Opening Bell: Down The Rabbit Hole…

with Freddie and Fannie; bad week for Countrywide; what’s the truth about inflation?; etc.

Freddie Mac, the government-sponsored enterprise that along with Fannie Mae underpins the entire housing market, reported a smaller-than-expected $151 million loss in the first quarter—almost entirely because it changed its accounting—and said it would raise $5.5 billion in capital. Without the accounting changes, it would have lost about $2 billion. Wall Street said “hurrah!” sending shares up 9 percent, which The New York Times on C3 describes thus:

Much like its rival Fannie Mae, whose share price rose last week after it reported enormous losses, Freddie Mac’s performance on Wednesday reinforced the idea that investors have become convinced that Freddie and Fannie are too important for either to fail.

Put another way, even bad news can be good, as long as the federal government needs to bolster an ailing housing market.

Here’s the Quote of the Day:

“Both these companies are clearly going to be insolvent by the end of the year, but everyone knows that Congress will do anything to keep them afloat, because if Fannie and Freddie go under, the entire global financial system will melt down,” said Christopher Whalen, a founder of Institutional Risk Analytics, an independent research firm. “These companies’ earnings don’t matter. Their accounting hardly matters. People buy the stock because they believe the federal government will bail them both out if things get really bad.”

The Wall Street Journal notes up high in its C2 story that Freddie is actually worth less than zero. Its assets are listed at an estimated negative $5.2 billion, down from plus $12.6 billion three months earlier. And it’ll get worse: execs say housing hasn’t hit bottom yet and they expect to take up to $20 billion more in losses.

The Journal’s Heard on the Street, now in its new home at the back of the Money & Investing section, says investors are missing the story—that the company is “weakened,” its balance sheet “enervated,” and it will likely have to dilute its shareholders by issuing new shares. Its debt-to-capital ratio is an enormous fifty—three times that of Citigroup.

Countrywide rebuked, suit is on

Countrywide Financial was slapped down earlier this week by a federal judge who allowed a shareholder lawsuit to move forward against the firm’s executives and board members, the Times says on C1 and the Journal briefs on C2.

The ruling doesn’t bode well for the company—or its buyer, Bank of America—with the strong language coming from the bench, which used terms like “red flags,” “widespread deviations,” and said that the company “misled the public” about Countrywide’s loan practices and financial health.

The Times notes dryly that of the hundreds of mortgage companies that have gone under in the housing bust, “few” at the top have blamed themselves. That’s particularly glaring for Angelo “The Orange” Mozilo, the Countrywide CEO who the lawsuit accuses of insider trading.

The chief executive of Countrywide, Angelo R. Mozilo, has argued that his $474 million in stock sales during the three-year period complied with securities laws under a planned selling program. But he revised the program, known as a 10b5-1 plan, several times, each time increasing the shares to be sold.

As a result, the judge wrote: “Mozilo’s actions appear to defeat the very purpose of 10b5-1 plans,” created to allow corporate insiders to sell stock regularly and without direct involvement.

Mozilo might as well have relieved himself on a hornet’s nest: the stock sales picked up as the company’s shares slid from $45 last year to $4.85 yesterday. And the hornets aren’t unsympathetic Wall Street types. They’re public pension funds like the Arkansas Teacher Retirement System and the Fire & Police Pension Association of Colorado, The Associated Press notes.

Drowning in condos

In yet more housing news, the Chicago Tribune says a record 6,000 new condos will be dumped into the already saturated downtown Chicago (with sales off an incredible 83 percent in the first quarter) this year. It reports that developers may have to cancel projects for years because of the excess supply.

“It’s tremendously serious,” said Steven Hovany, president of Strategy Planning Associates Inc., a planning and real estate consulting firm. “What you are going to see are buildings going into foreclosure.”

The Times has a very interesting story about condo owners who got stuck with higher costs and rundown conditions because tenants in their buildings are dwindling due to foreclosures. It says the housing market may be worse than numbers show because condos, which account for one in eight homes, aren’t included in “many of the numbers.”

And here comes (more) trouble: 202,000 new condo units will come online this year, adding more than a third to the total added over the last five years, which was no slack time.

Is the Fed losing its independence?

Former Federal Reserve Chairman Paul Volcker continued to question the current regime’s policies, this time in Congressional testimony where he said its unprecedented moves threaten its political independence, the Journal reports on A3. Why does that matter? The Fed was set up to be somewhat immune from political pressures to print money. Bloomberg notes that the Fed has already been pressured by Congress this month to accept student-loan debt as collateral for loans to banks and Wall Street.

Volcker called for tighter regulation of Wall Street to bring it in line with what’s required of commercial banks—especially now that the Fed is lending to investment banks as if they were regular banks, the WSJ and Bloomberg write. He noted that regulators let off-balance-sheet entities proliferate. As quoted by the Journal:

”They were not regulated and [banks] didn’t hold an adequate amount of capital against them. Why did that happen after the experience of Enron?”

The Financial Times writes that Volcker warned of a similarity between what’s going on today and the stagflation of the 1970s, and said the Fed should step up its fight against price increases getting out of control. (It also fronts news that the German president lashed out at bankers and markets, calling for “more severe” regulation.)

‘Statistical sleight of hand’

But the consumer-price index just edged up in April by 0.2 percent from the month before, which was less than economists expected, and was perhaps evidence that the downturn is slowing inflation, say the NYT on C4 and the WSJ on A4. Still, prices from a year ago are up 3.9 percent. Volcker joined the crowd saying there’s “a lot more inflation” than government numbers are showing, Bloomberg reports in its Volcker-testimony story.

Indeed, the report was made so moderate because of the way the Labor Department calculated gas prices, which were really up 5.6 percent on the month, but for seasonally adjusted inflation purposes were down 0.2 percent (NYT) or 2 percent (WSJ) depending on who you believe. The Times quotes PNC’s head economist calling it a “statistical sleight of hand.”

Drilling down a bit into the numbers, there were some worrisome signs. The numbers picked up a big increase in the price of food, which rose 0.9 percent on the month, the most in eighteen years, which the Journal and Times bury but Bloomberg and the Los Angeles Times correctly place in their ledes. The NYT writes that food prices are up 5.1 percent from a year ago.

“This is a fine inflation report if you don’t need to eat, drive or depend on your paycheck,” said Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington and author of the recently released book, “Crunch: Why Do I Feel So Squeezed?” (Berrett-Koehler).

The LAT’s, which drips with the skepticism so often absent from reporting on the government’s economic numbers, notes there are good statistical reasons for its adjustment of gas prices.

Backdating update

The Securities and Exchange Commission filed civil charges against the two founders of Broadcom as the stock-options backdating scandal continues, the WSJ says on B1. The government says they fraudulently backdated options over five years and the company a year and a half ago restated its earnings to account for a whopping $2.2 billion in compensation costs it hadn’t reported, the LAT says. We’ll refer to the WSJ, which broke the backdating scandal with some of the more ingenious reporting of the last few years, for a definition:

Back-dating refers to manipulating the date at which stock options are granted, resulting in a lower price to buy shares that employees can later sell at a greater profit.

Banks easing back into debt game

The WSJ on its Money & Investing front says banks are issuing debt to companies again—hesitantly—for acquisitions and share buybacks. Junk bonds are even coming back a bit. But the paper emphasizes the caution being employed still and notes that it may be a blip.

Banks and debt investors are treading carefully. While they are more open to financing deals where one corporation buys another, many are still somewhat reluctant to fund leveraged buyouts by private-equity firms.

Companies acquired in leveraged buyouts are often loaded up with a lot more debt relative to their cash flow, increasing their risk of default.

Although debt issuance is picking up, the activity is so far largely limited to bigger companies or those with relatively strong balance sheets. The average size of new junk-bond offerings is half of what it was a year ago, and bankers don’t think the market can yet stomach multibillion-dollar debt sales.

GE to unload iconic appliance division

General Electric is talking about selling its appliance division for $5 billion to $8 billion, the papers say. The Journal puts it on A1 while the Times drops it on its Business Day cover and the FT on its Companies & Markets front.

The NYT says a “sale would mark the end of a brand of household products that made General Electric a fixture in American homes over the last century.” The papers say the unit may end up owned by foreigners.

GE is trying to re-jigger itself to fend off calls to break up the conglomerate—and demands for the head of its CEO Jeff Immelt—that were accelerated by its miserable earnings report last month.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.