In fact, Fannie has had a quarterly operating profit only once in the last four years!

Derivatives and securities trading resulted in a $4.5bn loss for the quarter, versus a $500m gain in the same period last year.

For those keeping track, Fannie has now requested more than $111 billion from the US Treasury to stay afloat, while Freddie is #2 at $72 billion in taxpayer money.

-New Government-Assisted Refi Program Coming (MarketWatch)
-CHART: Areas With Most-Underwater Homes (NewYorkTimes)
-The Eurozone Crisis Explained in Brief (RobertSinn)
-Kids With Huge Jobs At Treasury (BusinessWeek)
-UK Shifting from ARMs to 30yr Fixed? (FT)
-Is Teaching A Profession (Weakonomics)

For banks, the Fed already came out right after S&P’s downgrade announcement with: “For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies and government- sponsored enterprises will not change.” So for banks this looks like a non-event although with bilateral ISDA contracts and collateral agreements at clearing houses (DTC, FICC, etc.) there could be problems when it comes to GSE debt – watch for potential downgrades early this week. [UPDATE: Fannie/Freddie downgraded]

Fannie Mae Loss
Fannie Mae reported a $2.9 billion second-quarter loss and said it would seek $5.1 billion in Treasury Department aid to balance its books since it has a net worth deficit of $5.1 billion for the three-month period that ended June 30. The loss, which compares with a $1.2 billion loss a year earlier, was mostly a result of credit-related expenses on home loans made before the 2008 financial collapse. Fannie Mae also made a $2.3 billion payment to the Treasury in the second quarter. As of the second quarter, Fannie Mae has drawn $104.8 billion in Treasury aid and paid $14.7 billion in dividends, the company reported. Fannie Mae and Freddie Mac together have drawn about $170 billion in taxpayer aid.

BofA Bad Loan Trouble
Bank of America’s stock was hit late last week after telling investors that claims from Fannie Mae and Freddie Mac may cost more than previously forecast. The buyback claims have analysts saying that the $30 billion of expenses booked may not be enough to clean up the faulty mortgages. F&F can request a buyback from a seller if a mortgage insurer denies coverage for a loan, even when the lender disputes the insurer’s decision, and companies currently have three months after being denied coverage to appeal the repurchase demand and will have just 30 days starting in July 2012.

Home Affordability Returning
At some point it comes back to our economy, and continued worries about jobs and housing. Feeble job growth and rising unemployment don’t help the housing market, and in turn construction or distributing distressed properties. For example, California has significantly reduced its backlog of foreclosures, while Florida has not. This will dictate the speed with which these housing markets return to normal. The home price-to-rent ratio has slipped just below one, which means rents are now slightly expensive to home prices on a national basis.

- The first is not an additional comment but a repeat of what I said yesterday:  S&P is 100% correct that the budget/debt issue did almost nothing to address fiscal sustainability.  The big ticket items:  Social Security, Medicare and Medicaid were specified as off-limits.  Politicians placed getting reelected in 2012 above adopting a plan for fiscal sustainability.  We do not need another commission.  Simpson-Bowles did this and Congress and the administration chose to ignore it for political reasons.

- Tomorrow’s market reaction will be (I believe) much more serious in equities than in Treasuries.  Equity buyers are more likely to react to media than fixed income (Treasury) buyers.  High-frequency trading programs will perhaps test the the equity markets in a manner which they have not previously been tested.

- There is likely to be net inflow to Treasuries if equities sell off but we may see most of the flow go to the short (duration) end and a consequent yield curve steepening.  Steepening is usually associated with concern about inflation but we could see steepening result from massive uncertainty.

- China. On Friday I had a lengthy phone conversation with someone I have known for over 40 years.  He is in the shoe manufacturing business and spends a great deal of time in China.  He stated that the Chinese people express a continuing displeasure with the heavy investments which China has in U.S. Treasuries.  With China holding as estimated $900 billion in U.S. Treasuries it makes little sense for China to sell off U.S. Treasuries and drive down the value of that $900 billion portfolio.  China’s expression of dissatisfaction with U.S. fiscal policy and its “downgrade” of U.S. Treasury debt is more about addressing internal dissent than it is about anything else.  China also has its own economic problems.  China has serious inflation.  This has at least two causes: (1) The ridiculously low wages which China had been paying demanded increase and (2) China’s pegged currency exchange rate is not sustainable.  China has adopted a “floating peg” but that is window dressing.  The problem with the pegged exchange regime is that it allows China’s money supply to be a slave to the peg and that causes expansion of their money supply and inflation.  China should give up the peg and float its currency.

China should address the problems created by the peg and let the U.S. address its fiscal problems.

- The worst outcome is not far-feched.  U.S Treasuries could remain strong and the Treasury Department and those in Congress could then dismiss the concerns expressed by S&P and do nothing toward achieving fiscal sustainability.  Congress cares more about reelection that it does about fiscal sustainability. If Treasuries tank, Congress is more likely to blame S & P than admit that the fault is with its own profligacy.

- I have been proposing for the past 5 years that we sever the deficit/debt ceiling issue from the rest of fiscal policy by placing control of the debt limit in the hands of a stand-alone non-political entity.  Here’s a complete explanation.

- This downgrade is another reason to do away with FNMA and FHLMC and have private securitiation of mortgages.  If a Treasury guarantee means nothing then getting the mortgage industry further distanced from the disasterous effects of policies such as HUD’s National Homeownership Strategy is to be desired.

- One last point about S&P itself.  S&P along with the two other debt rating firms was 100% remiss in rating mortgage debt during the housing bubble.  In the long run folks could realize that what S&P did on Friday was to rid itself if its habits about underestimating risk and S&P could – 10 years from now – be judged to have taken an heroic action.

The U.S. will reach its borrowing limit August 2, but it takes time to process legislation and money flows needed to raise the debt ceiling, so the target deadline is to agree on a budget by this Friday, July 22. If a deal is reached this week (or next), stocks are likely to rally and bonds would sell, pushing rates up. Below is a recap of last week and preview of this coming week.

Recap of July 11-15 Week
Rates dropped last week on weak economic data: Retail sales down, trade deficit spiked, consumer sentiment plummeted, manufacturing (Empire State) weakened, consumer and business inflation flat, European bank stress tests showed vulnerability, and Moody’s and S&P threatened to downgrade U.S. credit ratings if lawmakers don’t raise the debt ceiling.

During his two-day Congressional testimony last week, Fed chairman Ben Bernanke first said Fed would do whatever’s necessary to help fragile recovery, then took a harsher stance so markets don’t make false assumptions about more quantitative easing.

Here’s every economic stat from last week broken down by day—and we do this every day.

Preview of July 18-22 Week
There are key housing reports throughout this week: July homebuilder confidence Monday, June housing starts and June building permits Tuesday, June existing home sales Wednesday, and May FHFA home prices Thursday—this includes homes that have Fannie/Freddie mortgages.

We also have usual mortgage applications volume Wednesday which has been weaker lately and could mean we see weaker home sales (also Wednesday), a Fed survey of manufacturing activity in the Philadelphia area Thursday, and weekly jobless claims Thursday.

Also the debt ceiling budget battle will be center stage. There are lots of theories on market reaction to this, but there are two main views worth sharing:

(1) One theory says rates will spike if no debt ceiling deal is reached because ratings agencies will downgrade U.S. debt. But U.S. Treasury and mortgage debt is still the preferred safe haven trade in a questionable global debt picture. So ironically, Treasuries and mortgages could rally further in a debt ceiling impasse, pushing rates down.

(2) As noted above, stocks could rise if a debt ceiling deal is reached. If so, rates would rise as Treasuries and mortgages sold on stock strength.

The most probable scenario is number two. Combine this with next week’s housing data which should keep rates flat because the data are likely to reveal continued economic headwinds, and rates should be even to up slightly.

Volatility will continue and it’s hard to predict rates, so remember last week’s discussion on handling rate volatility.

And here’s all you may need to know on timing a debt ceiling deal.

That day, my wife and I checked into the hospital to deliver our first baby. Watching the movie brought it all back for me: a retail mortgage banker sitting on my cot in that hospital room, waiting for our baby induction process to run its course, trying to write clearly about how the U.S. mortgage market backstops had just failed. Today, I offer a few thoughts on the real life events versus the movie.

I just re-read lots of my daily posts from those months. I’m not surprised a few posts are off-the-mark given the market chaos of the day. But I stand by my Paulson writings, and I think HBO properly conveyed his execution of an impossibly complex role.

Of all my Paulson/TARP posts, this one from January 19, 2009—the last day of Paulson’s tenure—sums up TARP and Paulson’s role the most clearly. It’s also the most interesting to compare to HBO’s take on Paulson. Here’s an excerpt:

As we said at the time: “just like an emergency room team changes constantly to adapt to the needs of sick or dying patients, these Treasury strategy changes are standard in any crisis.” That’s when Paulson defended this triage approach:

“I will never apologize for changing a strategy or an approach if the facts change.

…First and foremost, because the system remains fragile, we must continue to stand ready to prevent systemic failures. That is the basis for Monday’s action to purchase preferred shares in AIG.”

So to us, that’s his lasting legacy, for better or worse. But legacies are only as good as the stories that are told, and the stories are only as good as the actual facts. When Paulson is judged in the future, most of the facts will be lost to chatter and partisan positioning.

Remarkably ‘Too Big To Fail’ director Curtis Hanson (8 Mile, LA Confidential) didn’t lose the facts after all this time. He captured fact that Paulson saved the economy from collapsing, and conveyed supporting facts without making Paulson out to be some hero.

This is exactly what I was trying to do at the time … because Paulson is no hero for the regular guy. He was presiding over Goldman Sachs during the deregulatory era. But he’s perhaps the only guy powerful and credible enough to get heavyweight bank CEOs to do what was needed during that precarious time.

People will always deride Paulson and the Wall Street establishment—and deride me and others who think Paulson did the right thing—but that’s precisely why it’s so interesting that the “liberal Hollywood establishment” took a documentary approach that preserves Paulson’s legacy. And I say Bravo to Curtis Hanson.

Also in today’s links: Facebook’s Like button turns one, the war to keep 30yr fixed loans, a word on Treasury Secretary Tim Geithner’s credibility problem in the wake of S&P’s warning on U.S. debt. And since markets are closed, I’m including a link about how Lady Gaga tried to shut down a Weird Al Yankovic parody of her. Not smart. Here’s his last parody from a couple years ago. It’s at 60,162,532 YouTube views and counting…

-Weird Al Gets Approval To Parody Lady Gaga (Billboard)

-Blogging tips for real estate pros (InmanNews)

-Democratic Faction Fights To Keep 30yr Fixed In A Post-Fannie Freddie World (DSNews)

-Facebook LIKE button celebrates first birthday (Mashable)

-Geithner downgrades his credibility to junk (Bloomberg)

Yesterday the Conference Board’s March consumer confidence showed a decline, confirming the same trend last week’s University of Michigan consumer sentiment showed: consumers are rattled by higher food and gas prices. This inflationary mood was part of why bonds sold off yesterday. The other reason was yesterday’s 5yr Treasury note auction and Mondays 2yr note auction were both met with mediocre demand, putting bond markets overall in a selling mood.

That trend continued today with the 7yr note auction being poorly received by markets. Also today, private payroll provider ADP reported that the economy added 201,000 new jobs in March. Both of these data points would suggest a continued mortgage bond selloff, pushing rates up, but the reverse is happening today as mortgages are stopping losses at a key technical support level.

Tomorrow we have jobless claims for the week, and if they confirm a fifth straight week of fewer claims, the bond selling sentiment would return because that data plus the ADP data suggest a better than expected March jobs report Friday from the Bureau of Labor statistics.

We’ve began the week up-trend rate outlook, and are sticking by that view for the next two days. Not just because of Friday’s jobs report, but because bond markets are very touchy about inflation right now, and there are clear inflationary signals emerging in numerous consumer and manufacturing reports of the past 2 months.