The Elephant in the Room – Well One of Many…

By Brad Keiser

For those of you who have been to our seminars, (coming to Southern California next month) You have heard me ask about Hank Paulson and Ben Bernanke…”Are they stupid or were they lying when they said everything was OK through out all of 2007 and most of 2008?” You have seen and heard why Neil and I declare we are of the belief that there is simply “not enough money in the world to solve this problem.”

Fannie Mae’s (FNM) 8k has an interesting slide of their questionable assets in the supplement. It can be found below along with the complete 2009 Second Quarter filing. The report describes FNM’s exposure to problematic classes of mortgages on their book. That total comes to almost $1 Trillion. (that’s with a “T”) The total book of business is about $2.7 Trillion, at least 30% and more likely as high as 50% of their book is troubled. The report muddles with the actual holdings, as there are overlaps in the descriptions. The actual numbers they provide include:

• Negative Amortization Loans: $15B
• Interest Only: $196B
• Low Fico: $357B
•  LTV>90%: $265B
• Low Fico AND > 90% LTV: $25B
• Alt-A: $269B
• Sub Prime: $8B

Those numbers add up to $1.13 trillion. They are troubled for multiple reasons. For example, $25 billion are loans that have BOTH  high LTV and a FICO score less than 620. While there are varying degrees of toxicity when it comes to “toxic” assets these would be considered highly toxic.

 What might all this mean? Some trends are emerging. Based on historical private sector experience with these types of troubled loans, particulary those 30 % of Alt A/No doc and Negative Am loans that are non-owner occupied properties, one could expect that 50% of these borrowers will go into default. On the defaulted loans the losses will be conservatively about 50% of the outstanding loan balances. In other words, losses of 25% on the troubled book are reasonable assumptions. That would imply a loss over time on these loans of $275-$300B. And that does not include losses on Prime loans. And that is JUST Fannie. The Obama Administration has an estimate of $250B over four years for the full cost of cleaning up the ALL the GSE Agencies. These numbers suggest it could be double that, triple that or more.

This is ONLY Fannie…not Freddie or Ginnie or Sallie, not Citi, not BoA, not Wells Fargo, not numerous community banks who owned preferred shares in Fannie or Freddie that had their capital severly eroded when those preferred shares were wiped out last fall. How about the dwindling balance of FDIC reserves? Ladies and Gents we have a veritable herd of these elephants lingering in the room.

Gee no wonder Mr. Lockhart decided now would be a good time to step down from running Fannie, Hank Paulson is getting a tan somewhere now that he has saved Goldman Sachs(for the moment)and something tells me Uncle Ben Bernanke would not be heartbroken if he was replaced by Summers or whomever this fall and could simply go back to pontificating at Princeton.

In the interest of full disclosure I hold no position in Fannie or any of the stocks mentioned….I am long 1200 shares of Smith & Wesson.

Fannie 8k August 2009

Double click chart below to enlarge

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