“Given the scrutiny the markets are under, Fannie and Freddie in particular, it’s irresponsible to put something like this out without having clearly done your homework.” cited in HousingWire 7/7 2008.
"Ladies and Gentlemen – The Day of Reckoning has arrived." - HousingDoom 7/7 2008
In retrospect it was last July 7th, the day Doom announced the Castle’s new chicken coop, when all hell broke loose. After reading HousingWire’s founder and Doom friend Paul Jackson’s measured response [1] to the situation I briefly regretted my earlier gut response,[2] but four months later it looks like my instincts were, regretably, the more accurate guide. I originally overreacted to a report [3] that a Lehman Brothers team headed by analyst Bruce Harting was suggesting that Fannie and Freddie would need to raise massive new capital because of an impending accounting rule change which might eventually force them to consolidate (bring back on their own balance sheets) many hundreds of billions of dollars worth of their MBS mortgage securities they had previously put into Qualifying Special Purpose Entity (QSPE) deals. Obviously a gross oversimplification 
On re-reading Paul’s post I have to agree with his assessment: "Shares seemingly fell by [the] second as investors read each word." Which is to say, investors were reacting so fast they were selling even before they got to the "of course OFHEO is going to exempt F&F" bit at the end of the sentence they were reading. This hair-trigger theme was played out two months later in the United Airlines false bankruptcy story fiasco,[4] and seems to be a driver in a lot of the markets’ recent volatility — maybe even yesterday’s gut-wrenching 911-point swing.[5]
Still, although the event was trivial, the result has been profound. The graphs we’re following in this series strongly suggest that Mr. Market is saying "No way on this Earth are those QSPEs bankruptcy remote." I think a lot of investors were thinking this before 7/7, but then the overreaction to the Harting analysis itself must have alerted many to the fact they were not alone in that assessment. The accountants are still working steadily to remove QSPEs from GAAP,[6] and investors are becoming quite wary of the longer issues of Agency Debt.[7] It could prove very difficult to restore the pre-July faith in agencies.
Meanwhile, at least some people are doing OK. Mr. Harting seems to have landed on his feet and has taken up new challenges — including, it would seem, the assignment of helping to write a sequel to the Hollywood blockbuster "Wall Street".[8] Sometimes life can get just a little bit weird.
Anyway, Reuters has reported [9] their regular summary of the week’s update at the NY Fed’s H.4.1 table site.[10] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[11]
Last week saw a significant selloff of agencies and a large buy of treasuries by foreign central banks, continuing the trend for both from recent weeks. However, the size of the moves moderated from the previous week. The net total of US obligations the Fed is holding for the cenbanks rose by a largish $8.87 billion. Neither the treasuries nor the agencies move threatened our Top-10 lists. However, the general trend continued. If you examine the data set, you will see that cenbank agencies holdings peaked at $985.9 billion on July 16, a week and a half after 7/7. Now 17 weeks later the holdings have dropped to $896.8 billion, and the last time agencies were under $900 billion was on March 19, 17 weeks before the peak. Thus the nice symmetrical pattern in the red line in the following.
Reuters has that "… holdings of agency securities fell by $5.08 billion in the week ended Nov. 12 to $896.79 billion, following a $7.24 billion fall in the previous week."
Twist’s 10-week bar graph puts this into perspective. There has been a steady moderation in the selling over the last while.
The large buy of $13.95 billion was still down quite a bit from last week’s figure, and is comfortably out of the Top-10.
However, the continuing rise in treasuries combined with the steady selling of agencies keeps our ratios graphs diving off a cliff.
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Notes and References
[1]: "Fannie, Freddie Socked by Investor Paranoia", by Paul Jackson, HousingWire, July 7, 2008.
[2]: Comment #6 to "Crack of Doom- Twist Bought A House", HousingDoom, July 7, 2008. NOTE: It’s quite possible Paul posted before I put up my comment. It’s just that I reacted before I read his post.
[3]: "Freddie Mac, Fannie Mae shares plunge; GSEs may need to raise capital – Lehman", TradingMarkets, July 7, 2008.
[4]: "False bankruptcy story stuns United Airlines: Shares plummet after story from 2002 is mistakenly reprinted on Internet", by Kyle Peterson, Reuters / Montreal Gazette, September 9, 2008.
[5]: "Stocks end sharply up, erasing three days of losses: Dow sees 911-point swing to close on third-biggest point gain on record", by Kate Gibson, MarketWatch, November 13, 2008.
[6]: "FASB Orders New QSPE Disclosures", by Ed Zwirn, Markets and Media, November 13, 2008.
The disclosures will serve as an interim measure ahead of the board’s FAS 140 and FIN 46(R) rewrites. Proposed amendments to these standards under these rewrites would impose disclosure requirements upon non-transferors and eliminate the QSPE itself as an acceptable accounting practice.
[7]: "Fannie, Freddie Debt Weakens Again", by Prabha Natarajan, Wall Street Journal, November 13, 2008.
Fannie, in its third-quarter filing, said it has "experienced reduced demand for our debt obligations from some of our historical sources of that demand, particularly in international markets."
This, the company said, has made it difficult "to issue debt securities with maturities greater than one year."
This bleak outlook of its inability to raise capital through long-term bonds worried investors.
[8]: "KKR Financial shares continue plunge", AP / CNN Money, November 13, 2008.
Barclays Capital analyst Bruce Harting wrote in a research note late Wednesday that KKR might have to divert cash to cover shortfalls in certain investments. While that will not affect earnings for the company, which is externally managed by a unit of Kohlberg Kravis Roberts & Co., it will reduce cash available for dividends, to make new investments and to fund operations, Harting wrote in the note.
Uncertainty and execution risk reduce the company’s ability to reinvest capital, which is likely to put pressure on its share price and ability to issue dividends in the future, Harting wrote in the note.
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[9]: "Foreign cenbank agency holdings fall 6th week – Fed", Reuters, November 13, 2008.
[10]: "H.4.1 Factors Affecting Reserve Balances", Federal Reserve Statistical Release (weekly), Federal Reserve Bank of New York.
[11]: The updated data set as a Comma Separated Value (CSV) file is here.
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I meant to mention that the “yield curve” for agency debt has been getting problematic. Basically, those juicy yields are attractive if you can roll the stuff over in a few months, but few are brave enough to park their money in these bonds for years. This article’s a must-read on the subject. Fannie’s sticking her toe in today trying to place just $2 billion of 2-year bills.
“Fannie to Sell First Long-Term Debt Since September”, by Jody Shenn, Bloomberg, November 17, 2008.