A long time ago I had always assumed that guys who rose to the top chair at big banks must be great poker players. I just figured that fellows like these were good strategic thinkers with an eye toward detail and a keen knowledge of their opponents (both internal and external) strengths and weaknesses. I imagined that one of their greatest strengths was the ability to bluff successfully. I have been disabused of this notion over the last year and a half. These guys, including Treasury Secretary Hank Paulson, are just horrible players.
If we go back to March and April of 2007 and equate things to a poker game, we essentially had Stan O'Neal, Dick Fuld, John Mack, Chuck Prince, Angelo Mozilo, Jimmy Cayne and a host of others all take turns bluffing the hell out of a good majority of the investment community. All these guys were showing cards that had them beat on the table. However, because they so confidently bluffed us with claims that losses were insignificant and everything was hedged, investors said to themselves, "Well, he does have three clubs showing, he saw me and raised me double, he must have two clubs in his hand for a flush, I'm out." However, after the third of fourth time of bluffing, investors called them and they folded. It has become common knowledge now that when any of these guys (on your player roster now playing for O'Neal is John Thain, while playing for Chuck Prince is Vikram Pandit) says they have enough capital, or things are turning the corner, they are bluffing. We therefore, call them and low and behold, they don't even have a low pair!
Lets turn to Hank Paulson, former chief of Goldman Sachs and now Treasury Secretary. He has played a huge bluff with the Fannie Mae, Freddie Mac bailout. Paulson made the dramatic move of asking for and receiving the authority to essentially nationalize Fannie and Freddie. However, after receiving such authority he, along with other Treasury officials and The White House, have repeatedly stated that they have no intention of having to actually do the deed. This move worked for a few weeks because frankly, there's just a lot of investors out there that either aren't doing their homework, or just don't get it. Both Fannie Mae and Freddie Mac are, after you adjust for accounting shenanigans like unreserved tax deferred assets (not reserving against them AND for fair value purposes, actually marking the tax deferred assets UP) and their "temporary losses" in their securities portfolios, insolvent on a GAAP basis and a "Fair Value" basis. That is a fact. It is also a fact that both companies have just a sliver of capital against a $3.6 trillion mortgage insurance book that only needs to take about 1.5% actual losses (and they are coming) to wipe out Fannie and Freddie. It's arithmetic. You can't argue that 2+2= 5.
So now here we are, after Freddie and Fannie's disastrous second quarter earnings, with Hank Paulson at the table showing not even a pair or a decent flush or straight possibility and he's still trying to bluff us. It's not working anymore. In fact it is starting to have a very detrimental effect on housing finance. Spreads on Fannie and Freddie mortgage backed securities are blowing out to record levels. Because the secondary market yield for these securities determine the rates mortgage originators charge you on a mortgage loan, this is making the already horrific housing technicals worse. These spreads are reflecting credit risk due to Paulson's bad bluff. More importantly, these spreads are moving out because everyone that invests in Freddie and Fannie MBS needs to know what the plan is for this multi-$trillion market once Treasury steps in. Questions like,
- Will they eventually stop making new Freddie and Fannie MBS (thats a good short term technical, but a real bad long term technical)?
- If they do stop, what will replace them? Will anything replace them?
This very harmful uncertainty has come about because Treasury and Congress and The White House have spent precious time bluffing and praying. We need a plan for the future of housing finance and a "Covered-Bond" photo-op with Paulson and a few bank chiefs doesn't cut it. I proposed a solution on this blog "What to do with Fannie and Freddie". Treasury's bluff has been called and its time for it to fold it's crappy hand and take charge.
Spot on post, Eric. With the market at large clearly piling on the other side of the potential nationalization trade, it's time for Hank for bail. This market sentiment reminds me of the paralysis that took over just ahead of the Iraq invasion.
Posted by: AntiLemming | August 19, 2008 at 08:31 AM