Today's Fleck:
Daily Rap for 09-23-2004
by Bill Fleckenstein
A Hurricane Named Fannie
The preopening economic data were weaker than expected: Jobless claims climbed back to the 350,000 level, and continuing claims were up slightly once again. That news, however, was ignored. In the early going, stocks were initially under a bit of pressure, though I assume as a function of residual selling from yesterday. But the tape caught a small bid when oil opened about 1% lower. Beta chasers were back trying to pile into tech and Sox-oriented names, which were quickly green when the other major indices were still modestly red, as bulls attempted to turn the tape.
Financials Tune In to CSI Fannie
Basically, the early going was what we got all day long, as the market chopped in a fairly narrow range into the close. The strength that could be found was in chips and Internets, with both speculative scenes finishing nicely green. Financials and related issues were all modestly red, most likely in sympathy/concern over what was happening to Fannie Mae, which wound up closing the day down just shy of 6%. (Much more about Fannie below.) I would describe today's action as somewhat inconclusive, though I'd give a small "w" to the bears, even though the bulls were able to win a bit with their beta-buying attempts.
Politics on Tap
Away from stocks, there was a great deal of action. Starting with oil, the government fired a shot across that market's bow by suggesting it might tap the Strategic Petroleum Reserve, something that I've been expecting, as I have stated. Of course, it's not being packaged as a "tap." That would be too political. It's being packaged as a possible loan to some refiners, due to hurricane-related issues. That's how these taps get packaged, as loans to be repaid later. That's exactly what happened last time the SPR was utilized. In any case, the net effect on the oil market was transitory, as after being down 2%, oil closed up 11 cents at $48.46.
Turning to the currencies, the dollar was quite weak in the early going, before stabilizing. The strength today was being led by the Aussie dollar, which was up over 1%, while the euro closed flat, after being 0.75% lower. The dollar's weakness appeared to give the precious metals a boost, with gold up about 1% and silver up about 1.5%. Fixed income fizzled, down small.
Checkmate for Chicanery?
Continuing on from yesterday about Fannie Mae, I think this is a very important story for everyone to pay attention to. First of all, it will be interesting to see if a proper and thorough investigation of Fannie Mae takes place. It looks like we may be headed in that direction. It will also be important to see what sort of consequences befall Fannie, depending on exactly what they have done.
Managing earnings has been the biggest open secret on Wall Street for years and years, as I was saying yesterday. Companies with far-flung interests and many moving parts cannot make the numbers and beat them by a penny with any regularity unless they are managing earnings, which is illegal. I will be most interested to see whether or not any of this actually finally stops.
The other important development that we need to see is: If this forces Fannie Mae -- the ultimate engine of the housing machine -- to modify its behavior, that would have huge ramifications for every facet of the economy, given the amount of leveraged speculation that's transpired in the housing market.
The Breakfast of Beat-the-Street Champions
Of course, one of the reasons why Fannie can do what it can do (and likewise every other financial institution) is thanks to the accounting treatment that financial institutions enjoy, whereby they get to choose whether an asset (or derivative) is marked to market or not. They can also switch their decision. In any case, it appears that the misapplication of an accounting rule for derivatives (SFAS 133) is one of the things that Fannie Mae has used to manage their earnings.
I expect that if the light of day is truly to be trained on Fannie Mae and other financial institutions, and an ounce of common sense is applied, their rules and behavior will have to change, and it will have enormous consequences. Fannie Mae is an absolutely gargantuan organization, with approximately $1 trillion assets and $1 trillion (notional) derivatives exposure, with only $26 billion of equity. Said differently, its $26 billion of equity is holding up an asset and derivatives book that is about 20% of GDP. That gives you some idea of how big the problems can get if something bad in fact is going to happen.
Hey Nonino, A-Lobbying They Shall Go
Whether or not something bad is going to happen cannot be forecast at this point, because we just don't know how serious "the authorities" are about discovering what went on (and at this point, we can't know exactly what went on). Also, these types of companies that I am mentioning are very politically connected. It may be too much to hope for to actually have everything treated as it should be.
But I would use the stock-price action in Fannie Mae as my indicator. I thought that yesterday's 7% drop could turn out to be just noise, and that we wouldn't know until the course of the next handful of days, if the stock continued to get hammered. (We must also monitor FNM spreads in the debt market.) In the early going today, it was down another 5%. But even that, I don't think, is proof-positive. However, I would note that all big accounting scandals start small. (Think back to Enron, WorldCom, etc.) So, I intend to follow this story closely, and everyone else should, too, because as I pointed out, the ramifications and the consequences will be quite large.
Of Central Banks & Fannie?-No-Thanks
Finally, in mulling over what Fannie Mae could mean for our markets, my friend Jim Grant pointed out something that I hadn't quite thought of initially. In an email to me, he wrote: "It might be useful also to mention Fannie's dollar connection. Federal agency securities held in custody by the Fed for the accounts of foreign central banks run to $244 billion, up $54 billion in the past 12 months. That compares to $1 trillion of Treasurys (up $273 billion in the past 12 months). As you know, foreign -- mainly Asian -- central banks absorb stupendous amounts of dollars. They invest them in Treasurys and agencies.
Jim continued: "If you were running the People's Bank of China, you might not take kindly to the Fannie revelations. You might sell Fannies for Treasurys, or stop buying Fannies AND Treasurys. Or do nothing, retaining every ounce of faith in the U.S. and its picture-perfect financial management." An excellent point made by Jim. Those are just other reasons why Fannie Mae might turn out to be the financial story of the decade. |
