While absurdity is entertaining, it seems like a bad way to run the world's largest economy. What could be more absurd than trying to cure a horrible credit bubble with still more bad credit? That is, as you'll see, exactly what is happening...
In my June 2008 issue of PSIA, titled Freddie Mac and Fannie Mae are Going to Zero, I told readers the two largest mortgage guarantors in the United States would declare bankruptcy. The numbers pointed to that one, obvious conclusion. But as was the case with my research exposing the problems at General Motors, that conclusion was unthinkable to most of Wall Street:
Today, on a combined basis, Freddie and Fannie own or guarantee 45% of all of the mortgages in the United States – $4.8 trillion worth of mortgages. But looking only at the mortgages they actually own and hold on their balance sheets, you find mortgages with a face value of $1.7 trillion. They hold these assets with only a sliver of equity, about $70 billion in "core" capital.
On a combined basis, they're leveraged by a little more than 24-to-1. Thus, a 5% loss in the value of their mortgages would wipe out 100% of the equity in each firm. Looking beyond their balance sheets to their off-balance-sheet guarantees, you see that they're actually leveraged 68-to-1, meaning a 1.4% decline in the value of their total on- and off-balance-sheet would wipe out shareholders.
As we've seen with Fannie, Freddie, Bear Stearns, Lehman, and every other failed financial institution over the past two years, absurdly high leverage ratios lead to bankruptcy. Yet, while the government has been busy policing the rest of the financial markets, it has overlooked a time bomb under its own umbrella... the Federal Housing Administration (FHA).
According to the Wall Street Journal, an undisclosed Housing and Urban Development (HUD) audit shows the FHA's cash reserves may fall below its congressionally mandated 2% of insurance liabilities by year's end.
The FHA is levered 50 to 1 – more than Bear Stearns on the eve of its crash. Its loan delinquency rate – more than 30 days past due – is over 14%, around two to three times higher than conventional mortgages. And its cash reserves have fallen by more than two-thirds in three years. The reason is reckless underwriting... From 2006 through the end of next year, the FHA's portfolio will have expanded to $1 trillion from $410 billion. Today, one quarter of all new mortgages carry an FHA guarantee, up from one in 50 in 2006. And between the FHA, the Veterans Administration, Fannie, and Freddie, taxpayers now guarantee 80% of all U.S. mortgages.
According to sources familiar with the HUD report, mortgage default rates are worsening the quickest on the most recent loans. There's no doubt the FHA will fail, costing taxpayers $100 billion or more. And the total losses from all government-guaranteed mortgages will likely exceed $1 trillion. These debts will never actually be repaid, of course – not even by my grandchildren. Instead, these debts will be "monetized" – inflated away. The resulting inflation will destroy the middle class and lower the average standard of living in America. If the government continues to insist on banana-republic financing schemes, it won't be long before we're living in one.
On the topic of failed government regulatory institutions, the latest plan from the chairman of the Federal Deposit Insurance Corp., Sheila Bair, is to completely change lending practices and credit markets as we know them... Bair proposes secured creditors, who lend money at lower interest rates in return for their loans being "secured" (or backed by assets), no longer receive any guarantee of full repayment...
"This could involve potentially limiting [secured creditors'] claims to no more than, say, 80% of their secured credits," Bair said in a speech to a banking conference in Istanbul yesterday. "This would ensure that market participants always have some skin in the game, and it would be very strong medicine indeed."
Bair's comments are among the most moronic I've ever seen. Without secured creditors, there's no way distressed companies will get the lending they need to survive this downturn. But... as long as the reign of King Hussein Obama lasts, there's no telling how crazy things will get.
Today is your last chance to sign up for the S&A FDA Report, written by Dr. George Huang, at a huge discount. Since George launched his advisory, readers have closed 17 trades with an average return of 40% and an average holding period of less than four months. His hit rate is more than 70% – unheard of in the biotech sector.
Most recently, he found a dominant medical-device firm trading at absurdly low valuations. The stock should climb at least 60% in the next few months. You've got until midnight tonight to take advantage of this generous offer. To sign up, click here...
We may be in for a short-term correction in gold... The speculators betting on more gains for the precious metal outnumber the shorts by a ratio of nearly 10 to 1, according to Commodity Futures Trading Commission data. That's up from 4 to 1 a year ago. We've asked before, when the big investors – the ETFs and hedge funds – move to sell, who will be there to buy?
Ten miles off the coast of Miami Beach last Saturday, an exceptionally fast Homeland Security boat, with four heavily armed and body-armor-clad men intercepted a new Everglades 35', center-console fishing boat. Onboard were one large dead fish, a captain, a mate, and your weary editor. (Weary from the government meddling in every aspect of his life...)
As the government's thugs pulled alongside us, one of the government's four-man team asked, "What are you guys doing out here?" Apparently, the dozen rods and reels, the bloodstained bait station, and the nature of our boat – designed solely for fishing – wasn't obvious enough. I barely contained my glib reply, "Growing tomatoes." Instead, wisely, I let the captain do all of the talking. I just sat there wondering how bad this was going to get...
What followed were several very uncomfortable minutes. They'd obviously been tracking us on their radar. And they asked us a dozen questions, trying to catch us in a lie – a lie that would have given them probable cause to search our vessel, where they might plant some drugs onboard my boat and seize it. How far out did you go? Where are you coming from? Whose boat is this? How many fish have you caught? Where are you going? Where did you get this boat?
We had done nothing wrong. We were well inside U.S. waters. All of our "papers" were in order. And yet, we were forced to answer dozens of questions shouted at us by four men armed with automatic weapons. I badly wanted to ask these thugs if they'd heard the new Everlast song Stone In My Hand.
Let me tell you my friends... sooner or later, there's going to be a terrible confrontation. And not like Ruby Ridge, either. Sooner or later, these government thugs with guns and body armor are going to pick on the wrong guy: someone who doesn't have anything to lose and who knows how to handle himself, someone who would rather die than get picked on again and again. That's how it will start. Then, the people of this country who still love freedom and cherish their liberty are going to ask themselves: Why do we put up with a government that terrorizes us, that takes half of our incomes, that props up criminal banks, and supports ghetto organizers like ACORN... Love in my heart. Stone in my hand.
New highs: Managers Fremont Bond Fund (MBDFX), Vanguard Tax Exempt (VWSTX), Coca-Cola (KO).
In the mailbag... nothing. We got a few letters over the weekend, but nothing that we actually understood very well. Sorry about that. Send us something better and we'll publish it: feedback@stansberryresearch.com.
"'But now? Fears of "deflation" have returned. Stocks don't go up every day anymore. That's a good sign, believe it or not. Remember, nothing is more dangerous than euphoria. Nothing is more valuable than pure panic.' Sorry, I was expecting you to go on to say 'War is Peace' and 'Slavery is Freedom.' Wow! You've really fully mastered 'Newspeak.' George Orwell's Big Brother would be proud. Given that and your recent propensity for Groupthink you are becoming a 'better' citizen all of the time." – Paid-up subscriber Leland Hosford
Porter comment: You lost me. Completely.
"I have had a subscription to The S&A Digest for some time now, but I have never seen the information on the small mining company that you keep offering new subscribers, which you say has the potential for 94 million ounces of Gold to be mined there, once the permits are gotten. I believe, I as a subscriber, should have access to this information. I am asking why I have not received this information, and I am requesting that you send it to me. Please send me the stock symbol for this company, as well as all the info concerning the company. I understand the mining potential to be located in the Bristol Bay area of Alaska. I will be watching my e-mail for your reply. Thank you in advance for your immediate response." – Paid-up subscriber Verdean Baumgartner
Porter comment: I'm not sure which product of ours you subscribe to because The Digest comes free with any paid subscription. But the small mining company you refer to above is a stock we provided to our S&A Resource Report readers, written by our in-house geologist, Matt Badiali. We will happily send you the information you've requested if you sign up for the Resource Report, which you can do here...
Regards,
Porter Stansberry and Sean Goldsmith
Miami, Florida, and Baltimore, Maryland
October 5, 2009