Armando Falcon, Jr.: An Enemy of the People?

Armando Falcon, Jr. (pictured above) was the director of the Office of Federal Housing Enterprise Oversight (OFHEO) who brought to light problems at Fannie Mae and Freddie Mac several years ago. For his service as a diligent regulator, he received something less than gratitude from certain Members of Congress, as the video below (which got a lot of hits on YouTube last fall) shows¹. For some reason, the connection between that and the Ibsen play "An Enemy of the People" (which I last read when it was assigned in one of my high school English classes) just came to me yesterday. For those who aren't familiar with the play, here is the summary of it from Wikipedia:

Dr. Thomas Stockmann is the popular citizen of a small coastal town in Norway. The town has recently invested a large amount of public and private money towards the development of baths, a project led by Dr. Stockmann and his brother, the Mayor. The town is expecting a surge in tourism and prosperity from the new baths, said to be of great medicinal value, and as such, the baths are the pride of the town. However, as the baths are starting to succeed, Dr. Stockmann discovers that waste products from the town's tannery are contaminating the baths, causing serious illness among the tourists. He expects this important discovery to be his greatest achievement, and promptly sends a detailed report to the Mayor, which includes a proposed solution, which would come at a considerable cost to the town.

But to his surprise, Stockmann finds it difficult to get through to the authorities. They seem unable to appreciate the seriousness of the issue and unwilling to publicly acknowledge and address the problem because it could mean financial ruin for the town. As the conflict ensues, the Mayor warns his brother that he should "acquiesce in subordinating himself to the community." Stockmann refuses to accept this, and holds a town meeting at Captain Horster's house in order to convince the people to close the baths.

The townspeople - eagerly awaiting the prosperity that the baths are believed will bring - refuse to accept Stockmann's claims, as his friends and allies, who had explicitly given support for his campaign, turn against him en masse. He is taunted and denounced as a lunatic, an "Enemy of the People." In a scathing rebuke of both the Victorian notion of community and the principles of democracy, Dr. Stockmann proclaims that in matters of right and wrong, the individual is superior to the multitude, which is easily led by self-advancing demagogues. Stockmann sums up Ibsen's denunciation of the masses, with the memorable quote "...the strongest man in the world is the man who stands most alone."

And here is that video¹ showing how Falcon's warnings were resented by come Congressional Reps:



¹The creators of this video overstate their case slightly when they claim that Democrats opposed tighter regulation of the GSEs while Republicans advocated tighter regulation. Falcon mentioned to Real Clear Politics that one Democrat, Rep. Maurice Hinchey of New York, was supportive of his efforts. Also, although Republicans in Congress and the Bush Administration advocated stronger regulation of the GSEs, President Bush shared the zeal of most of the Democrats for encouraging the extension of credit to marginal borrowers, in order to increase home ownership levels, particularly among minorities.

The photo of Falcon above comes from this New York Times article, and is credited to Chris Kleponis/Bloomberg News.

Richard Pzena's Picks For 2008

Hat tip to GuruFocus poster Abeck for this Barron's interview with Richard Pzena dated December 31^st, 2007: "Opportunity Amid the Ruins". Excerpt:

Barron's: What is your downside risk [of holding Citigroup]?

Richard Pzena: There is some short-term downside risk. Looking out three years-plus, you have a really spectacular risk/reward trade. The odds that Citigroup sells for less than 30 in three years are very low, and the odds of it selling for substantially above that are very high.

Barron's: Do you feel the same about other banks?

RP: Bank of America [BAC] is the same story. They are going through a downturn, so they're going to have losses and provisions. We're estimating earnings of $3.70 a share for 2007 and $4.10 for '08. Right now, people aren't buying banks because the next quarter might be bad. Whenever investors become hypersensitive to the next piece of information, value opportunities arise.

You have to have a strong stomach to do this. I always joke about it, but the most common question we get from clients in any market environment is "don't you read the paper? How could you possibly do this, given what is going on?" And the response is, these shares don't trade at these valuations unless this kind of stuff is going on. If this proves to be fatal to Citi or Fannie or Freddie, we'll get killed. If it proves not to be fatal, as we suspect, then over the long term we're going to make a lot of money.

The article included this table listing Pzena's six stock picks (Fannie, Freddie, Citi, BofA, Alcatel-Lucent, and Capital One) and their prices as of the end of 2007.

The photo above, of Richard Pzena, is from the Barron's article linked to in this post.

Fannie Mae Exposé

Today's New York Times features a long cover article by Charles Duhigg on the fiasco at Fannie Mae, "Pressured to Take More Risk, Fannie Reached Tipping Point". The broad strokes of this have been covered before, but the Times article fills in some of the sordid details.

The article notes how former Fannie Mae CEO Franklin Raines and his CFO J. Timothy Howard expanded Fannie's share of the mortgage market by having the company increase its purchases of risky mortgages. Those two were of course forced to resign in 2004, after the accounting scandal at Fannie came to light, and Daniel Mudd took over as CEO then. Mudd was shown the door last month, after the federal government took over Fannie Mae. The Times article concludes by describing what Raines, Howard, and Mudd are up to today:

Mr. Raines and Mr. Howard, who kept most of their millions, are living well. Mr. Raines has improved his golf game. Mr. Howard divides his time between large homes outside Washington and Cancun, Mexico, where his staff is learning how to cook American meals.

But Mr. Mudd, who lost millions of dollars as the company’s stock declined and had his severance revoked after the company was seized, often travels to New York for job interviews.

Incidentally, at first I wondered why McCain didn't push back in the first debate when Obama blamed the credit crisis solely on "failed Republican policies", by noting Obama's receipt of campaign contributions from the GSEs, and his association with Franklin Raines. Then I read that McCain's campaign manager, Rick Davis, had been a lobbyist for Freddie Mac.

"Freddie Mac is the Cheapest Stock I've Ever Seen"

So said value investor Richard Pzena¹, of Pzena Investment Management, at the 3rd annual Value Investing Congress in New York last November, according to the notes of attendee Amit Chokshi. Chokshi posted the following notes from Pzena's presentation on Seeking Alpha last November 30th (hat tip to commenter "cm1750" on GuruFocus):

* Pzena's talk was entitled 'Evaluating Financials in a State of Panic'
* The only time good businesses sell for cheap prices is during times of distress
* Financial stocks are cheap on a P/B basis against historical multiples
* Freddie Mac (FRE) is the cheapest stock Pzena has 'ever seen':
* Losses are absorbable and GAAP is not useful in evaluating FRE
* Pzena believes the mortgage payment resets that result in higher monthly payments will be handled by borrowers because they will be reluctant to forfeit the equity in their homes
* Fears in the market don’t necessarily impact FRE’s business but are impacting its stock
* FRE Loan to Value = 60% and are mostly in fixed high credit
* Believes FRE will follow similar action to P&C insurance companies

1. Hurricane/natural disaster occurs, P&C insurance companies experience losses, P&C companies raise prices/premiums, P&C stock goes up
2. Housing crisis has occurred, FRE and other industry players will raise fees, tighten credit standards, experience lower losses resulting in strong capital returns and thus improving stock price.

At the time, Freddie Mac (NYSE: FRE) was trading at about $30 per share. Today it closed at 95 cents per share. Off the top of my head, I can't think of a value investor who has made money going long on a financial stock over the last year and a half, but another investor at last November's Value Investing Congress, David Einhorn, has done well shorting Lehman Brothers (NYSE: LEH).



¹Richard Pzena went to Wharton with Joel Greenblatt, author of The Little Book That Beats the Market. In that book, Greenblatt appeared to be alluding to Pzena as "the smartest money manager I know" on p.72.

Paul Kedrosky on Fannie & Freddie

On his Infectious Greed blog, Paul Kedrosky summarizes the Fannie and Freddie intervention:

Details on the just-announced Fannie/Freddie bailout plans were initially scant, but the OFHEO and Treasury websites now have most of what you're looking for. Here is the gist:

1. The two mortgage giants will open Monday under Treasury control
2. New CEOs and boards are inbound
3. Common shareholders are being massively diluted as preferred of a preferred/warrant deal that is being held out as offering taxpayers upside
4. The U.S. is now buying MBS securities direct from GSEs in the open market, and there is no explicit limit specified
5. The U.S. just [added] a planet-sized new (red) line item on its national balance sheet [one would think it also added some offsetting assets too]

For those of you who like more words, here is OFHEO's description of the bailout's key elements:

There are several key components of this conservatorship:

First, Monday morning the businesses will open as normal, only with stronger backing for the holders of MBS, senior debt and subordinated debt.

Second, the Enterprises will be allowed to grow their guarantee MBS books without limits and continue to purchase replacement securities for their portfolios, about $20 billion per month without capital constraints.

Third, as the conservator, FHFA will assume the power of the Board and management.

Fourth, the present CEOs will be leaving, but we have asked them to stay on to help with the transition.

Fifth, I am announcing today I have selected Herb Allison to be the new CEO of Fannie Mae and David Moffett the CEO of Freddie Mac. Herb has been the Vice Chairman of Merrill Lynch and for the last eight years chairman of TIAA-CREF. David was the Vice Chairman and CFO of US Bancorp. I appreciate the willingness of these two men to take on these tough jobs during these challenging times. Their compensation will be significantly lower than the outgoing CEOs. They will be joined by equally strong non-executive chairmen.

Sixth, at this time any other management action will be very limited. In fact, the new CEOs have agreed with me that it is very important to work with the current management teams and employees to encourage them to stay and to continue to make important improvements to the Enterprises.

Seventh, in order to conserve over $2 billion in capital every year, the common stock and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. Subordinated debt interest and principal payments will continue to be made.

Eighth, all political activities -- including all lobbying -- will be halted immediately. We will review the charitable activities.

Lastly and very importantly, there will be the financing and investing relationship with the U.S. Treasury, which Secretary Paulson will be discussing. We believe that these facilities will provide the critically needed support to Freddie Mac and Fannie Mae and importantly the liquidity of the mortgage market.

One of the three facilities he will be mentioning is a secured liquidity facility which will be not only for Fannie Mae and Freddie Mac, but also for the 12 Federal Home Loan Banks that FHFA also regulates. The Federal Home Loan Banks have performed remarkably well over the last year as they have a different business model than Fannie Mae and Freddie Mac and a different capital structure that grows as their lending activity grows. They are joint and severally liable for the Bank System’s debt obligations and all but one of the 12 are profitable. Therefore, it is very unlikely that they will use the facility.

William Poole Again

The former St. Louis Fed chief has an op/ed in today's NY Times, "Too Big to Fail, or to Survive". With all the hysteria exhibited by pundits on this subject, Poole's is a voice of reason. He's no fan of Fannie and Freddie, and thinks the federal government should eventually get rid of them, but he also acknowledges that, at this point, a bailout was necessary. Poole is also rightly skeptical that the promised tighter regulation of the GSEs will prevent future problems. He writes,

Some believe that tighter regulation is the answer. I am skeptical of that because I know the extent to which the regulatory system is tied up in Fannie’s and Freddie’s political activities. I find it deeply troubling that Fannie and Freddie, essentially in receivership to the secretary of the Treasury today, continue to employ lobbyists and hand out campaign contributions to influence the legislative debate over their own futures. Fannie and Freddie paid out more than $170 million to lobbyists over the last decade — more than General Electric spent. Government departments cannot hire lobbyists or give money to campaigns — why should Fannie and Freddie, now wards of the government, be permitted to do so?

Those huge lobbying fees don't fully capture the political influence of the GSEs. Two politically well-connected former Fannie Mae CEOs come to mind, Franklin Raines, who was the head of President Clinton's Office of Management and Budget before returning to Fannie Mae as CEO, and James A. Johnson, the former Carter administration official and, until recently, the reported head of Barack Obama's running mate selection process.

Malapropism of the Day

I didn't expect to get a laugh out of an article about the Fed and Treasury attempting to calm fears about the big GSEs (AP: "US spells out Fannie-Freddie backstop plan"), but I did when I got to the second paragraph below:

A senior Treasury official said any increase in the line of credit — now at $2.25 billion for each company_ would be at the Treasury secretary's discretion. The same would apply to any equity investment made by the government.

The official, who spoke on condition of animosity, also sought to send a calming message about Fannie's and Freddie's financial shape, saying: "There's been no deterioration of the situation since Friday."