A big rally, little rally, and yesterday a pause. Is reality sinking back in and trumping euphoric optimism? The concern about the coming inflation has sparked some talk on the airwaves – how to counter inflation you ask? Drive the market up faster than the rate of inflation! Ok that was funny.
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Freddie Mac needs MORE money….
Freddie and Fannie have been perfect examples of why government socialism and nationalism fails.
Let’s break that down.
1. The first rule of business is understanding the formula of business: Revenue – Cost = Margins (which determine profit or loss)
Part of Costs include debt (debt payments), labor, materials, taxes, etc. If the formula is NOT able to produce a profit (“Margins in the Black”) there is something that NEEDS to be fixed or the company is DOOMED to fail. This first rule is ALWAYS ignored by the government because they BELIEVE they can just print money and loan it – with the ridiculous expectations that tax payers CAN pay it back.
2. The second rule is DEBT and DEBT financing. Being able to PAY for debt financing doesn’t mean you can AFFORD debt financing.
Companies don’t WANT to be in debt, but may NEED to be. However, debt accumulation should ONLY be considered if there is the ability to pay it back in full at some time in the future. A company that runs on a debt model and is unable to ever pay down the debt is doom to fail. Bailout money, Tarp, etc will put a company so far in the rears that it will never be able to recover. The government doesn’t concern itself with the first or second rule of business, simply because they don’t want the business to fail.
3. The third rule is Leverage. Leverage is good as long as it is used correctly – it allows companies to increase margins without having to (usually) incur more costs.
Just like with debt it is a tool of business and can be used effectively. However, too much leverage can collapse a business quickly and additionally expand the risk to 3rd parties. The government has encouraged and requested the expansion of leverage to the point of no return, because they don’t want anyone to fail.
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Let’s look at Freddie and Fannie again. First it is important to note that these two companies have been the most scrutinized and regulated businesses in the history of the United States, they were mandated and drafted by Congress, they are DIRECTLY monitored by Congress, Congress has complete oversight of these companies. They are really a hybrid company – since they are publicly traded, but also chartered and regulated by the government. That mix never works.
Only a decade ago were they involved in a massive accounting scandal, that if happened to an independent company (like Arthur Anderson) – charges, trials, etc. would follow – people fired or gone to jail. Instead they paid a $50 million dollar fine and executives paid a $500,000 fine. Opps – slap on the wrist.
The government also felt that home ownership should be made available to everyone, whether they could afford it or not. They believed that if people could make a payment, that meant they could afford it. Thus leverage was increased, beyond what is normally acceptable.
When the bottom fell out of the market, Freddie and Fannie needed MORE money – they received way more money (bailout from the government). Barney Frank (Chairman of the Finance Committee) believed that increasing the leverage of Freddie and Fannie will allow them to buy down more toxic paper. He was right, but failed to consider rules 1, 2, and 3. They took the companies to 70:1 leverage (INSANE LEVELS). Barney was warned that they would never recover if they were allowed to take on those levels of leverage to buy toxic assets. A few months later they fully collapsed.
But that is not the end of the story. They have now both been nationalized, instead of allowing them to fail or wind them down – since they are NOW owned completely by the government they have been allowed to continue to operated (ignoring those 3 rules) – the government now runs them and has dumped recently another $200 billion. But that will not be enough.
Today Freddie Mac has pretty much said they need MORE money and probably will never be able to recover – under the leveraged debt load.
Ravjiv Setia (fixed-income strategist at Barclay’s Capital in New York) sums it up, “Basically, there is no exit strategy. There is no way they can repay the taxpayer even when credit losses tail off.”
Congress was warned – STOP spending our money! Yet they consistently do not listen, they have their hand on the printing press – they don’t understand money NEEDS to be financed, they ignore the 3 laws of business and that is why government should stay out of business.
Bloomberg story: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=atl5eNc3rm.c
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Genentech and Roche – marriage counseling
Roche Holdings (ROG) – has won the court battle to buyout the rest of Genentech after it has raised the bid to $46.8 billion. Genentech is up in the pre-market (DNA). This is the 3rd large drug business to consolidate or merge in the last few months.
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Futures Pre-Market
The futures had been off in the pre-market but are gaining ground. It looks like the spreads are narrow and that means the market should not see too much opening pressure (for now anyway).
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Supports / Resistance
INDU 7000 ! (We are almost there – can we gain some traction to move above the 7k marker? Or do we slide back to the 6500 level. Yesterday was a pause.)
NDX 1100 – 1150 (We are above that 1100 level – but the real question is do we move higher to the 1150 – we are right in the middle.)
SPX 700 – 750 (We are above the 700 level – not much action yesterday – closing above it, even with a little slide today – means we are putting in some new supports.)
RUT 350 – 400 (RUT gave up some ground yesterday, while the others moved higher. It would be nice to see a confirmation in those supports – but the RUT needs to move higher to confirm that)
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Gold 900+ (900 is a short-term shoulder support – if it doesn’t hold it will suck down to 850 fast.)
Silver 12+
Oil 35-40 / 50+ (We are right in that 40-50 range – not really support or resistance. However, I think in the longer term it is going higher.)
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Conclusion
Freddie and Fannie are nationalized, but that doesn’t mean they are done – I have a sneaky feeling they will be with us for a long time, thus a massive sink hole for the U.S. tax payer as they will never be able to get out from under that rock. They will continue to operate – however the government would be making a serious mistake (furthering their EPIC blunder) if they allowed Freddie and Fannie to EXPAND inventory (debt), rather than trying to fix and pay down what they have. It is an ideological vs. business model problem, the government has ignored math and wants to bailout homeowners and companies – as well as keep the credit (debt) spending going. They want people to continue to buy homes they can’t afford – and that means Freddie and Fannie expanding more.
I join “Nation Write Your Congressman” http://www.nwyc.com/ - that keeps track of every vote, allows you to cast votes, detailed databases of upcoming legislation, allows you to directly send messages to Congress/Senate, etc. It is the most detailed and informative government website that I have ever used. It does cost money to join, but the information, database, and research they provide is worth it. We need to take a MORE responsible role other than just casting a vote every 4 years and hoping for the best. Otherwise more Freddie and Fannies will be coming to town and unless you raise your voice you are going to get steamrolled with “government knows best” attitudes.
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