Monday, July 7, 2008

Dear Freddie

Dear Freddie,

By the time you read this, I’ll be gone. I’m sorry for doing this, but it’s for the best. I know this might come as a bit of a surprise to you, especially since I’ve been so happy lately. I’ve certainly benefited from our relationship, but I’ve gotten as much out of it as I should reasonably expect. Although we could have dragged this out a little longer, I think it’s in my best interest to move on.

I’ve come to realize that our association isn't healthy as it was built only on lies, misleading communication, and our differences. Even when it came to finances, we never really clicked. I’m financially independent and you’re not. I’m fairly frugal, but you just can’t stop spending. I care about quality and value while you like chasing the latest fad. I prefer to save, and you prefer to borrow. Furthermore, you’re not nearly as popular as you used to be, you don’t make as much money, your credit score is falling, and you’re always arguing with your supervisor.

Anyway, I’m going online to peruse the Edgar filings for some new friends. I’d still like to keep in touch. Who knows. In another time under different circumstances, maybe I’ll look you up again.



P.S. Rumors that I've been seen hanging out with your cousins, Fannie and Sallie, are completely false. They're both girls of low moral character.

Ok. Let's get serious. Per my recent quarterly portfolio commentary, I began reducing short positions in the financial sector at the end of last quarter, and I mentioned that I would be looking for opportunities to further reduce exposure if the sector continued selling off. Today's 20%+ decline in Freddie Mac shares provided just this opportunity.

FRE - One year

FRE Today

From the New York Times today:

Shares of Fannie Mae and Freddie Mac, the largest providers of funding for United States home mortgages, plunged Monday on concern the companies need to raise more capital amid larger-than-expected losses.

The corporate “federal agency” debt obligations and mortgage-backed securities guaranteed by the companies also plummeted relative to government debt as investors thinned positions, analysts said.

Today's collapse holds a special place in my heart. My first post on the Market Rubbernecker actually dealt with FNM and FRE and the issue of their capital adequacy. In that post, I took issue with the sharp rebound that the shares experienced in mid-March (see chart above) following the announcement that their capital requirements were actually being reduced which would allow them to expand their portfolios in the midst of a housing bust.

Those concerns about capital adequacy have clearly been weighing on investors after that mid-March climb as shares have lost about 50% since then, with another 20% getting lopped off today.
As I stated back in March, there is a very good chance that the equity holders of FNM and FRE will be wiped out, and I still believe that may happen. Despite that, Aspera's clients have had a very nice gain from the FRE short, and I usually prefer to exit a position a little early and leave a little something for the next guy (FRE was sold today in the $11.30-11.40 range).

I still have a short position in Wachovia, but I've now covered most of the financial shorts. I also reduced exposure to TWM intraday for clients that were overweight the position (double inverse Russell 2000 ETF) as it was up another 5% over the past few days.

We need to remember that bear markets are always punctuated by strong short-term rallies like we experienced this past spring. It would not be at all surprising, from a contrarian stance, to see another rally in the near future given the increasingly pervasive bearishness in the market. Regardless of which way the market moves in the near-term, I suspect that the increased level of volatility will result in further outstanding investment opportunities, both long and short.