Emergency US Interest Rate Cut Rumoured as Freddie Mac Posts $5b Loss

Poor Freddie (NYSE:FRE). The federally-chartered lender announced a loss of nearly US$5 billion. You’d think it had lit up a cigarette in a sushi joint. Suddenly, everyone was jumping all over it. Investors spanked the company...the shares fell 30% after the firm announced a cut of as much as 50% in the dividend. Sister Fannie (NYSE:FNM) didn’t get away either. Her shares went down 22%.

Meanwhile, the US dollar went down again – hitting another record low against the euro. Years ago, we guessed it would drop to US$1.50 per euro. Today, it is at US$1.48.

Yesterday, a rumour made the rounds...that the Fed was getting ready for an emergency cut. “The Fed will keep its options open,” said Neil Mellor of the Bank of New York Mellon. But an emergency cut seems unlikely. Instead, the futures market is giving a 90% probability of another cut at the Fed’s regular meeting on December 11th.

And what happened to that correction? Gold added US$15 yesterday. We were hoping for more of a downturn. We don’t like to buy when the price needs to correct.

Oil, too, headed up – it’s at US$96 a barrel, a new record high. Here comes the explanation: the winter is going to be cold.

But back to Freddie, Fannie et al. What had they done wrong?

Nothing, according to Richard Styron, Freddie’s CEO.

“We aren’t happy about this,” he told a conference call. Then, he went on to describe what it was he wasn’t happy about. As the Financial Times put it:

“Mr. Styron blamed the meltdown in the US mortgage market and the attendant decline in the value of mortgage-related shares.”

Who could have seen that coming, he seemed to ask?

It is always a source of great amazement and entertainment to us here at the dour headquarters of The Daily Reckoning on the banks of the River Thames (in the building with the golden balls) – how the smartest and best informed investors can walk into the most obvious traps.

Freddie buys mortgages. It has an instruction to do so from the United States Congress – based on the ostensible grounds that a little more money in the mortgage market might be good for homeowners...and the hidden motivation that it might help get some undeserving politicians re-elected. Freddie borrows money at low rates...in order to lend it at higher rates. A pretty simple business, it has two risks: 1. That interest rates will move in an adverse direction...and 2. That the mortgages it holds will turn out to be worth less than it thought (when homeowners stop making payments...for example...or housing prices fall). Fannie’s executives must have to look at these risks more often than they shave. They are so much a core part of the business that the company cannot deny them; instead, it has to manage them – for which it has access to a huge army of hedgers, quants, intermediaries and speculators with very sharp pencils and very rich imaginations.

But wouldn’t you know it, just when things were going so well – with mortgage brokers lending money coast to coast like a house o’ fire – then along comes this totally unanticipated event, like a meteor striking the earth! And wham...all those sharp pencils break at once.

Seriously, this subprime housing meltdown ...who could have seen that coming?

Not the rating agencies. Last month, Fitch said it was caught off guard by “the unprecedented reversal in home prices”. What’s the matter with these people? What’s unprecedented about house prices going down? Funny how no one took these guys aside and whispered in their ear:

“Pssst...markets go up AND down. And by the way, when you lend out money recklessly...you gotta expect trouble.”

Apparently, no one said a thing. It is as if these guys had come to Wall Street on the back of a turnip truck...and signed up for work the next day.

Now, they find the work is not as easy as they had thought. This week, the cost of protecting against credit whammies rose to an 18-year high – based on two year interest rate swap prices. “More black clouds on the credit horizon,” the Financial Times reports. Countrywide (NYSE:CFC) is trading at less than US$10 a share. And Citigroup (NYSE:C) shares have been almost cut in half.

“‘The widening of swap spreads is a function of tight lending and a de-leveraging in the financial system...’ said one bond strategist. ‘The last two times we saw these meteor-like spikes in swap spreads in the US, they were followed by a recession. Liquidity is absolutely horrible.’”

And so papers are all talking about the credit crisis beginning to crunch down on the middle classes. Building permits are at a 14-year low. Foreclosures are still rising. House prices are still going down. More and more economists are forecasting recession.
“The Coming Consumer Crunch,” Business Week calls it.

And this from our old friend Jim Rogers:

“This is worse than the S&L crisis. This is the first time – this is the worst credit bubble we’ve ever had in American history. No – never in American history have people been able to buy a house with no money down...never. That’s never happened anytime in the world. So, we have the worst credit bubble. It’s going to take a long time to work its way out. You don’t cure a bubble in five or six months... It takes five or six years.”

Bill Bonner
The Daily Reckoning Australia

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