Will the SEC End the Short Sale Party?

I just saw this headline in the Wall Street Journal a few minutes ago:

"WASHINGTON--The Securities and Exchange Commission announced an emergency action aimed at reducing short-selling that targets Wall Street brokerage firms as well as Fannie Mae and Freddie Mac, and will immediately begin considering new rules to extend new requirements to the rest of the market."

Not only will it involve selling short FRE and FNM, but according to the journal, it will also apply to Lehman Brothers (LEH) , Goldman Sachs (GS), Merrill Lynch (MER) and Morgan Stanley (MS).

I tried to find this emergency order on the SEC web site, but could not. Please send a link my way if anyone can find it.

What About the FDIC?

If you think Fannie Mae or Freddie Mac are under capitalized, then how about this very rough, and very non analytical back of the envelope capitalization for the Federal Deposit Insurance Corporation (FDIC) insurance deposit fund.

Combined Deposit Insurance Fund Balance - $ 52.8 billion (before Indy Mac failure).
Insured Deposits $4.4 trillion.
Reserve Ratio - 1.19%.

Of course I am sure there is more to it than that. The FDIC can raise premiums, and ultimately, the U.S. Government is there.

Here are some historical nuggets that I gleaned from the same page:

1) The chart goes back to 1990, which is the year that failed assets peaked at $145.339 billion. Indy Mac has $32 billion in assets so we are already at 20% of the 1990 peak.

2) The fund balance went negative in 1991, at $6.9 billion.

3) The current reserve ratio of 1.19%, is the lowest since 1995, when it was 1.08%. This is calculated before the latest bank failure. If we use the mid point of the estimated losses of $4-8 billion, then the fund balance falls to $46 billion, and the reserve ratio falls to approximately 1.04%.

I don't understand why the FDIC let the reserve ratio run down from a high of 1.38% in 1999, considering that everyone and their mother saw this storm coming. During the good times is when they should have over assessed the banks to prepare for this.

Smart Money - May You Rest in Peace

I don't mean to rub salt in a wound, since I have had my share of bad investments, but I have always despised the concept of "smart money." It implies that everyone else is not smart money, but rather is "dumb money." I also maintain that a belief in this theory promotes a herd instinct among investors, which is something we desperately need less of.

So to finally put this theory in its grave, here is a list of the largest holders of Freddie Mac (FRE) and Fannie Mae (FNM).





The data is as of 3/31/2008, so there may have been some major changes since then. Also, some of the holders are index funds. The biggest losers appear to be American Capital Group, which holds large amounts of both, mostly in three of its largest funds, the Washington Mutual Fund, the Investment Company of America and the Growth Fund of America. This large ownership is somewhat mitigated by the absolute size of these funds.

If you measure by what percent of an individual mutual fund is held in both FRE and FNMA then the following will be the most hurt:

FNM

Lord Abbett Affiliated Fund - 2.2%
Fidelity VIP II Contrafund Portfolio - 1.7%
AMCAP Fund - 1.4%

FRE

John Hancock Classic Value Fund - 4.6%
Hotchkis and Wiley Large Cap Value Fund - 3.7%
Legg Mason Value Trust, Inc. - 3.6%
DWS Dreman High Return Equity Fund - 2.7%

The Legg Mason listing is in the fund run by Bill Miller, an investor that is familiar to everyone, and the DWS Dreman High Return Equity Fund is run by David Dreman, another very well regarded Value Investor.