This is The Wall Street Digest Hotline Update for Tuesday, April 29, 2008, at 6:00 p.m. EST.
Traders are waiting for the FOMC rate cut announcement at 2:15 tomorrow. At the close, the Dow lost almost 40 points, closing at 12,831, while the Nasdaq gained almost 2 points, closing at 2,426. Oil closed $3.46 lower at $115.29 per barrel, and gold closed $24.00 lower at $871.50 an ounce.
The Fed is expected to cut the Fed Funds rate from 2.25 percent to 2.00 percent tomorrow. First quarter GDP will also be released Wednesday morning. The Fed Funds interest rate at 2.25 percent is below the 2-year note at 2.35 percent for the first time in years that is bullish for stocks and the economy.
Let's continue to avoid the housing sector, as well as most of the banking and financial sectors. I would not purchase residential nor commercial real estate. I still do not expect the housing market to bottom in 2008.
Stay close to our Tuesday/Friday Hotline Updates. I will be adjusting our portfolio of recommendations to capture maximum profits from a stock market rally that will surprise everyone, but you.
The next Hotline Update will be on Friday, May 2, 2008, at 6:00 p.m. EST.
Wednesday, April 30, 2008
Tuesday, April 29, 2008
Foreclosures spike 112% - no end in sight
More than 155,000 families have lost their homes to foreclosure this year; one out of every 194 U.S. households received a foreclosure filing.
By Les Christie, CNNMoney.com staff writer
Last Updated: April 29, 2008: 9:09 AM EDT
NEW YORK (CNNMoney.com) -- Foreclosure filings in the first three months of 2008 rose more than 112% over last year, according to a study released Tuesday.
Real estate information firm RealtyTrac reported that nearly 650,000 foreclosure filings - which include notices of default, auction sales and bank repossessions - were issued in the first quarter. That represents 1 of every 194 households and marks a 23% increase from the last quarter of 2007.
Housing bust: Tell us your story
So far this year 156,463 families have lost their homes to repossessions.
"Foreclosure activity hasn't slowed down yet," said Rick Sharga, spokesman for RealtyTrac. "But I was a little surprised that foreclosure filings more than doubled since last year."
Foreclosures increased in 46 states and in 90 of the nation's 100 largest metro areas. Some regions that had been only marginally hurt by the mortgage meltdown recorded large increases in filings. In Connecticut, for instance, filings tripled compared with the first three months of 2007. Massachusetts recorded a 260% increase.
Nevada: Hardest hit
The worst hit states are still clustered in the Southwest; Nevada, California and Arizona lead the nation in foreclosure filings. Prices ran up rapidly in these areas during the bubble years as speculators snapped up single-family homes and condos as investments.
In the first quarter, 1 of every 54 homes in Nevada received some type of foreclosure filing - more than any other state. Its largest city, Las Vegas, had 1 out of every 44 homes go into foreclosure.
Stockton, Calif., had the highest foreclosure rate out of any U.S. metro area, with 1 out of every 30 homes receiving a notice - nearly seven times higher than the national average. The Riverside/San Bernardino region had the second highest rate in the quarter, with one of every 38 homes in default.
Only two metro areas in the ranks of the 20 hardest hit were outside the Sunbelt - Detroit, which ranked sixth in the nation with 1 in every 68 households in default, and Cleveland which saw 1 in every 105 homes go into foreclosure.
The news comes despite increased foreclosure prevention efforts by lenders and community organizations. Hope Now, the coalition of mortgage lenders, servicers investors and community groups, announced Monday that it helped over a half a million home owners avoid foreclosure during the first three months of the year.
And some local governments have stepped up their programs to help borrowers, according to RealtyTrac CEO James Saccacio.
"For example, in late March Philadelphia issued a temporary moratorium on all foreclosure auctions for April," he said. "The city has since adopted a program that will delay foreclosure proceedings on owner-occupied properties until the owners have met face-to-face with lenders to attempt to create a loan workout plan that would prevent foreclosure."
More trouble ahead
Additionally, lawmakers in Washington, D.C. are at work on several plans that would deliver foreclosure relief to distressed borrowers.
All of these foreclosure prevention efforts may not be able to stand up to the tsunami of foreclosures on the way. Sharga says that a record number of hybrid adjustable rate mortgages (ARMs) - worth $362 billion - will reset in 2008.
These so-called "exploding ARMs" usually have low introductory interest rates that reset much higher after two or three years, and then re-adjust as often as every six months after that. Unless these loans can be reworked, many will fail.
"We expect to see another foreclosure peak in the late third or fourth quarter of the year," said Sharga, "because of the record number of resets coming."
First Published: April 29, 2008: 5:01 AM EDT
By Les Christie, CNNMoney.com staff writer
Last Updated: April 29, 2008: 9:09 AM EDT
NEW YORK (CNNMoney.com) -- Foreclosure filings in the first three months of 2008 rose more than 112% over last year, according to a study released Tuesday.
Real estate information firm RealtyTrac reported that nearly 650,000 foreclosure filings - which include notices of default, auction sales and bank repossessions - were issued in the first quarter. That represents 1 of every 194 households and marks a 23% increase from the last quarter of 2007.
Housing bust: Tell us your story
So far this year 156,463 families have lost their homes to repossessions.
"Foreclosure activity hasn't slowed down yet," said Rick Sharga, spokesman for RealtyTrac. "But I was a little surprised that foreclosure filings more than doubled since last year."
Foreclosures increased in 46 states and in 90 of the nation's 100 largest metro areas. Some regions that had been only marginally hurt by the mortgage meltdown recorded large increases in filings. In Connecticut, for instance, filings tripled compared with the first three months of 2007. Massachusetts recorded a 260% increase.
Nevada: Hardest hit
The worst hit states are still clustered in the Southwest; Nevada, California and Arizona lead the nation in foreclosure filings. Prices ran up rapidly in these areas during the bubble years as speculators snapped up single-family homes and condos as investments.
In the first quarter, 1 of every 54 homes in Nevada received some type of foreclosure filing - more than any other state. Its largest city, Las Vegas, had 1 out of every 44 homes go into foreclosure.
Stockton, Calif., had the highest foreclosure rate out of any U.S. metro area, with 1 out of every 30 homes receiving a notice - nearly seven times higher than the national average. The Riverside/San Bernardino region had the second highest rate in the quarter, with one of every 38 homes in default.
Only two metro areas in the ranks of the 20 hardest hit were outside the Sunbelt - Detroit, which ranked sixth in the nation with 1 in every 68 households in default, and Cleveland which saw 1 in every 105 homes go into foreclosure.
The news comes despite increased foreclosure prevention efforts by lenders and community organizations. Hope Now, the coalition of mortgage lenders, servicers investors and community groups, announced Monday that it helped over a half a million home owners avoid foreclosure during the first three months of the year.
And some local governments have stepped up their programs to help borrowers, according to RealtyTrac CEO James Saccacio.
"For example, in late March Philadelphia issued a temporary moratorium on all foreclosure auctions for April," he said. "The city has since adopted a program that will delay foreclosure proceedings on owner-occupied properties until the owners have met face-to-face with lenders to attempt to create a loan workout plan that would prevent foreclosure."
More trouble ahead
Additionally, lawmakers in Washington, D.C. are at work on several plans that would deliver foreclosure relief to distressed borrowers.
All of these foreclosure prevention efforts may not be able to stand up to the tsunami of foreclosures on the way. Sharga says that a record number of hybrid adjustable rate mortgages (ARMs) - worth $362 billion - will reset in 2008.
These so-called "exploding ARMs" usually have low introductory interest rates that reset much higher after two or three years, and then re-adjust as often as every six months after that. Unless these loans can be reworked, many will fail.
"We expect to see another foreclosure peak in the late third or fourth quarter of the year," said Sharga, "because of the record number of resets coming."
First Published: April 29, 2008: 5:01 AM EDT
Homes Facing Foreclosure More Than Double in the First Quarter
Tuesday, April 29, 2008
LOS ANGELES
The number of U.S. homes heading toward foreclosure more than doubled in the first quarter from a year earlier, as weakening property values and tighter lending left many homeowners powerless to prevent homes from being auctioned to the highest bidder, a research firm said Monday.
Among the hardest hit states were Nevada, Florida and, in particular, California, where Stockton led the nation with a foreclosure rate that was 6.6 times the national average, Irvine, Calif.-based RealtyTrac Inc. said.
Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of the year, up 112% from 306,722 during the same period last year, RealtyTrac said.
The latest tally also represents an increase of 23% from the fourth quarter of last year.
RealtyTrac monitors default notices, auction sale notices and bank repossessions.
All told, one in every 194 households received a foreclosure filing during the quarter. Foreclosure filings increased in all but four states.
The most recent quarter marked the seventh consecutive quarter of rising foreclosure activity, RealtyTrac noted.
"What would normally alleviate the foreclosure situation in a normal market is people starting to buy properties again," said Rick Sharga, RealtyTrac's vice president of marketing.
However, the unavailability of loans for people without perfect credit and a significant down payment is slowing the process, he said.
"It's a cycle that's going to be difficult to break, and we're certainly not at the breaking point just yet," Sharga added.
The surge in foreclosure filings also suggests that much-touted campaigns by lawmakers and the mortgage lending industry aimed at helping at-risk homeowners aren't paying off.
Hope Now, a Bush administration-organized mortgage industry group, said nearly 503,000 homeowners had received mortgage aid in the first quarter. Most of the aid was temporary, however.
Pennsylvania was a notable standout in the latest foreclosure data. The number of homes in the state to receive a foreclosure-related filing plunged 24.4% from a year earlier.
Sharga credited the decline to the state's foreclosure relief measures, noting that cities such as Philadelphia put in place a moratorium on all foreclosure auctions for April and implemented other measures aimed at helping slow foreclosures.
Nearly 157,000 properties were repossessed by lenders nationwide during the quarter, according to RealtyTrac.
The flood of foreclosed properties on the market has contributed to falling or stagnating home values, yet lenders have yet to implement heavy discounts on repossessed homes, Sharga said.
Nevada posted the worst foreclosure rate in the nation, with one in every 54 households receiving a foreclosure-related notice, nearly four times the national rate.
The number of properties with a filing increased 137% over the same quarter last year but only rose 3% from the fourth quarter.
California had the most properties facing foreclosure at 169,831, an increase of 213% from a year earlier. It also posted the second-highest foreclosure rate in the country, with one in every 78 households receiving a foreclosure-related notice.
California metro areas accounted for six of the 10 U.S. metropolitan areas with the highest foreclosure rates in the first quarter, RealtyTrac said.
Many of the areas -- including Stockton, Riverside-San Bernardino, Fresno, Sacramento and Bakersfield -- are located in inland areas of the state where many first-time buyers overextend themselves financially to buy properties that have plunged in value since the market peak.
"California still hasn't hit bottom," Sharga said. "We have a lot of California homes that are in early stages of default that may not be salvageable because either there's no market or financing available, or both."
Arizona had the third-highest foreclosure rate, with one in every 95 households reporting a foreclosure filing in the quarter. A total of 27,404 homes reported at least one filing, up nearly 245% from a year ago and up 45% from the last quarter of 2007.
Florida had 87,893 homes reporting at least one foreclosure filing, a 178% jump from the first quarter of last year and a 17% hike from the fourth quarter last year.
That translates into a foreclosure rate of one in every 97 households.
The other states among the top 10 with the highest foreclosure rates were Colorado, Georgia, Michigan, Ohio, Massachusetts and Connecticut.
LOS ANGELES
The number of U.S. homes heading toward foreclosure more than doubled in the first quarter from a year earlier, as weakening property values and tighter lending left many homeowners powerless to prevent homes from being auctioned to the highest bidder, a research firm said Monday.
Among the hardest hit states were Nevada, Florida and, in particular, California, where Stockton led the nation with a foreclosure rate that was 6.6 times the national average, Irvine, Calif.-based RealtyTrac Inc. said.
Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of the year, up 112% from 306,722 during the same period last year, RealtyTrac said.
The latest tally also represents an increase of 23% from the fourth quarter of last year.
RealtyTrac monitors default notices, auction sale notices and bank repossessions.
All told, one in every 194 households received a foreclosure filing during the quarter. Foreclosure filings increased in all but four states.
The most recent quarter marked the seventh consecutive quarter of rising foreclosure activity, RealtyTrac noted.
"What would normally alleviate the foreclosure situation in a normal market is people starting to buy properties again," said Rick Sharga, RealtyTrac's vice president of marketing.
However, the unavailability of loans for people without perfect credit and a significant down payment is slowing the process, he said.
"It's a cycle that's going to be difficult to break, and we're certainly not at the breaking point just yet," Sharga added.
The surge in foreclosure filings also suggests that much-touted campaigns by lawmakers and the mortgage lending industry aimed at helping at-risk homeowners aren't paying off.
Hope Now, a Bush administration-organized mortgage industry group, said nearly 503,000 homeowners had received mortgage aid in the first quarter. Most of the aid was temporary, however.
Pennsylvania was a notable standout in the latest foreclosure data. The number of homes in the state to receive a foreclosure-related filing plunged 24.4% from a year earlier.
Sharga credited the decline to the state's foreclosure relief measures, noting that cities such as Philadelphia put in place a moratorium on all foreclosure auctions for April and implemented other measures aimed at helping slow foreclosures.
Nearly 157,000 properties were repossessed by lenders nationwide during the quarter, according to RealtyTrac.
The flood of foreclosed properties on the market has contributed to falling or stagnating home values, yet lenders have yet to implement heavy discounts on repossessed homes, Sharga said.
Nevada posted the worst foreclosure rate in the nation, with one in every 54 households receiving a foreclosure-related notice, nearly four times the national rate.
The number of properties with a filing increased 137% over the same quarter last year but only rose 3% from the fourth quarter.
California had the most properties facing foreclosure at 169,831, an increase of 213% from a year earlier. It also posted the second-highest foreclosure rate in the country, with one in every 78 households receiving a foreclosure-related notice.
California metro areas accounted for six of the 10 U.S. metropolitan areas with the highest foreclosure rates in the first quarter, RealtyTrac said.
Many of the areas -- including Stockton, Riverside-San Bernardino, Fresno, Sacramento and Bakersfield -- are located in inland areas of the state where many first-time buyers overextend themselves financially to buy properties that have plunged in value since the market peak.
"California still hasn't hit bottom," Sharga said. "We have a lot of California homes that are in early stages of default that may not be salvageable because either there's no market or financing available, or both."
Arizona had the third-highest foreclosure rate, with one in every 95 households reporting a foreclosure filing in the quarter. A total of 27,404 homes reported at least one filing, up nearly 245% from a year ago and up 45% from the last quarter of 2007.
Florida had 87,893 homes reporting at least one foreclosure filing, a 178% jump from the first quarter of last year and a 17% hike from the fourth quarter last year.
That translates into a foreclosure rate of one in every 97 households.
The other states among the top 10 with the highest foreclosure rates were Colorado, Georgia, Michigan, Ohio, Massachusetts and Connecticut.
Tuesday, April 22, 2008
The best fund manager of our time
Robert Rodriguez has accomplished the unheard-of-feat: driving staggering returns in both a stock and a bond fund for more than two decades.
By Jason Zweig, Money Magazine senior writer/columnist
April 8, 2008: 9:43 AM EDT
(Money Magazine) -- To invest in a mutual fund is to make a bet on the future. Whether that bet pays off is a function of how skillful the fund manager is, how lucky he is, how well the market does and how well the manager treats you.
The first two factors are very difficult to measure or predict, and the third is impossible to know in advance. But the fourth is quite easy to evaluate. You want a fund manager who will charge reasonable fees, keep his fund from growing too big for your own good, think independently and courageously and communicate his actions and intentions clearly.
You also want someone who will invest his own money alongside yours - and who knows how much it hurts to lose it. The best fund manager, then, combines a long and convincing track record of excellent performance with a fierce dedication to treating his investors fairly.
And the winner is...
Our vote goes to Robert L. Rodriguez of the FPA Capital and FPA New Income funds. Ever since mid-1984, Rodriguez, now 59, has led these two funds to the front of the pack, the investing equivalent of running two marathons at the same time. Overseeing both a stock and a bond fund is so hard that well over 99% of all fund managers lack the guts to even try it - and nobody has ever done both better than Rodriguez.
At FPA Capital (FPPTX), a fund specializing in smaller U.S. stocks, Rodriguez has outperformed Standard & Poor's 500- stock index by an annualized average of 3.9 percentage points; he has beaten the Russell 2000 small-stock index by six points annually. And at FPA New Income (FPNIX), Rodriguez has never lost money in a calendar year; he has outlegged the Lehman Brothers aggregate bond index by 0.2 percentage points annually since 1984. In bond investing, a game of inches, that's a country mile.
Bob Rodriguez has achieved all this while steadfastly treating his investors fairly. Perhaps because he is the largest individual shareholder in each fund, FPA Capital charges only $8.60 in annual expenses per $1,000 invested (barely over half the average cost of a U.S. stock fund), and New Income costs just 0.62% in annual expenses.
Rodriguez also periodically closes his funds' doors, ensuring that too much new money won't flow in too quickly; FPA Capital has not accepted new shareholders since 2004 (though New Income is still open).
When the funds are open, he deters short-term traders with a 2% redemption fee on shares held for three months or less. (Because the funds are distributed by financial advisers, there's also a maximum sales charge of 3.5% on New Income and 5.25% on Capital. But if you hold on for a few years, their lower annual expenses more than make up for the sales charge.)
By preventing asset elephantiasis, Rodriguez protects his ability to be a patient and choosy buyer of only those stocks that he believes are the best bargains. He usually holds as few as 25 stocks, packing up to 40% of assets into the top 10 and hanging on for three to five years at a time.
Peering into a crystal ball
Industrywide, the typical fund has nearly 100 stocks, with less than 25% in the top 10 and an average holding period of less than one year. Last June, Rodriguez gave a speech that warned of the coming credit crisis so accurately that it reads with hindsight as if he had been peering into a crystal ball.
Taking his own warnings to heart, Rodriguez raised cash to levels high enough to withstand a nuclear war: 43% in FPA Capital and roughly 66% in New Income. In December he declared a formal moratorium on buying any stocks or high-yield bonds until he felt it was safe to invest again - essentially putting both portfolios into a state of suspended animation. As of press time he has not lifted that moratorium.
He still owns electronics distributor Avnet (avt), apparel retailer Foot Locker (fl) and drilling company Patterson-UTI Energy (pten), among others, which he describes as "market-leading companies with strong balance sheets."
Throughout, Rodriguez has been forthright with his shareholders, warning that his funds are not appropriate for an investor who wants quick results or wishes to replicate the returns of the overall stock and bond markets.
Rodriguez has another strength: He knows how much it hurts to lose money. His grandparents, wealthy landowners in Mexico, were wiped out in 1916 when the government seized their assets as punishment for sympathizing with Pancho Villa's revolutionary movement.
An investing junkie is born
Rodriguez grew up in Los Angeles, where his father worked as an electroplater. In fifth grade, assigned to write a letter to a stranger, he picked William McChesney Martin, chairman of the Federal Reserve Board. Martin replied personally, signing up Rodriguez as the youngest subscriber to the "Federal Reserve Bulletin," and an investing junkie was born.
Fresh out of college in 1971, Rodriguez jumped into the hot growth stocks of the day. "I thought if you couldn't compound money at 20% to 25% a year, you were basically incompetent," he recalls.
Then came the bear market of 1973-74. His favorite stock, a recreational-vehicle company called Executive Industries, started dropping from his initial purchase price of $22 a share. He bought more all the way down to $8, when he ran out of money. (His average cost per share was in the low teens.) The stock hit bottom at 88¢. The memory still haunts Rodriguez, who explains with a bitter laugh: "When somebody says to me today, 'This stock can't go any lower,' I say, 'Au contraire!' "
The lesson didn't stop there. "I learned that if you make a mistake and you don't tear it apart to see what you did wrong, you're going to repeat it in the future. I learned that fear is a terrible thing to have." He adds, "The best way to minimize your fear is to have a solid understanding of the companies you invest in."
Searching for answers in the library at the University of Southern California, where he was studying for his M.B.A., Rodriguez discovered Benjamin Graham and David Dodd's Security Analysis. Graham and Dodd helped him realize that chasing hot stocks was no way to pile up cold cash; instead, Rodriguez began to look past the fluctuating prices of stocks to determine the enduring value of the underlying businesses.
He realized that Executive Industries, trading at less than $1 a share, had $2 a share in cash and $3.50 a share in real estate - plus an ongoing business that should bounce back once the recession ended. Instead of selling, he held on for dear life and eventually got out for around $22 a share, turning a nice profit on a stock that Wall Street had left for dead.
"I realized then," he recalls, "that if I can survive the downturn I can live to participate in the upturn." According to Rodriguez, a true contrarian has to feel comfortable being lonely. And that, he says, means you can shrug off three unpleasant questions. The first is "Don't you know that...?" The next is "You're buying what?" And the third is "Are you nuts?"
Sit tight and ride it out
So even as the stock market kept stumbling lower in early 2008, Rodriguez sat on his hands. He thinks that housing will continue to get hammered and the credit crisis will get far worse before it gets better. Instead, he and his analysts have been scrutinizing dozens of companies, primarily in retailing, technology and energy. (Convinced that financial stocks have further to fall, he thinks it will be "at least another year" before any bargains will be had there.)
If he remains true to form, Rodriguez and his team will spend the coming months learning everything they can about the values of these underlying businesses while stock prices continue to drop. When the stocks on his buy list finally get cheap enough, Rodriguez will have hundreds of millions of dollars to deploy into companies he will understand better than many of the sellers do.
Rodriguez recently moved his office from Los Angeles to his home on Lake Tahoe. He believes that being able to look out over the water has given him a different perspective, helping him see the credit crisis coming.
Living in Nevada also frees him up to indulge in his hobby of racing Porsches around desert racetracks at speeds of up to 180 mph. "It's not speed that kills," laughs Rodriguez. "It's that sudden stop at the end."
He might as well be talking about the market. And you don't have to invest in his funds to learn from his technique: Keep your foot on the brake when other people are going dangerously fast, and when they all slam on the brakes, tap the gas pedal and swerve past them.
By Jason Zweig, Money Magazine senior writer/columnist
April 8, 2008: 9:43 AM EDT
(Money Magazine) -- To invest in a mutual fund is to make a bet on the future. Whether that bet pays off is a function of how skillful the fund manager is, how lucky he is, how well the market does and how well the manager treats you.
The first two factors are very difficult to measure or predict, and the third is impossible to know in advance. But the fourth is quite easy to evaluate. You want a fund manager who will charge reasonable fees, keep his fund from growing too big for your own good, think independently and courageously and communicate his actions and intentions clearly.
You also want someone who will invest his own money alongside yours - and who knows how much it hurts to lose it. The best fund manager, then, combines a long and convincing track record of excellent performance with a fierce dedication to treating his investors fairly.
And the winner is...
Our vote goes to Robert L. Rodriguez of the FPA Capital and FPA New Income funds. Ever since mid-1984, Rodriguez, now 59, has led these two funds to the front of the pack, the investing equivalent of running two marathons at the same time. Overseeing both a stock and a bond fund is so hard that well over 99% of all fund managers lack the guts to even try it - and nobody has ever done both better than Rodriguez.
At FPA Capital (FPPTX), a fund specializing in smaller U.S. stocks, Rodriguez has outperformed Standard & Poor's 500- stock index by an annualized average of 3.9 percentage points; he has beaten the Russell 2000 small-stock index by six points annually. And at FPA New Income (FPNIX), Rodriguez has never lost money in a calendar year; he has outlegged the Lehman Brothers aggregate bond index by 0.2 percentage points annually since 1984. In bond investing, a game of inches, that's a country mile.
Bob Rodriguez has achieved all this while steadfastly treating his investors fairly. Perhaps because he is the largest individual shareholder in each fund, FPA Capital charges only $8.60 in annual expenses per $1,000 invested (barely over half the average cost of a U.S. stock fund), and New Income costs just 0.62% in annual expenses.
Rodriguez also periodically closes his funds' doors, ensuring that too much new money won't flow in too quickly; FPA Capital has not accepted new shareholders since 2004 (though New Income is still open).
When the funds are open, he deters short-term traders with a 2% redemption fee on shares held for three months or less. (Because the funds are distributed by financial advisers, there's also a maximum sales charge of 3.5% on New Income and 5.25% on Capital. But if you hold on for a few years, their lower annual expenses more than make up for the sales charge.)
By preventing asset elephantiasis, Rodriguez protects his ability to be a patient and choosy buyer of only those stocks that he believes are the best bargains. He usually holds as few as 25 stocks, packing up to 40% of assets into the top 10 and hanging on for three to five years at a time.
Peering into a crystal ball
Industrywide, the typical fund has nearly 100 stocks, with less than 25% in the top 10 and an average holding period of less than one year. Last June, Rodriguez gave a speech that warned of the coming credit crisis so accurately that it reads with hindsight as if he had been peering into a crystal ball.
Taking his own warnings to heart, Rodriguez raised cash to levels high enough to withstand a nuclear war: 43% in FPA Capital and roughly 66% in New Income. In December he declared a formal moratorium on buying any stocks or high-yield bonds until he felt it was safe to invest again - essentially putting both portfolios into a state of suspended animation. As of press time he has not lifted that moratorium.
He still owns electronics distributor Avnet (avt), apparel retailer Foot Locker (fl) and drilling company Patterson-UTI Energy (pten), among others, which he describes as "market-leading companies with strong balance sheets."
Throughout, Rodriguez has been forthright with his shareholders, warning that his funds are not appropriate for an investor who wants quick results or wishes to replicate the returns of the overall stock and bond markets.
Rodriguez has another strength: He knows how much it hurts to lose money. His grandparents, wealthy landowners in Mexico, were wiped out in 1916 when the government seized their assets as punishment for sympathizing with Pancho Villa's revolutionary movement.
An investing junkie is born
Rodriguez grew up in Los Angeles, where his father worked as an electroplater. In fifth grade, assigned to write a letter to a stranger, he picked William McChesney Martin, chairman of the Federal Reserve Board. Martin replied personally, signing up Rodriguez as the youngest subscriber to the "Federal Reserve Bulletin," and an investing junkie was born.
Fresh out of college in 1971, Rodriguez jumped into the hot growth stocks of the day. "I thought if you couldn't compound money at 20% to 25% a year, you were basically incompetent," he recalls.
Then came the bear market of 1973-74. His favorite stock, a recreational-vehicle company called Executive Industries, started dropping from his initial purchase price of $22 a share. He bought more all the way down to $8, when he ran out of money. (His average cost per share was in the low teens.) The stock hit bottom at 88¢. The memory still haunts Rodriguez, who explains with a bitter laugh: "When somebody says to me today, 'This stock can't go any lower,' I say, 'Au contraire!' "
The lesson didn't stop there. "I learned that if you make a mistake and you don't tear it apart to see what you did wrong, you're going to repeat it in the future. I learned that fear is a terrible thing to have." He adds, "The best way to minimize your fear is to have a solid understanding of the companies you invest in."
Searching for answers in the library at the University of Southern California, where he was studying for his M.B.A., Rodriguez discovered Benjamin Graham and David Dodd's Security Analysis. Graham and Dodd helped him realize that chasing hot stocks was no way to pile up cold cash; instead, Rodriguez began to look past the fluctuating prices of stocks to determine the enduring value of the underlying businesses.
He realized that Executive Industries, trading at less than $1 a share, had $2 a share in cash and $3.50 a share in real estate - plus an ongoing business that should bounce back once the recession ended. Instead of selling, he held on for dear life and eventually got out for around $22 a share, turning a nice profit on a stock that Wall Street had left for dead.
"I realized then," he recalls, "that if I can survive the downturn I can live to participate in the upturn." According to Rodriguez, a true contrarian has to feel comfortable being lonely. And that, he says, means you can shrug off three unpleasant questions. The first is "Don't you know that...?" The next is "You're buying what?" And the third is "Are you nuts?"
Sit tight and ride it out
So even as the stock market kept stumbling lower in early 2008, Rodriguez sat on his hands. He thinks that housing will continue to get hammered and the credit crisis will get far worse before it gets better. Instead, he and his analysts have been scrutinizing dozens of companies, primarily in retailing, technology and energy. (Convinced that financial stocks have further to fall, he thinks it will be "at least another year" before any bargains will be had there.)
If he remains true to form, Rodriguez and his team will spend the coming months learning everything they can about the values of these underlying businesses while stock prices continue to drop. When the stocks on his buy list finally get cheap enough, Rodriguez will have hundreds of millions of dollars to deploy into companies he will understand better than many of the sellers do.
Rodriguez recently moved his office from Los Angeles to his home on Lake Tahoe. He believes that being able to look out over the water has given him a different perspective, helping him see the credit crisis coming.
Living in Nevada also frees him up to indulge in his hobby of racing Porsches around desert racetracks at speeds of up to 180 mph. "It's not speed that kills," laughs Rodriguez. "It's that sudden stop at the end."
He might as well be talking about the market. And you don't have to invest in his funds to learn from his technique: Keep your foot on the brake when other people are going dangerously fast, and when they all slam on the brakes, tap the gas pedal and swerve past them.
A strong case for market optimism
Believe it or not - you have several good reasons to believe the sky isn't falling. In fact, it may be clearing up.
OK the world isn't ending
But what has to go right for stocks to rebound?
By Michael Sivy, Money Magazine editor-at-large
Last Updated: April 22, 2008: 4:40 AM EDT
(Money Magazine) -- The economy is in trouble and fear rules Wall Street. No wonder. Banks and other financial companies are posting huge losses. The Federal Reserve has had to engineer a rescue of investment bank Bear Stearns. Home prices are sinking.
The Fed is cutting interest rates to battle recession, but the stock market refuses to be calmed. The Dow swings wildly even as it teeters on the edge of a bear market. And oil keeps rising while the dollar keeps falling. It's all unsettling in the extreme.
But the really scary question is, What's next? Are we at the start of a deep recession and a crushing decline in stock prices? And however serious the problems, how can you best protect your investments?
I'd argue that if you apply a little long-term thinking to the worries that are keeping you up at night, you may well conclude that the outlook for your portfolio isn't so bad - and in fact, that it may even be mildly encouraging.
We've had downturns before. Why does this one seem scarier?
Normally, bear markets and recessions are simply a phase of the business cycle. But the current slump in the stock market and the economy has a different, and potentially more dangerous, origin - a financial crisis.
The outlines of the story are by now depressingly familiar. When the real estate boom ended, a variety of supposedly safe mortgage-backed financial instruments turned out to be poison. The banks and other institutions that owned this debt - or were exposed to it indirectly - suddenly found themselves on the hook for enormous losses. Exactly how big no one could say. The uncertainty has made them much more cautious about lending, and that in turn is hurting companies that rely on short-term borrowing.
Falling home prices and the credit squeeze also hit consumers directly. The cash-out refinancings that homeowners used to pay off other debt and support their standard of living are harder to come by. The big fear is that reduced consumer spending and a credit crunch together could trigger a recession much worse than the normal business-cycle slump.
How bad could things get?
Bear markets that are set off by a shock can be severe. The Great Depression of the 1930s, the stagflation caused by the oil crisis in the 1970s and the real estate bust in Japan in the 1990s all crushed stock returns for years.
Among the most pessimistic economists now is New York University's Nouriel Roubini. He worries that the damage caused by the housing bust will be too big for the Fed to contain. Roubini expects that without far more extensive government intervention, home prices will fall a lot further, leading millions of homeowners to walk away from their mortgages. Banks will have to write down the value of mortgage-backed assets much more sharply than they already have.
The resulting domino effect would knock down the entire financial sector, commercial real estate and commercial lending. The process could take several years to play out and would wreak havoc on the portfolios of pros and Joes alike.
Other gloomy forecasters take more measured positions, but many still believe that the decline in housing prices is at best half over. They expect that stocks will suffer another significant decline and that any near-term rebound in prices will prove only a temporary respite.
That sounds awful. Why on earth should I be optimistic?
First, remember that predictors of doom make headlines precisely because their positions are so extreme. Most forecasters are more positive. The UCLA Anderson Forecast still anticipates that the slowdown won't even be severe enough to rank as an official recession. (To qualify, the economy has to actually shrink for at least six months, not just stagnate.)
Edward Yardeni of Yardeni Research is one of many economists who expect a short, shallow recession during the first half of the year with a recovery starting by fall, and he projects that S&P 500 operating earnings will rise 7% for the year. Yardeni also notes that the price/earnings ratios of big value stocks are quite low and that growth stocks are the cheapest they've been in more than a decade.
Even Warren Buffett, who has said we're now in a recession, is bullish longer term. His Berkshire Hathaway has sold a variety of options basically betting that the stock market is close to a bottom.
I'm inclined to agree that the outlook for the economy is more encouraging than most investors seem to think. For one thing, it appears likely that most of the damage has been done and that stock prices today reflect what are now widely recognized problems. Moreover, while you can find similarities between the three big shocks of the past 80 years and today's situation, none really matches present circumstances. Let's look at them in more detail.
Depression. The 1929 stock market crash was the best-known event leading into the Great Depression, but the loss of paper wealth wasn't what unleashed the calamity. The more important causes included bank failures, excessive consumer debt and restrictions on international trade. Some of these seem to have parallels today, but the most important factor is completely different.
As banks failed in the early 1930s, the Federal Reserve allowed the money supply to shrink by as much as 35%, causing the economy to keep contracting. Today, by contrast, the Fed has been pumping money into the economy as fast as it can. Over the past year, in fact, the money supply has grown more than 7%.
In addition, the Fed is intervening to an unprecedented degree to shore up troubled banks and brokerages. It's likely that Bernanke & Co. will keep pushing interest rates down to make it easy for banks to lend money, thus minimizing the credit squeeze.
Once all the banks' bad loans have been identified and written off over the next year or so, some institutions will be out of business and others will have been forced to merge à la Bear Stearns. Their stockholders and bondholders will have suffered - a lot. But most of the U.S. economy will be poised to recover.
Stagflation. In the 1970s a sharp spike in oil prices following the OPEC embargo produced a devastating combination of slow growth and soaring inflation. Today oil prices are as high as they were in the '70s, after adjusting for inflation. Yet the U.S. economy is more than twice as energy-efficient as it was back then.
Like a car that gets 28 miles to the gallon instead of 14, today's economy can better tolerate high fuel costs (although there is still some pain). And despite a few bad inflation numbers in recent months, pressure for price increases generally remains moderate.
Stagnation. In the late 1980s, Japanese real estate boomed. When the bust came, financial authorities there kept trying to prop up prices so that companies could avoid big write-downs. The result was much like removing a bandage very slowly, and for 13 years investors in Japanese stocks felt the pain.
The recent real estate bubble in the U.S., however, never got as overinflated as the one in Japan did. And although the Fed and other parts of the government are trying to cushion the fall, they aren't trying to postpone it indefinitely. U.S. banks, unlike their Japanese counterparts of the '90s, tend to acknowledge loan losses fairly promptly. That may hurt stocks in the short run, but it should leave the economy and the market open for a recovery much sooner.
The stock market always recovers from setbacks, if you're prepared to wait long enough. The real question is what's needed for a prompt recovery. The average bear market lasts 14 months, but declines can end in less than six months if the economy doesn't suffer an extended slump - and if share prices are not massively overvalued to begin with.
On this second point, the numbers are encouraging. The most popular blue chips were trading at price/earnings ratios above 30 back in 2000, right before growth stocks collapsed. The historical average for those stocks is 24, and they were at less than 20 when the market topped last October.
As for how big a decline might be, past bear markets have split into two categories: those in which blue chips drop by an average of 22% and much bigger declines in which the drop averages 39%. The S&P 500 has been down as much as 18% from its October high, so I don't expect much more downside.
That said, my optimistic outlook for stocks does rest on two reasonable, though by no means surefire, assumptions. The first is that the Fed will pursue the right interest-rate policy - specifically, that it will continue to cut short-term rates this year and that it will also start nudging them back up in a year or two so that the economy and inflation don't over-heat.
That's not as easy as it sounds. A big part of the blame for the current troubles can be laid at the feet of the Greenspan Fed, which in hindsight kept rates too low for too long following 9/11 and ended up pumping more and more hot air into the real estate bubble.
The second assumption is that the scale of loan losses will remain within manageable bounds. The doomsayers notwithstanding, the total equity in the U.S. financial system is many times larger than the total losses most economists expect.
But what about the dollar? If it keeps dropping, that has to be bad, no?
" The dollar normally declines when the U.S. runs a very big budget deficit and the economy slows, especially if similar trends aren't occurring in countries that we trade with. Even more important is the level of interest rates. Europe hasn't been cutting rates much, while the Fed has slashed ours by three percentage points in less than a year. Foreigners don't want investments in declining dollars when their interest income is also falling.
A weak dollar is inconvenient if you travel overseas, and it pushes up the prices of imports. But the weakness also makes U.S. products cheaper for foreigners and helps U.S. exports. Many U.S.-based multinational companies get more than 40% of their earnings from outside the country. At the very least, export growth saves jobs and helps lessen the impact of a recession.
In any event, the Fed can't afford to worry about the dollar as long as it has the credit crunch to deal with. Low interest rates are necessary to limit damage to the economy which has to be top priority. When growth resumes and the Fed is raising rates once again, the dollar should recover much of its lost value.
What should I be doing with my portfolio?
You can't buy low and sell high if you dump stocks in a depressed market. Today lots of blue chips trading at below-average P/Es are likely to be bargains. When you're considering such stocks, start by looking at businesses that get a large share of earnings overseas, where economies are more stable now.
Low debt is always good. So is a dividend yield of more than 2.5%. The blue chips mentioned in our 100 best list share these characteristics. If you prefer mutual funds, dollar-cost averaging into a total stock market mutual fund or investing in a high-yield stock fund makes sense psychologically and financially in this market.
Beyond that, follow the rules of investing that apply in any market. Diversify your investments as broadly as possible, minimize your trading costs, and balance growth stocks with income investments.
What if things do go wrong?
If you buy into the dire outlook that Roubini sees, you might want to take all your money and put it into Treasury bonds or CDs and wait things out. The problem with that strategy is that you not only have to be right in your pessimism, you have to know exactly when to turn optimistic again. Even the experts have a hard time getting that right.
And it's worth noting that Roubini, despite his concerns about the next few years, keeps his entire portfolio in stocks because he sees himself as a long-term investor.
But if you feel like you must do something, there are more reasonable insurance strategies you can employ. Increase the size of your emergency cash fund. Put a small slice of your portfolio into an inflation hedge like T. Rowe Price's New Era fund, which invests in commodity producers. Invest in foreign blue-chip mutual funds to hedge against a falling dollar.
For my money, this insurance is too expensive now. Commodity and foreign-stock funds have already had a big run, and those are the areas of the market where investors have been piling in lately. Historically, following the crowd only leaves you poorer. I'd rather pick up bargains among the strongest U.S. stocks. That would let me rest easier at night.
- Reporting By Joe Light; Donna Rosato contributed to this article.
First Published: April 22, 2008: 4:20 AM EDT
OK the world isn't ending
But what has to go right for stocks to rebound?
By Michael Sivy, Money Magazine editor-at-large
Last Updated: April 22, 2008: 4:40 AM EDT
(Money Magazine) -- The economy is in trouble and fear rules Wall Street. No wonder. Banks and other financial companies are posting huge losses. The Federal Reserve has had to engineer a rescue of investment bank Bear Stearns. Home prices are sinking.
The Fed is cutting interest rates to battle recession, but the stock market refuses to be calmed. The Dow swings wildly even as it teeters on the edge of a bear market. And oil keeps rising while the dollar keeps falling. It's all unsettling in the extreme.
But the really scary question is, What's next? Are we at the start of a deep recession and a crushing decline in stock prices? And however serious the problems, how can you best protect your investments?
I'd argue that if you apply a little long-term thinking to the worries that are keeping you up at night, you may well conclude that the outlook for your portfolio isn't so bad - and in fact, that it may even be mildly encouraging.
We've had downturns before. Why does this one seem scarier?
Normally, bear markets and recessions are simply a phase of the business cycle. But the current slump in the stock market and the economy has a different, and potentially more dangerous, origin - a financial crisis.
The outlines of the story are by now depressingly familiar. When the real estate boom ended, a variety of supposedly safe mortgage-backed financial instruments turned out to be poison. The banks and other institutions that owned this debt - or were exposed to it indirectly - suddenly found themselves on the hook for enormous losses. Exactly how big no one could say. The uncertainty has made them much more cautious about lending, and that in turn is hurting companies that rely on short-term borrowing.
Falling home prices and the credit squeeze also hit consumers directly. The cash-out refinancings that homeowners used to pay off other debt and support their standard of living are harder to come by. The big fear is that reduced consumer spending and a credit crunch together could trigger a recession much worse than the normal business-cycle slump.
How bad could things get?
Bear markets that are set off by a shock can be severe. The Great Depression of the 1930s, the stagflation caused by the oil crisis in the 1970s and the real estate bust in Japan in the 1990s all crushed stock returns for years.
Among the most pessimistic economists now is New York University's Nouriel Roubini. He worries that the damage caused by the housing bust will be too big for the Fed to contain. Roubini expects that without far more extensive government intervention, home prices will fall a lot further, leading millions of homeowners to walk away from their mortgages. Banks will have to write down the value of mortgage-backed assets much more sharply than they already have.
The resulting domino effect would knock down the entire financial sector, commercial real estate and commercial lending. The process could take several years to play out and would wreak havoc on the portfolios of pros and Joes alike.
Other gloomy forecasters take more measured positions, but many still believe that the decline in housing prices is at best half over. They expect that stocks will suffer another significant decline and that any near-term rebound in prices will prove only a temporary respite.
That sounds awful. Why on earth should I be optimistic?
First, remember that predictors of doom make headlines precisely because their positions are so extreme. Most forecasters are more positive. The UCLA Anderson Forecast still anticipates that the slowdown won't even be severe enough to rank as an official recession. (To qualify, the economy has to actually shrink for at least six months, not just stagnate.)
Edward Yardeni of Yardeni Research is one of many economists who expect a short, shallow recession during the first half of the year with a recovery starting by fall, and he projects that S&P 500 operating earnings will rise 7% for the year. Yardeni also notes that the price/earnings ratios of big value stocks are quite low and that growth stocks are the cheapest they've been in more than a decade.
Even Warren Buffett, who has said we're now in a recession, is bullish longer term. His Berkshire Hathaway has sold a variety of options basically betting that the stock market is close to a bottom.
I'm inclined to agree that the outlook for the economy is more encouraging than most investors seem to think. For one thing, it appears likely that most of the damage has been done and that stock prices today reflect what are now widely recognized problems. Moreover, while you can find similarities between the three big shocks of the past 80 years and today's situation, none really matches present circumstances. Let's look at them in more detail.
Depression. The 1929 stock market crash was the best-known event leading into the Great Depression, but the loss of paper wealth wasn't what unleashed the calamity. The more important causes included bank failures, excessive consumer debt and restrictions on international trade. Some of these seem to have parallels today, but the most important factor is completely different.
As banks failed in the early 1930s, the Federal Reserve allowed the money supply to shrink by as much as 35%, causing the economy to keep contracting. Today, by contrast, the Fed has been pumping money into the economy as fast as it can. Over the past year, in fact, the money supply has grown more than 7%.
In addition, the Fed is intervening to an unprecedented degree to shore up troubled banks and brokerages. It's likely that Bernanke & Co. will keep pushing interest rates down to make it easy for banks to lend money, thus minimizing the credit squeeze.
Once all the banks' bad loans have been identified and written off over the next year or so, some institutions will be out of business and others will have been forced to merge à la Bear Stearns. Their stockholders and bondholders will have suffered - a lot. But most of the U.S. economy will be poised to recover.
Stagflation. In the 1970s a sharp spike in oil prices following the OPEC embargo produced a devastating combination of slow growth and soaring inflation. Today oil prices are as high as they were in the '70s, after adjusting for inflation. Yet the U.S. economy is more than twice as energy-efficient as it was back then.
Like a car that gets 28 miles to the gallon instead of 14, today's economy can better tolerate high fuel costs (although there is still some pain). And despite a few bad inflation numbers in recent months, pressure for price increases generally remains moderate.
Stagnation. In the late 1980s, Japanese real estate boomed. When the bust came, financial authorities there kept trying to prop up prices so that companies could avoid big write-downs. The result was much like removing a bandage very slowly, and for 13 years investors in Japanese stocks felt the pain.
The recent real estate bubble in the U.S., however, never got as overinflated as the one in Japan did. And although the Fed and other parts of the government are trying to cushion the fall, they aren't trying to postpone it indefinitely. U.S. banks, unlike their Japanese counterparts of the '90s, tend to acknowledge loan losses fairly promptly. That may hurt stocks in the short run, but it should leave the economy and the market open for a recovery much sooner.
The stock market always recovers from setbacks, if you're prepared to wait long enough. The real question is what's needed for a prompt recovery. The average bear market lasts 14 months, but declines can end in less than six months if the economy doesn't suffer an extended slump - and if share prices are not massively overvalued to begin with.
On this second point, the numbers are encouraging. The most popular blue chips were trading at price/earnings ratios above 30 back in 2000, right before growth stocks collapsed. The historical average for those stocks is 24, and they were at less than 20 when the market topped last October.
As for how big a decline might be, past bear markets have split into two categories: those in which blue chips drop by an average of 22% and much bigger declines in which the drop averages 39%. The S&P 500 has been down as much as 18% from its October high, so I don't expect much more downside.
That said, my optimistic outlook for stocks does rest on two reasonable, though by no means surefire, assumptions. The first is that the Fed will pursue the right interest-rate policy - specifically, that it will continue to cut short-term rates this year and that it will also start nudging them back up in a year or two so that the economy and inflation don't over-heat.
That's not as easy as it sounds. A big part of the blame for the current troubles can be laid at the feet of the Greenspan Fed, which in hindsight kept rates too low for too long following 9/11 and ended up pumping more and more hot air into the real estate bubble.
The second assumption is that the scale of loan losses will remain within manageable bounds. The doomsayers notwithstanding, the total equity in the U.S. financial system is many times larger than the total losses most economists expect.
But what about the dollar? If it keeps dropping, that has to be bad, no?
" The dollar normally declines when the U.S. runs a very big budget deficit and the economy slows, especially if similar trends aren't occurring in countries that we trade with. Even more important is the level of interest rates. Europe hasn't been cutting rates much, while the Fed has slashed ours by three percentage points in less than a year. Foreigners don't want investments in declining dollars when their interest income is also falling.
A weak dollar is inconvenient if you travel overseas, and it pushes up the prices of imports. But the weakness also makes U.S. products cheaper for foreigners and helps U.S. exports. Many U.S.-based multinational companies get more than 40% of their earnings from outside the country. At the very least, export growth saves jobs and helps lessen the impact of a recession.
In any event, the Fed can't afford to worry about the dollar as long as it has the credit crunch to deal with. Low interest rates are necessary to limit damage to the economy which has to be top priority. When growth resumes and the Fed is raising rates once again, the dollar should recover much of its lost value.
What should I be doing with my portfolio?
You can't buy low and sell high if you dump stocks in a depressed market. Today lots of blue chips trading at below-average P/Es are likely to be bargains. When you're considering such stocks, start by looking at businesses that get a large share of earnings overseas, where economies are more stable now.
Low debt is always good. So is a dividend yield of more than 2.5%. The blue chips mentioned in our 100 best list share these characteristics. If you prefer mutual funds, dollar-cost averaging into a total stock market mutual fund or investing in a high-yield stock fund makes sense psychologically and financially in this market.
Beyond that, follow the rules of investing that apply in any market. Diversify your investments as broadly as possible, minimize your trading costs, and balance growth stocks with income investments.
What if things do go wrong?
If you buy into the dire outlook that Roubini sees, you might want to take all your money and put it into Treasury bonds or CDs and wait things out. The problem with that strategy is that you not only have to be right in your pessimism, you have to know exactly when to turn optimistic again. Even the experts have a hard time getting that right.
And it's worth noting that Roubini, despite his concerns about the next few years, keeps his entire portfolio in stocks because he sees himself as a long-term investor.
But if you feel like you must do something, there are more reasonable insurance strategies you can employ. Increase the size of your emergency cash fund. Put a small slice of your portfolio into an inflation hedge like T. Rowe Price's New Era fund, which invests in commodity producers. Invest in foreign blue-chip mutual funds to hedge against a falling dollar.
For my money, this insurance is too expensive now. Commodity and foreign-stock funds have already had a big run, and those are the areas of the market where investors have been piling in lately. Historically, following the crowd only leaves you poorer. I'd rather pick up bargains among the strongest U.S. stocks. That would let me rest easier at night.
- Reporting By Joe Light; Donna Rosato contributed to this article.
First Published: April 22, 2008: 4:20 AM EDT
Monday, April 21, 2008
The trillion-dollar mortgage time bomb
Risks are rising that Fannie Mae and Freddie Mac may need a government bailout that could cost far more than previous rescues.
By Chris Isidore, CNNMoney.com senior writer
Last Updated: April 21, 2008: 5:46 AM EDT
NEW YORK (CNNMoney.com) -- Among the nightmares lurking around the corner for the already battered housing and credit markets would be a meltdown at mortgage financing giants Fannie Mae and Freddie Mac.
Although few are predicting an imminent need for a bailout just yet, credit rating agency Standard & Poor's recently placed an estimated price tag on this worst case scenario -- $420 billion to $1.1 trillion of taxpayer's money.
This dwarfs how much it cost to help banks during the savings and loan crisis of the late 1980's and early 1990's. That cost taxpayers about $250 billion in today's dollars.
S&P added that saving Fannie (FNM) and Freddie (FRE, Fortune 500) might cost so much that the federal government's AAA credit rating, the top possible rating, might even be at risk. If that was lost, then all federal government borrowing would become more expensive.
Fannie Mae and Freddie Mac both help the mortgage market function by purchasing pools of loans and packaging them into securities.
So it is crucial for the mortgage industry for the two agencies to continue functioning smoothly.
The two companies are known as government-sponsored entities because they have Congressional charters, which implies that the federal government is behind them.
Fannie did not comment about the S&P report. According to a statement from Freddie, the firm said the S&P report was just "a scenario analysis, not a prediction" and added that "Freddie Mac remains a well capitalized company."
Victoria Wagner, a S&P credit analyst who worked on the report, said S&P isn't predicting that Fannie and Freddie would necessarily need a bailout at this time.
But she and other analysts are concerned about the impact more problems could have on the mortgage market since the two companies have become increasingly important to the health of the industry. Both companies are forecast to report more losses this year due to declining home prices and rising mortgage defaults.
Risks increasing
Wagner pointed out that at the end of January, 82% of all mortgages in the U.S. were backed by one of the firms, up from only 46% in the second quarter of 2007.
Fannie and Freddie primarily back so-called conforming loans, those made to borrowers with good credit and large down payments. But even limited exposure to subprime loans hasn't stopped them from running up huge losses as home prices tumbled and foreclosures soared.
And Fannie and Freddie's role in the mortgage and real estate markets is likely to grow, as Congress recently allowed them to back larger mortgages, up to $729,750, up from the previous limit of $417,000.
The Office of Federal Housing Enterprise Oversight (OFHEO), which regulates both firms, also recently lowered the capital requirements for Fannie and Freddie in an effort to pump $200 billion more into the credit markets.
The new loan limits will increase the risks and losses for Fannie and Freddie, said Wagner and other experts.
The high priced markets where homeowners and buyers need larger loans are now the ones seeing steep home price declines. And the default rates on larger loans are greater than the smaller loans that had previously been the core of their business.
"I don't think the message is a bailout is necessary or imminent," Wagner said. "But they're facing this increased role at a time that their own credit performance is suffering from the rifts in the housing and mortgage markets. They're both projecting much higher losses than we've seen in some time."
Some see bailout as more likely
But other experts expect that declining home values will force more borrowers who have a Fannie- or Freddie-backed loan to stop making payments in the coming months, rather than continuing to make payments on a home now worth less than their loan balance.
Rising job losses may also make it difficult for other borrowers who formerly had good credit to stay current on their mortgage payments.
"The real fundamental problem is real estate prices have been falling and they might fall substantially more," said Robert Shiller, a Yale University economist who argued for years that a bubble was forming in real estate prices. "OFHEO and Fannie and Freddie never considered the possibility of a massive real estate correction."
Some economists suggest that if investors start to see problems in the performance of loans backed by Fannie and Freddie, they'll dumping them. And that would force the federal government to step in.
"I would say there's at least a 50-50 chance of some sort of bailout. I'm not saying it will necessarily cost $1 trillion, but they'll need some kind of help, and it very well could happen this year," said Dean Baker, co-director of the Center for Economic and Policy Research
Investors are signaling growing concern as well. The yield premium for securities backed by Freddie and Fannie compared to the yield on Treasury bills has grown to about 2.25 percentage points from 1.7 percentage points at the beginning of the year. That's a sign that the investors see a greater risk of Fannie and Freddie running into bigger problems.
And OFHEO, in its annual report this week, said that while Fannie and Freddie have made progress clearing up accounting problems that had dogged both firms, they remain "a significant supervisory risk."
The agency added that since current home price declines are without precedent, the firms will have a difficult time correctly pricing the risk of the mortgages they're backing.
But Jaret Seiberg, financial services analyst for policy research firm Stanford Group, said Fannie and Freddie ultimately should be able to weather the storm though simply because there is no question that the government would bail them out.
So there shouldn't be a crisis of confidence about their future in the way that there was for investment bank Bear Stearns before the Fed stepped in and agreed to back $29 billion in potential losses so JPMorgan Chase (JPM, Fortune 500) could buy Bear Stearns (BSC, Fortune 500).
"What has allowed Fannie and Freddie to continue to operate when the private mortgage-backed security market dried up is their implicit government guarantee," said Seiberg.
First Published: April 21, 2008: 3:51 AM EDT
By Chris Isidore, CNNMoney.com senior writer
Last Updated: April 21, 2008: 5:46 AM EDT
NEW YORK (CNNMoney.com) -- Among the nightmares lurking around the corner for the already battered housing and credit markets would be a meltdown at mortgage financing giants Fannie Mae and Freddie Mac.
Although few are predicting an imminent need for a bailout just yet, credit rating agency Standard & Poor's recently placed an estimated price tag on this worst case scenario -- $420 billion to $1.1 trillion of taxpayer's money.
This dwarfs how much it cost to help banks during the savings and loan crisis of the late 1980's and early 1990's. That cost taxpayers about $250 billion in today's dollars.
S&P added that saving Fannie (FNM) and Freddie (FRE, Fortune 500) might cost so much that the federal government's AAA credit rating, the top possible rating, might even be at risk. If that was lost, then all federal government borrowing would become more expensive.
Fannie Mae and Freddie Mac both help the mortgage market function by purchasing pools of loans and packaging them into securities.
So it is crucial for the mortgage industry for the two agencies to continue functioning smoothly.
The two companies are known as government-sponsored entities because they have Congressional charters, which implies that the federal government is behind them.
Fannie did not comment about the S&P report. According to a statement from Freddie, the firm said the S&P report was just "a scenario analysis, not a prediction" and added that "Freddie Mac remains a well capitalized company."
Victoria Wagner, a S&P credit analyst who worked on the report, said S&P isn't predicting that Fannie and Freddie would necessarily need a bailout at this time.
But she and other analysts are concerned about the impact more problems could have on the mortgage market since the two companies have become increasingly important to the health of the industry. Both companies are forecast to report more losses this year due to declining home prices and rising mortgage defaults.
Risks increasing
Wagner pointed out that at the end of January, 82% of all mortgages in the U.S. were backed by one of the firms, up from only 46% in the second quarter of 2007.
Fannie and Freddie primarily back so-called conforming loans, those made to borrowers with good credit and large down payments. But even limited exposure to subprime loans hasn't stopped them from running up huge losses as home prices tumbled and foreclosures soared.
And Fannie and Freddie's role in the mortgage and real estate markets is likely to grow, as Congress recently allowed them to back larger mortgages, up to $729,750, up from the previous limit of $417,000.
The Office of Federal Housing Enterprise Oversight (OFHEO), which regulates both firms, also recently lowered the capital requirements for Fannie and Freddie in an effort to pump $200 billion more into the credit markets.
The new loan limits will increase the risks and losses for Fannie and Freddie, said Wagner and other experts.
The high priced markets where homeowners and buyers need larger loans are now the ones seeing steep home price declines. And the default rates on larger loans are greater than the smaller loans that had previously been the core of their business.
"I don't think the message is a bailout is necessary or imminent," Wagner said. "But they're facing this increased role at a time that their own credit performance is suffering from the rifts in the housing and mortgage markets. They're both projecting much higher losses than we've seen in some time."
Some see bailout as more likely
But other experts expect that declining home values will force more borrowers who have a Fannie- or Freddie-backed loan to stop making payments in the coming months, rather than continuing to make payments on a home now worth less than their loan balance.
Rising job losses may also make it difficult for other borrowers who formerly had good credit to stay current on their mortgage payments.
"The real fundamental problem is real estate prices have been falling and they might fall substantially more," said Robert Shiller, a Yale University economist who argued for years that a bubble was forming in real estate prices. "OFHEO and Fannie and Freddie never considered the possibility of a massive real estate correction."
Some economists suggest that if investors start to see problems in the performance of loans backed by Fannie and Freddie, they'll dumping them. And that would force the federal government to step in.
"I would say there's at least a 50-50 chance of some sort of bailout. I'm not saying it will necessarily cost $1 trillion, but they'll need some kind of help, and it very well could happen this year," said Dean Baker, co-director of the Center for Economic and Policy Research
Investors are signaling growing concern as well. The yield premium for securities backed by Freddie and Fannie compared to the yield on Treasury bills has grown to about 2.25 percentage points from 1.7 percentage points at the beginning of the year. That's a sign that the investors see a greater risk of Fannie and Freddie running into bigger problems.
And OFHEO, in its annual report this week, said that while Fannie and Freddie have made progress clearing up accounting problems that had dogged both firms, they remain "a significant supervisory risk."
The agency added that since current home price declines are without precedent, the firms will have a difficult time correctly pricing the risk of the mortgages they're backing.
But Jaret Seiberg, financial services analyst for policy research firm Stanford Group, said Fannie and Freddie ultimately should be able to weather the storm though simply because there is no question that the government would bail them out.
So there shouldn't be a crisis of confidence about their future in the way that there was for investment bank Bear Stearns before the Fed stepped in and agreed to back $29 billion in potential losses so JPMorgan Chase (JPM, Fortune 500) could buy Bear Stearns (BSC, Fortune 500).
"What has allowed Fannie and Freddie to continue to operate when the private mortgage-backed security market dried up is their implicit government guarantee," said Seiberg.
First Published: April 21, 2008: 3:51 AM EDT
Tuesday, April 15, 2008
Wall Street Digest Hotline Update
This is The Wall Street Digest Hotline Update for Tuesday, April 15, 2008, at 6:00 p.m. EST.
The 60-day cycle should have bottomed today and removed downward pressure on stock prices. At the close, the Dow gained 60 points, closing at 12,362, while the Nasdaq added 10 points, closing at 2,286. Oil closed $2.03 higher at $113.79 per barrel, and gold closed up $3.30 at $932.00 an ounce.
Producer prices were up almost twice as much as expected last month. Food costs are rising at the fastest pace in 17 years. On the plus side, the New York Manufacturing Index grew unexpectedly last month, reducing the odds that the Fed will cut the Fed Funds rate by more than a quarter point at the next FOMC meeting.
New York Stock Exchange cash levels are at the highest levels ever, while hedge fund cash levels are at the highest levels since the market bottom in the fall of 2003.
The Fed continues to create new M3 money every week. Monetary policy is extremely loose because the Fed is more concerned about the economy and the housing sector than inflation or the dollar. The yield curve is steep and has never failed to end a recession at these levels. Stay fully invested for the coming rally.
Let's continue to avoid the housing sector, as well as the banking and financial sectors. I would not purchase residential nor commercial real estate. I do not expect the housing market to bottom in 2008.
Stay close to our Tuesday/Friday Hotline Updates. I will be adjusting our portfolio of recommendations to capture maximum profits from a stock market rally that will surprise everyone, but you.
The next Hotline Update will be on Friday, April 18, 2008, at 6:00 p.m. EST.
The 60-day cycle should have bottomed today and removed downward pressure on stock prices. At the close, the Dow gained 60 points, closing at 12,362, while the Nasdaq added 10 points, closing at 2,286. Oil closed $2.03 higher at $113.79 per barrel, and gold closed up $3.30 at $932.00 an ounce.
Producer prices were up almost twice as much as expected last month. Food costs are rising at the fastest pace in 17 years. On the plus side, the New York Manufacturing Index grew unexpectedly last month, reducing the odds that the Fed will cut the Fed Funds rate by more than a quarter point at the next FOMC meeting.
New York Stock Exchange cash levels are at the highest levels ever, while hedge fund cash levels are at the highest levels since the market bottom in the fall of 2003.
The Fed continues to create new M3 money every week. Monetary policy is extremely loose because the Fed is more concerned about the economy and the housing sector than inflation or the dollar. The yield curve is steep and has never failed to end a recession at these levels. Stay fully invested for the coming rally.
Let's continue to avoid the housing sector, as well as the banking and financial sectors. I would not purchase residential nor commercial real estate. I do not expect the housing market to bottom in 2008.
Stay close to our Tuesday/Friday Hotline Updates. I will be adjusting our portfolio of recommendations to capture maximum profits from a stock market rally that will surprise everyone, but you.
The next Hotline Update will be on Friday, April 18, 2008, at 6:00 p.m. EST.
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