Phil’s Favorites

Interesting article on Fannie Mae, Courtesy of James Hamilton, Professor of Economics at the University of California, San Diego, writing at the Econbrowser. Thank you James!

Fast and Easy Fannie

The Wall Street Journal had a very disturbing story on Wednesday about the “Fast and Easy” loan program of Countrywide Financial Corporation, many of whose mortgages were bought up by Fannie Mae.

WSJ reports:

Some of the problems are surfacing in a mortgage program called “Fast and Easy,” in which borrowers were asked to provide little or no documentation of their finances, according to [people with knowledge of a Federal probe] and to former Countrywide employees…. Fast and Easy borrowers aren’t required to produce pay stubs or tax forms to substantiate their claimed earnings. In many cases, Countrywide didn’t even require loan officers to verify employment, according to an October 2006 presentation by Countrywide’s consumer-lending division. That left the program vulnerable to abuse by Countrywide loan officers and outside mortgage brokers seeking loans for customers who might have been turned away if their finances had been more closely scrutinized, according to three current and former Countrywide senior executives and to several mortgage brokers who arranged loans through the program.

But here’s the part that really scared me:

Both Countrywide and Fannie Mae, the government-sponsored company that bought many of the loans, classify the loans as “prime,” meaning low-risk…. A Fannie spokesman agreed that the verification of employment wasn’t required on all loans, but added that Countrywide was expected to verify employment details on a “sampling” of loans. The Countrywide spokesman said his company fulfilled that obligation.

It’s news to me that Fannie was buying no-doc loans and calling them prime. I presume that if the WSJ article is correct as to the magnitude of fraud, Fannie would have a case in trying to recover any losses by suing Countrywide. But if Countrywide goes bankrupt, that plus a few dollars will get you a cup of coffee. Or perhaps we hope our Fannie is covered by credit default swaps that are supposed to pay if these loans default. Unfortunately, it doesn’t require much imagination to conjecture a scenario in which the counterparty to those CDS also lacks the resources to make good on their promises. So who’s holding the bag here?

Fannie Mae total book of business from their 2007 Annual Report.

From page 102 of Fannie’s 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders’ equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058). But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%.

From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can’t happen.

Market in general update from Mish, what’s Sitka doing now?

Sitka Update: Reducing Market Exposure

On March 24 I reported that the firm I represent, Sitka Pacific Capital Management, moved its allocation model from market neutral to long. Prior to that we had been fully hedged in our “Hedged Growth” strategy from August of last year until late March.

This rally, in spite of what many think, has been weak and corrective looking. Volume has not been impressive. Over the last two days we have reduced exposure and are now back to a fully hedged state. We do not like the risk reward setup here.

However, there are individual plays that seem attractive and we are still seeking those out. For example, we did not like the risk reward setup in gold at the time and sold our position at 980 on the way up, not down. Gold is much more attractive to us at these prices, so we have added partial exposure.

Like always we are striving to remain flexible. If gold or some of the energy plays we are in reverse back down, we will be out, and without notice.

Over the past few days, many have asked me about the strength of this rally and why it was occurring. The answer is that nothing moves in a straight line. The S&P dropped 20% over a 5-6 month period and the Nasdaq and other indexes even more. Some foreign markets, notably Shanghai, fell 50%. Simply put, bearish sentiment simply was too extreme. The reverse is happening now. The bottom is in calls keep getting louder and louder while the economic data is anemic.

April appeared to us to be not much more than a series of choppy, overlapping short covering rallies with air pockets below. If breadth, volume, and other indicators we are watching pick up, we are willing to change our minds. However, as of right now, we are comfortable being fully hedged in one strategy and high in cash in another.

This is not a recommendation to go short, or to take any specific action at all. Rather, I am merely stating our beliefs that risk and optimism are both too high for our tastes. Whatever is left of this rally, someone else can have it.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Glimpse into the intriguing world of penny stocks — companies claiming miracle cures, early stage mining companies, price manipulation, white collar crime. David Baines writes weekly articles on the subject, for anyone interested just go to the Vancouver Sun and search his name. As investment ideas, finding and shorting “crap” stocks seems like a potentially very profitable strategy, though you need a certain confidence to hold on to paper losses (e.g., don’t look) while the game plays out. That’s where I’ve blown it before, not holding on — e.g., brlc - got scared out on a .50 cent bounce somewhere near the top… Also, many penny stocks can’t be shorted (have come across a few biotechs I’ve wanted to short but couldn’t) But there are surely many opportunities — anyone have any favorite “crap” stocks we could add to a list and keep an eye on?

Here’s one idea, coin, being written up by Timothy Sykes

Is Dennis Gartman A Classy Pump And Dumper? You Be The Judge

Let’s see what you guys think: after I labeled him a “classy pump and dumper” in THIS post, Dennis Gartman, the man himself, was kind/brave/classy enough to post this comment under that post:

Tim,

I take rather strong exception to your comment referring to me as a “Pump and Dumper.” That is simply not true. I know of no one in the industry who puts forth his positions in the funds managed or the personal trading accounts run that are as transparent and as clear as are mine.

Rather than “pump and dump” COIN last time, I bought it and ended up losing a goodly sum of money… Indeed, that was the largest loss I’ve had this year, although I remain up 7% for the year-to-date, and was up a bit more than 22% last year, and nearly that same amount the year before that, and the year before that. Oh, and the fund I manage in Canada is up 29% from its inception last April, so clearly I have some modest abilities in the arena of investing/trading.

At any rate, I have indeed bought back into COIN; the company intrigues me. My position is small, and as is always the case, I’ll add more when my initial positions proves profitable and has been insulated from what I perceive to be random market noise.

Warm regards,
Dennis Gartman

Dennis, thanks for your reply, I never meant to offend you—it’s nothing personal, it’s just business—tracking pump and dumps is my business. When Barrons publishes a list of your stock picks and COIN a.) is the only microcrap listed, b.) the company not only has a shady past, but is directly connected/managed by people with shady pasts and c.) you admit to selling into strength just a few days after that article, strength that was directly caused by your article, something ain’t right.

There’s no doubt you’re a talented investor, but you must realize how microcrap momentum works, so I gotta call it like I see it. Not because I have a problem with stock promotion or price manipulation—I welcome the opportunity to profit from such market inefficiencies—I do it the legal way, through short selling , but because your article loses lazy/naïve investors money and makes it tougher for me to get people to trust me. No different from CNBC touting paid-for microcrap stock promotion as credible research, TheStreet.com pumping a product a microcrap company sold off a month earlier and Investopedia being dead wrong in saying shorting penny stocks/microcraps is impossible (and this all just in the past few weeks!), you’ve used a “credible media outlet” to pump (COIN was pumped up through your article) and dump (you did sell into that pump). I’m sorry, but I gotta cut through this kind of BS—I’ve already gotten rich from it, now it’s time to help others (and like a good Jew, I’ll also profit from that teaching!)

You must’ve known that by including COIN—a company in a hot sector with ZERO revenues, tons of fluffy forward looking press releases (while somehow being unable to find the time to ever put out an earnings press release), thousands of naïve investors who, not knowing any better, believe those fluffy press releases (never questioning where the earnings releases are) and some very sophisticated short sellers—in the Barrons article where all your other picks are much larger and fundamentally sound companies, the price would spike as thousands of naïve investors would buy in, thinking this is the next big thing, squeezing the shorts and inevitably creating a 50%+ drop due to the cause and effect of the runup—again, all thanks to your pumping.

So, tell me Dennis, how are you any different than stock promoters who are paid by these kinds of sketchy/99% of the time fraudulent-type companies or third-parties except that you might or might not have accepted cash—all you did was profit from selling into the strength you helped create (hence, me complimenting you for being classier than those other promoters) even if somehow you believed this company’s line of BS (trust me, I’ve been there) and now have a loss.

PS I’ve made millions profiting from both the long and short side of this kind of boom-bust pattern—which I call a Supernova—as detailed in my 6-hour instructional DVD PennyStocking…I even made some nice gains shorting COINW right at the top—even while screwing it up, as is typical for me

PPS Dennis, until you start listing all your entries/exits and position sizes, blogging like a madman and answering 500 emails/day relating to your strategies and theories, I am the most transparent person in this industry, but I welcome you to try to dethrone me.