Jim Rogers speaks the truth about Fannie Mae and Freddie Mac

 (YouTube video from CNBC, July 15, 2008)

For many years Fanny Mae was a viable mortgage lender, well capitalized, considered a blue chip investment. It could be found in many retirement funds, mutual funds and other institutional investors. Then about five years ago, the managers began to leverage the common equity capital by borrowing more and lending it out, in the process violating the number one rule of investment...matching assets and liabilities. 

The universal warning given for all capital investment is to match the maturities of your debt with the maturity of your investments made with that debt. Failure to do this (also called "borrowing short and lending long") is the sure path to bankruptcy over time. The reason is simple, long term money loaned out is locked for long periods, while short term borrowings come due quickly, and you don't know at what interest rate that debt can be renewed.

The original shareholders capital invested in FNM is matched beautifully. It never expires. The shareholders can trade the stock, but the capital stays in the company. As long as they don't leverage that capital highly, and follow good lending practices, everything will be fine. And it was for many years.

Three years ago, Jim Rogers noticed that FNM was rapidly increasing its leverage by borrowing short term, as well as relaxing its control over the creditworthiness of its borrowers. Rogers began shorting FNM when it was $75 per share. He mentioned it often in his interviews (He was also shorting the home builders which closely related to the unwise lending practices). The stock began to fall, slowly at first. I noticed that many interviewers would ask him if he was ready to cover his short and take his profit. His answer was always, no, if it goes up some, I'll short some more. 

Finally they began asking him at what point he would consider covering his short. He answered that his assumption was that the stock would fall to 8. Then he would consider covering it. That happened Monday I believe. It wouldn't surprise me if we hear in a few days or weeks that Rogers has covered his short. Why not, he's already made 95% of his potential profit on the trade?

So, what's Fanny's future? Well, the shareholders will lose most if not all their investment. But, if the government makes funds available to it at very low interest rates (thus removing the damage of borrowing short and lending long), and puts tighter controls on its lending practices and expenses, it can continue to operate indefinitely. My guess is that is what will happen, and bankruptcy will be avoided. The common stock equity might vanish, and the government become the operator of FNM. If it's managed well enough, it might even become profitable again. 

But that's not the end of the story. When the Fed runs out of money to lend to over leveraged financial institutions, it will crank up the printing presses and print the money. This will further lower the value of the dollar. Nothing new here. The big question is, when will the taxpayers wake up and realize that they are being drained by the inflation tax created by flooding the system with more paper currency (which has no intrinsic value). Some day they will, although it is amazing to me how complacent the public is.

I have a neighbor who walks his dog about the same time I walk ours every day. Yesterday, he mentioned to me that he had a CD coming due at the bank, and was wondering what he should invest it in. We have never discussed money before. I asked him if he knew how fast the dollars he had in his CD were losing purchasing power. I told him the little bit of interest he earned after taxes would make only a tiny dent in his loss of purchasing power (when I mentioned gasoline and food, he understood). 

Then I asked him if he owned any gold or silver. He said no, and didn't have any idea how to to buy it. I explained to him there was a reputable coin dealer 7 blocks from our houses, and suggested he might consider taking some of the money from his CD and buying gold and silver coins. 

When a sufficient number of the American people do finally wake up, they will panic out of the dollar, and gold, silver and other tangible assets will skyrocket in terms of the dollar. 

This article is public domain.  It was written by Jay O'Keefe.
This page was last updated on 16 October 2008 .