Beware... the Credit Crunch
Part II Is Here
By Dr. Steve Sjuggerud
March 7, 2008
Yesterday, the U.S. Treasury explicitly said it has no plans to back Fannie Mae and Freddie Mac, the U.S. government-sponsored mortgage guarantors.
If these two struggle, the entire U.S. mortgage market is in trouble. And if the government won't back these two... then our recommended virtual banks, like Annaly, are no longer safe. Or at least that's what the market thought yesterday...
The Credit Crunch Part II is in now in full swing. And the sequel is scarier than the original version back from last summer.
In August 2007, the entire U.S. banking system teetered on seizing up... Banks didn't want to lend to each other. They called in their loans. Then Fed Chairman Ben Bernanke jumped in, cutting the discount rate and easing the crisis.
But now, once again, banks are nervous. They're calling in loans and asking questions later.
At first, the banks were just calling back loans that were obviously questionable – like subprime loans. But now, even safe credits are getting hit. As an example, it appears that Thornburg Mortgage (TMA) might not survive the next two days.
Thornburg has an incredibly high-quality portfolio of loans. If it were able to hold onto those loans, chances are excellent it'd get more than 99% of its money back. That's what Thornburg's been able to do throughout its history. But now it's being forced to liquidate that clean portfolio at fire-sale prices.
Thornburg's problem is leverage – it's basically borrowed 94 cents of every dollar it invests. If the value of those assets falls to 90 cents on the dollar, Thornburg will be "upside down"... it will have negative equity.
That shouldn't ever happen... but it is now. Banks are demanding their collateral back, which forces Thornburg to sell, which causes more banks to demand their collateral... It's a vicious circle.
Now, it is reaching ridiculous proportions. It appears banks are demanding their money back from the safest credits out there... virtual banks.
To me, this is ludicrous... These companies only hold securities that carry the implied backing of the U.S. government. The credit risk is as close to zero as it gets... or is it?
The biggest virtual banks are all about 10 times leveraged, which mean that they've borrowed 90 cents on the dollar of their purchases. The risk of their guaranteed assets falling below a price of 90 cents on the dollar should be extremely small. But the Treasury Department's announcement has made big banks nervous.
Now we're seeing a "liquidity" crunch... Banks are demanding their money back. Virtual banks are flooding the market with these believed-to-be-government-guaranteed bonds, selling at whatever price they can get.
I think and hope and expect the virtual banks will survive... But the best thing to do right now is to follow your trailing stops.
Once again, I am flabbergasted... This is unbelievable. If government-sponsored Fannie Mae and Freddie Mac go belly-up, that's it for our virtual banks. It's a real disaster scenario for the U.S. mortgage market. I don't expect disaster, but it's a tenuous moment.
If you're an owner of a company with significant leverage – like my recommended virtual banks – do the right thing. We can't know if this ends tomorrow... or in a month... or more...
Play it smart, and protect your capital for a safer day.
Good investing,
Steve
Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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