My 1st Million At 33 – yes, you can do it too

The big news this week is obviously the selling panic in the two GSEs (government sponsored enterprise): FNM (Fannie Mae) and FRE (Freddie Mac). The two companies together hold about 3.7 trillions of home mortgage. With increasing defaults on mortgages, sub-prime or prime, the total loss can easily exceed all of their capital reserve for the companies. According to a few GSE watchers, the net worth of FNM and FRE could eventually be negative (if not already).

Markets participants have always assumed that US government will bail out GSE. But since the mortgage portfolio at GSE is in the same order of magnitude as the total debt owed by US government, such actions may easily double the level of current US debt. A big increase in the US debt, I believe, will translate into a lower $US. And a lower $US will probably kick the existing high inflation into the next high gear. Gold in that case should soar.

Of course, this “efficient” but extremely short-sighted market has demonstrated through the subprime mortgage crisis that the market does NOT think ahead much. The initial process of price discovery is quite slow (until lately). Such “gradual” market reaction will mean that being multiple steps ahead of the market will not be immediately rewarded. In fact, with GSE going down, and the stock markets going down, US dollar tends to rise initially like what is happening now. US dollar have just bounced off the support, and may be heading higher in the short term. However, it gives plenty of time for people to heed the cautions and make preparation on what may come to pass.

With more banks and investment firms trying to find the final last fool to take on their toxic mortgages, while GSEs continue to happily loosen their underwriting standards with a low down payment (3% now in some cases), it is only time that separates the GSEs away from a devastation. There are many other reasons why $US will head lower in the longer term. But whether GSEs are bailed out by taxpayers or not, $US should go lower either due to the increase in the total debt, or through selling of GSE debts (in the case of no bailouts). Either case, the loss of confidence in US financial systems is becoming the reality.

Disclosure: shorting markets through combinations of selling/buying calls/puts on IAI, SKF, QID, SDS.