Subprime Woes
Bailout Delayed, Free Market Returns With Vengeance
Congress Killed the bailout. Everybody is mad at somebody. The bailout is too big. Too small. Doesn't spread the wealth. Will hurt taxpayers. Will lead to more bad behavior. This list goes on. In this upside down world, Republicans want big government solutions to market problems while Democrats want to redistribute wealth to bankers. Everybody has a bone to pick on the bailout yet nobody can explain exactly how $700 billion stops the market madness.
What did the stock market think about the delay in the $700 billion fix? Dow down -777. Yesterday, even lucky numbers meant bad luck.
With big banks dropping like flies (A.T.B.T.F. almost to big to fail...) and every kind of debt with more default risk than U.S. government bonds going through bouts of panic selling (even munis! ) its time to reflect back and remember one thing: this is all the result of the Great Real Estate Bubble.
While there is certainly much blame to go around, the biggest villain was a simple widespread belief that homes were a perpetual upward motion machine.
Like everybody, we have our own ideas on how to 'save' humanity from our greatest bubble yet (bonus feature - it doesn't require creating another bigger bubble somewhere else). But who cares what we think about the bubble anymore... All you need to know is there are only three parties that can take the fall as trillions in phantom real estate wealth evaporates:
1) Home Owners
2) Lenders (this includes investors in mortgage debt, not just jet-set bank execs)
3) Taxpayers
Government polices and bailouts can shift the burden between the big three, but all will take a hit. Without magically re-inflating the housing bubble, there is no way all groups can come out unscathed. The best way to start crafting a bailout package is determine how you want to spread the multi-trillion dollar burden.
And remember when you go around finger pointing, those that live in glass houses shouldn't have taken out a pick-a-payment home equity loan to renovate their kitchen with stainless steel appliances and a granite counter top because someone on HGTV said repeatedly it adds value beyond the cost of the renovation...
Safety First
As investors get optimistic, riskier assets tend to outperform. As they get more pessimistic, safer assets tend to win. While there were some big ups and downs in the stock market in 2007, the real fear was in the bond market - the place where real estate bubble borrowing goes to find a buyer.
In 2007 investors started to question the likelihood that all these trillions in borrowing would get repaid. What started in real-estate-related debt moved to all consumer debt and even lower grade corporate borrowing. Where did all this newly conservative money flock? Good ole' Uncle Sam debt. That's right - capitalists favorite whipping boy, the government, is the investment of choice when the going gets rough.
Look no further than Vanguard for an indication how the bond market was in 2007. Vanguard Long-Term U.S. Treasury (VUSTX) was up 9.2%, while Vanguard High Yield Corporate (VWEHX) was up a paltry 2%.
But the real winner in 2007 was bond king Bill Gross, who's negative outlook on the economy and general suspicion of the fancy financial footwork in the housing market led his bond funds to a strong return in 2007, after a ho-hum 2006:
The Pimco Total Return fund that Gross runs scored a gain of 8.6% last year, a higher return than 90% of its peer bond funds -- and better than the 6.4% gain of the average stock fund -- after Gross' gamble that the housing crisis would force the Federal Reserve to cut interest rates paid off late in the last third of the year.
For the fourth quarter, Gross' fund returned 3.8%."
We've had a long-time Powerfund Portfolio holding in Bill Gross-managed Harbor Bond Institutional (HABDX), which was up 8.7% in 2007.
Some Top Fund Managers Sour On Economy
Bob Rodriguez manages the (closed) small cap value fund, FPA Capital (FPPTX), and bond fund FPA New Income (FPNIX). He has been hoarding a large cash stake for quite some time, which hasn't been such a smart move in general for stocks, but considering this year's crummy small cap stock returns has helped him stay competitive with other similar funds.
Morningstar noticed Rodriguez's recent move to the even more dour camp of PIMCO's Bill Gross when it comes to America's future:
...[Rodriguez] recently announced he put a halt to purchases of stocks and high-yield bonds at both portfolios on Dec. 14. His decision is a reaction to the subprime mortgage-induced credit crunch, which he expects to worsen in coming months. Rodriguez says he'll review his actions weekly, but he doesn't anticipate any change in course until February or March 2008.
Rodriguez's move is virtually unprecedented. Many investors, including Rodriguez himself, aren't shy retreating to cash when they're nervous. But few money managers have ever publicly foresworn stocks and bonds altogether."
When your smarter fund managers are starting to sound this pessimistic, it may be time to reassess your expectations for stocks and bonds in 2008.
Will The Government Bail Out Fannie and Freddie?
This morning cutesy-pie named “Freddie Mac” (FRE) scared investors with the news that the company’s third quarter loss was just a smidgen over $2 billion, and that they might cut their dividend for the first time ever - by as much as half. Freddie Mac is Federal Home Loan Mortgage Corporation, own of two giant government sponsored entities at the very center of the mortgage storm. Fannie Mae (FNM), or Federal National Mortgage Association, is the other.
Both stocks opened down sharply this morning – continuing a slide that started a few weeks ago but well after the mortgage market started melting earlier this year.
Investor’s confidence in the wonder twin’s power to avert trouble amidst the collapsing lesser giants like Washington Mutual (WM) and Co untrywide (CFC) could best be summed by CNBC’s David Faber on "Squawk on the Street” this morning at the opening bell:
…don't know if we have a bid/ask [for Freddie] but it’s looking below $26 dollars a share down over $11... It’s not like Freddie is going to get taken out here or anything in terms of any problems. The government will be there at some point."
Perhaps the government will “be there at some point” when things go awry, but does that mean the government will support the shareholders of Fannie and Freddie? Would there not be outrage by taxpayers (some renters surely) stuck paying hundreds of billions to support the mortgage market – a crisis of S&L bailout proportions – AND shareholders including Fannie and Freddie executives with millions worth of stock who drove the car off the cliff?
In the great real estate bubble, all roads eventually lead to Fannie and Freddie. This may be bad news for shareholders of many large cap value funds with big Fannie or Freddie stakes, notably two Weitz offerings: Weitz Value (WVALX), down 1.38% today, or Weitz Partners Value (WPVLX) down 1.18% on a day the S&P 500 was up slightly.
Funds Keep Singin’ The Subprime Blues
Every few years there is a mini bond crisis. Each time the same thing happens: bond funds that looked great by beating their peers, fall precipitously. Same goes for 2007.
The [Regions Morgan Keegan Select High Income Fund (MKHIX)] is down about 35% this year, and is at the bottom of the junk-bond fund category for the one-, three- and five-year annual performance periods, illustrating how recent events are starting to tarnish even manager Jim Kelsoe's impressive long-term record."
Lord knows how much investors would have lost in these high flying RMK bond funds if the giant financial firm behind the funds didn’t step in (RMK funds are owned by Regions Financial RF):
The annual report that covers these funds also outlines some important steps taken by the funds' adviser and affiliates to help cope with recent losses. These include stepping in to buy about $55.2 million in shares of the High Income Fund and $30 million in the Intermediate Bond Fund [MKIBX] from the beginning of July to the end of August to help provide liquidity."
The takeaway is that you shouldn't mix mutual funds with thinly-traded higher-risk investments, or you could end up singing the subprime blues:
I went to the bond market, fell down on my knees
I went to the bond market, fell down on my knees
Asked the Lord above, have mercy now, save my poor bonds if you please
Standin' at the bond market, tried to flag a buy
Whee-hee, I tried to flag a buy
Didn't nobody seem to know me, everybody pass me by
Standin' at the bond market, risin' sun goin' down
Standin' at the bond market baby, the risin' sun goin' down
I believe to my soul now, my po' bonds is sinkin' down
You can run, you can run, tell my friend Bennie B
You can run, you can run, tell my friend Bennie B
That I got the bond market blues this mornin', Lord, baby my bonds are sinkin' down
(To the music of Crossroads Blues / Robert Johnson 1936)
Safe Money Market Fund Yields Plummet
It looks like the era of earning a nice risk-free 5% is over. The Federal Reserve hasn’t even lowered the Fed funds rate (the main driver of money market yields) from the current level of 5.25% and many good low fee money market funds are already yielding closer to 4%.
Uncertain times on Wall Street have sent even high-risk investors running for cover. Demand for the lowest of the low risk investments – U.S. Government Treasury bills – has sent yields way down. Today’s terrible jobs number and continued boo-scary foreclosure news has all but assured investors that interest rates are heading down fast and furious, lest the economy tailspin into a depression.
What this all means is a nice old fund like Vanguard Treasury Money Market Fund (VMPXX) yields 4.48%, 10% less than just a few weeks ago. Higher fee money market funds like T. Rowe Price U.S. Treasury Money (PRTXX) are now yielding 3.88%. As new money goes into these funds, their managers are forced to load up on lower yielding debt, which waters down the higher-yield holdings.
Interestingly, money market funds that own CD’s and commercial paper (highly rated, sort term debt backed by corporate America, not Uncle Sam) still yield around 5% (and higher). The perception is that this debt now has some risk - if not default risk than liquidity risk. Vanguard Prime Money Market Fund (VMMXX) yields 5.1%. Fidelity Cash Reserves (FDRXX) yields 5.11% - even more than it did a few months ago. Both funds tip the scales at about $100 billion in assets.
Apparently people don’t like seeing “Countrywide Financial Corp” in their money market portfolios anymore.
And there are some issues here... ...read the rest of this article»
Market To Politicians: Thanks, But No Thanks...
Remember last week when the Dow fell 777 because politicians didn't pass the Banker Bailout Bill (BBB)? Well earlier today the Dow was down over 800. Worse, this was 1,300 from the market peak last Friday, around the time the bill passed.
My government spent almost one trillion dollars and all I got was this crummy market! For those looking for a bright side, consider many emerging market funds are down 50% from the peaks; heck Russia fell around 20% in a day and is now down 65% from highs. And Russia didn't even have a housing bubble! They did have a commodity bubble but we'll save that tale for another day.
This makes one wonder, what would have happened if no rescue package was passed? The non-U.S. government bond market - the area the bailout is targeting - is not fairing much better.
The trouble is panic has set in. Not just with investors, but consumers. For the first year or so of the unwinding of the Great Real Estate bubble, experts were sure it was somehow going to be contained - that trillions of instant wealth could just disappear with nobody noticing (except the banks then lent money against the phantom gains). Well if you've been to a car dealership lately, people have started to notice.
While we don't think the Dow under 10,000 is such a bad place to be compared to government bonds, CDs, or real estate, if this downward spiral continues HGTV's "My House Is Worth What?" will be renamed "My House Is Worth What!"