Tuesday, May 06, 2008

Fannie Mae...or May Not

So let's say that I take a large position in the market and wind up with a harrowing loss that forces me to cut back my lifestyle. What would you think of my decision to borrow additional funds to add to that losing position?

Few rookie traders would engage in such dismal risk management. That, however, describes the situation of Fannie Mae (FNM), which today reported large losses and a dividend cut, but rose nicely on news that their regulator is giving them greater rein to expand their mortgage portfolios.

If the housing market stabilizes, the decision to go "all in" will be hailed as a ballsy vote of confidence in the U.S. economy. (It also might set an interesting moral hazard precedent, when the next crises hit).

If, however, the housing market experiences a deeper drop than is currently projected, the liabilities incurred by FNM are truly mind-boggling. This is because billions of dollars of equity are supporting trillions of dollars of debt, as recently reported by the New York Times in an excellent article.

I'll be tracking price performance for FNM and money flows into the stock as a way of staying on top of this theme. I'm not a bear by temperament, but it makes me nervous to see our government engaging in actions that are characteristic of losing traders.