Friday, August 10, 2007

Fannie Mae -- A Pictures Tells . . .

Why would the price of the company loaded with more home mortgages than any institution in the world be moving higher over the last month when it seems the US real estate market is in the process of vaporizing?

The chart at the right is of Fannie Mae, the quasi-government home mortgage company and largest holder of US home mortgages in the world. For you technicians, you see a classic divergence over the last month with Fannie Mae - FNM, moving higher and the SP 500 moving lower.

Surely the chart must be wrong. Why would FNM be moving higher at a time when many stocks with no connection to real estate at all are falling?

The answer is that there is not a problem with the "prime" mortgage business in the US, so FNM's loan portfolio, which averages about 80% of the value of the underlying houses, is very secure. FNM is moving higher because the problems in the subprime market have tainted the available supply of credit for all housing. This has prompted FNM's CEO and many congressmen to ask that FNM's statutory lending limit be raised, both in the amount they can loan in an single transaction, as well as, the size of their total loan portfolio. In essence FNM is moving higher because the odds are good that they are going to be able to --yes--make more mortgage loans.

In my judgment traders are jumping to huge conclusions that US housing is collapsing; it is not. High risk mortgages are in big trouble, but Fannie Mae and other prime mortgages lenders, such as the banks, are well protected by the equity in their outstanding mortgages. Furthermore, the overall US housing market is protected by the solid US economy and the low unemployment rates.

The traders are panicked and stocks are flying all over the place. Do not confuse that with the strength of the underlying economy, or the value of the average stock. Cooler heads, however, are starting to step forth to diminish the confusion. The Federal Reserve just announced that they stand ready to provide liquidity to banks with unusual or extraordinary credit needs who cannot find funding through normal channels. They also bought $19 billion in mortgage backed securities from banks. The Fed is now firmly in the game, and I believe the markets will begin to calm down. The Fed has not stepped in to bail out bad loans; it has stepped in to be sure that the gyrating markets don't cause the banking system to freeze up. That's their job. I'm glad to see that they are finally doing it.

I own FNM, but this is not a recommendation. I am just using it to make the above points.