Fannie Mae's Debt Issue & Credit Yield Spreads

Amid speculation that Fannie Mae doesn't have enough capital to weather the continuing credit crisis, it has gone ahead and issued $3 billion in new debt. What's interesting about this, however, is the yield (cost) at which it was issued. The new debt will yield 3.25% - a full 74 basis points above the equivalent U.S. Treasuries. Given that Fannie Mae, theoretically, has the backing of the U.S. government and, consequently, should benefit from essentially risk-free cost of capital, this suggests the investing community feels otherwise about its credit worthiness.

With all the talk about the ratings agencies and the validity of those ratings, I suppose it's not all that surprising to see investors making their own determinations about the credit risk associated with a particular issue. Moreover, when you think about it, shouldn't the market as a whole be better qualified to determine the risk associated with a particular security than a single ratings agency?

The capital markets serve as a pricing mechanism. The collective buying and selling of millions of investors every day works to determine the value that we, on average, associate to a particular security. Why, then, should we not use the power of the same distributed intelligence to ascertain the credit risk associated with a debt issue? To be fair, the markets already do this - using the ratings agencies as a sort of starting-point for their evaluation. My question, I suppose, is whether or not we actually need that starting-point.

What an Ugly June that was!

It's July 1st and the headlines are pretty much dominated by news of how badly the second quarter closed. From the horrible IPO market performance, to the worst June recorded for the Dow Jones Industrial Average since 1930; that's right, we're talking about numbers we haven't seen since the great depression. From stocks to bonds, everyone is losing money. Well... not everyone.

Energy is the sole sector that's making money. Mining too, but the fact that that's spurred-on by coal mining predominantly, let's just call it energy. I suppose that that's not too surprising since everyone seems to agree that the rising energy costs, along with the weaker dollar, are responsible for the slowing economy. The question is, where do we go from here.

Banks want us to believe that we're approaching (or have hit) a bottom and that things will turn around soon. Brokers and traders are beginning to encourage people to get into the market to take advantage of the declines and prepare to reap the profits that will come from the market's climb. Personally, I believe that this is still quite premature. The credit crisis is widely seen as having caused the initial turmoil and from Buffett to Greenspan, the consensus is that we've yet to see the worst as far as the reported write-downs are concerned. Furthermore, the housing market has not yet recovered. Sure, the media is shining a bright spotlight on the nice markets in Florida and California that are seeing moderate recoveries, but this is likely more the result of foreigners entering the real estate market to take advantage of some deep discounts than it is a sign of a recover in the domestic market. The reality is that the U.S. is still slowing and that will have a domino affect on the rest of the world that is only beginning to show.

Unfortunately, the ugly June and Q2 is just the tip of the iceberg; this is a sign of what the near future holds and not a marker for the bottom that many would like us believe we've just hit. If you're looking for a silver lining, then consider this: wealth is not created or destroyed on the whole. If someone is loosing money, then someone else is making money. With so many loosing money, that should only mean that there are a whole lot more opportunities to cash-in. Happy hunting!

Banks need to shed the fat before the next lending feast can begin

Banks have been working diligently to rid themselves of the lending commitments that  helped to take down Bear Stearns. It's not only the mortgage-backed securities and CDOs that everyone's been talking about. Low-rated, high-risk, debt sitting on the balance sheets of many of the top banks is holding back any new motivation for new lending. It's gotten so bad that banks are willingly taking a loss on these loans just to get themselves clear of the whole mess.

From Citibank to Goldman to Deutsche Bank, no one is exempt. Banks are not only selling off loans with junk ratings at almost half-price, but are offering below-cost financing terms to anyone who will buy them. To put that into perspective, that's like someone selling you their home for less than what it's worth (on paper) and lending you the money to buy it at interest rates lower than what you could get elsewhere. Sure, if someone wants to get rid of something that badly, then it can't be all-good, but rest assured that some of these risk-loving buyers are going to win big when things finally do settle.

Cut your losses. It's a saying that every investor knows (or should know). Banks are well known for their ability to make money in any market and their ability to weather almost anything (obviously with some exceptional exceptions). They do so by knowing when to get out of a bad situation. There's a lesson in there, I'm sure...