Franklin Raines (Mr. Potato Head) is the head of Fannie Mae. He was paid approximately $20 million last year (2003) to run Fannie Mae, a so-called GSE (Government Sponsored Enterprise) that is the principal facilitator of the housing bubble. Franklin is an ex-bureaucrat whose job appears to be basically to schmooze political Washington while he and his buddies make hay. Fannie Mae buys mortgages from the originating institution and then either holds them or securitizes them for resale with a guarantee. Fannie Mae’s portfolio is about $1 trillion, support by a mere $26 billion in capital. It gets away with this on the theory that, as a GSE, there is an implicit government guarantee associated with Fannie’s debt. There is no explicit guarantee (unlike Ginnie Mae, a similar GSE, which does have a formal guarantee from the US Treasury).

Another GSE, Freddie Mac, had a series of major accounting screwups and was discovered to have been indulging in, shall we say, questionable accounting. The guy running Freddie escaped, however, with a mere $50 million in loot. Nonetheless, this fiasco led to increased scrutiny of the GSEs, which is entirely appropriate considering their thin capital and the size of the portfolios. Fannie Mae’s portfolio is about 20% of GDP, just to put it into perspective. A new regulator was appointed (OFHEO) who today issued a report damning Fannie’s accounting. It appears that Fannie has been illegally managing its earnings, probably both to enhance its apparent creditworthiness and to justify the huge compensation paid to its executives, including but not limited to Mr. P.H.

This could be a huge story in the credit markets as it unfolds, as much of the credit bubble is based on Fannie’s guarantee of housing debt. What is it worth? What is Fannie’s real GAAP capitalization? Have the executives been cheating for personal gain? What does this mean for the housing market? What about the huge derivatives portfolio that Fannie has used to hedge credit risk? Is there any there there? By any measure, systemic risk just went up a notch.

More as it unfolds.

Only once (before now) in the last 35 years have bond yields fallen after a Fed rate hike. That was in 1971. The Fed was soon cutting rates as the economy sank into recession.

As expected, Uncle Al raised by a quarter point to 1.75%, saying that policy remained “accommodative” and that increases would be “measured”. Whatever that means. Anyway, bonds rallied strongly and the equities were jammed with massive buy programs. Bonds at 4.04% on the 10-year are forecasting a dismal economic future, while stocks apparently see blue skies everywhere. One of them has it wrong. I suppose there is a community that buys stocks based on the so-called “Fed model” that says that stocks act like bonds and go up when rates go down. Too bad it doesn’t stand up, except during the brief 15-year period the Fed used to develop the model.

Oil ramped back up to $47 today, and natural gas up to $5.60. Gold was strong as the dollar took it on the chin as a result of the rate fall in bonds. The Canadian portfolio was gangbusters as a result, with the energies up 2% and the golds up 3%.

A little tidbit from the folks at Cellstar (CLST), who took down their Asia-Pacific revenue forecast by 52%; “Current excess inventory levels are reported to be greater than they were during the outbreak of SARS in 2003, with some estimates as high as 40 million excess handsets.” Hmmm. Well at least it wasn’t bought. Most techs that warn are being bought, bizarre as it may seem.

Early this morning, PMC-Sierra warned, reducing its revenue forecast by about 20%. After an initial dip, PMCS closed up more than 4%. This is the same pattern of excess bullishness that has accompanied most of the semiconductor industry warnings. This in an industry group where a Gartner Group analyst has predicted that 40% of the companies will be out of business within the next 10 years.

Mania.

In other news, on the real estate side; “NEW YORK (Money Magazine) - Forget book clubs and poker nights. America’s property craze has spawned a new social network: The real estate investment club.” Bubble Trouble

Mania.

A Morgan Stanley research report last week pointed out that the inventory situation is even worse than it appears in the months-of-sales ratios. In absolute terms, inventories have risen for almost five years and, as a proportion of total homes, are reaching the 1990s recession level of 2.5%.

Rapid turnover — the quick flipping of homes - is masking the inventory buildup. Turnover is at an all-time high of over 9%.

Mania.

Technically, most US indexes look to be at or close to the top of the slowly declining channel that has enclosed them since February/March of this year. Volatility is very low. VIX is low. I suspect we either break out higher in a repeat of last year’s fall rally, or we roll over in the next week or two and head much lower.

Fundamental weakness, in my view, favors the “roll over”. Bullish sentiment probably does also, although bullishness can always get more bullish until the last bear has given up.