wrong side of the federal balance sheet. That’s 2½ times higher than last year’s $161 billion budget deficit. Dubya’s 2004 record deficit of $417 billion is still intact, for now…

None of this, by the way, includes the Fannie and Freddie bailout. So kiss 2009 buh-bye… the CBO projects next year’s deficit closer to $500 billion. “The federal budget is on an unsustainable path,” said a statement from the CBO. Thanks for the memo.

  Crap, how will the government pay for all this? Treasuries? Definitely. Taxes? Probably. But we’re missing something… oh, right! Global military interventionism!

The Pentagon proudly announced a $7 billion deal with the UAE today. In exchange for its petrodollars (that the U.S. likely sent there in the first place), the UAE will get a state-of-the-art missile defense system to “protect” the region from Iran.

  Incredibly, the dollar continues to rally . The dollar index is currently hovering around yesterday’s high of 79.7. If you’re a chartist, keep your eye on that 80 level… it’s been a rallying point for the greenback ever since the dollar index was introduced.

  “From its low on July 15, the U.S. dollar index has now rallied 9.8%,” notes James Turk , “which equates to an eye-popping 69% annualized rate. It is the dollar’s first meaningful bear market rally in three years, and I call it a bear market rally on purpose. This bounce has all the characteristics of a bear market rally. It is sharp and swift and happened without any change for the better in the fundamental outlook for the dollar.

“In fact, if it has changed at all, the outlook for the dollar has worsened, which is the first reason to suggest that the buck stops here, namely, that its bear market rally is ending. As the recession in the U.S. deepens, the probability of the Federal Reserve raising interest rates anytime soon has fallen. Consequently, real (i.e., inflation-adjusted) U.S. dollar interest rates remain negative.

“There are meaningful reasons to suggest that the bear market rally in the dollar stops here, and, by implication, that the correction in the precious metals stops here too.”

But gold is getting hit hard today. The spot price shed $20 at the New York open. An ounce goes for $780 as we write.

  Oil prices retreated a bit, as well. As the dollar maintains its gains, light sweet crude fell $2, to $104.

  “Wheat looks set for a move to the upside,” writes Money Morning’s Gabriel Andre. Wheat, along with other grains, was the talk of the town back in the first quarter. But in the past six months, wheat futures have been chopped in half, to about $7.50 a bushel.

“The recent decline of the wheat prices is now explained by current economic circumstances. First, the rise of the U.S. dollar is a brake for the non-U.S. importers. The other reason is that several exporting countries have just eased restrictions that they had decided a few months ago, when the food inflation and the alimentary crisis were peaking.”

But according to Gabriel, all the fundamentals for higher wheat prices are still in place. “Global demand is easily predictable. In the past few years, it has moved between 615-625 million tonnes per year.

“On the offer side, 20% of world production is put on the market, while 80% is domestically consumed. The main producers and exporters are the U.S., Canada, Australia, the EU, the ex-USSR area and Argentina.
“Last year, many farmers in the U.S. changed wheat plants to corn (at this time, producing corn was more profitable, thanks to the biofuels’ rising demand) and the weather conditions were really terrible worldwide (drought in Australia, heavy rains in Europe and Russia, a cold wave in the U.S. and Canada). The correlation between weather and prices on the wheat market is really strong.

“As a result, global stocks decreased massively during the past year. The current level of inventories is the lowest in the last 60 years in the U.S., the lowest in the last 30 years globally!”

  “Just have a comment on the state of the silver market, at least in my local market, Victoria, British Columbia,” writes a reader. “I went to cash in on the recent increase of the gold/silver ratio — to trade my gold for silver and then reverse the trade when the ratio (hopefully) drops — at the largest coin dealer in the area. To my surprise, they were sold out of silver — SOLD OUT!

“The dealer said the recent drop in silver had people lining up out the door to buy silver. They said in 30 years of business, they have never sold out of stock. Just from a purely social commentary, I would say the ‘gold rush’ is far from over.

“Alas, I went home still holding my gold — not altogether a bad thing in today’s market conditions.”

  “You write that Dan Mudd and Richard Syron,” comments a reader, “were paid $26 million for their ‘work’? at Fannie and Freddie, and stand to get a further $23 million as severance pay/bonus/etc. From one of the average Joes, this is unbelievable, a travesty and a disgrace. In this country, we pay people millions to destroy an institution and then give them a bonus? Arrogance and greed is their business, and that describes all those CEOs of the big investment banks. They destroy their businesses and then want the average Joe to pay for their losses and their golden parachutes. What a wonderful future we have waiting for us and our children. We will be serfs in our own country.”

  “Let me see if I understand this,” writes another. “The two CEOs of Fannie and Freddie run their companies right into the ground and force the government to take over their respective companies. The little guy who invests foolishly in these companies by purchasing stock looses everything, while these two incompetent idiots walk away with about $23 million apiece???!!!!! The American people should contact their respective congress people and DEMAND that if the contract specifies that they be paid that much money, that it should at least be in Zimbabwean dollars. Let those bastards have a taste of their own medicine!”

The 5: Heh. It’s $23 million possible bonuses in between the two of them, but we hear you. Those two are the poster children for contractual clauses. Geesh.

Thanks for reading,

Ian Mathias
The 5 Min. Forecast
P.S.  I.O.U.S.A. is still grabbing headlines. You can check out Paul Farrell’s thoughts on the film in his latest MarketWatch article.  

And don’t forget, I.O.U.S.A. is still playing in theaters around the country… learn which ones, here.


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