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A recent ProPublica/NPR report on Freddie May refusing to refinance mortgages for struggling homeowners shows that the market is still coming to terms with new ways of measuring risk.
Jesse Eisinger and a ProPublic co-author, Cora Currier, along with NPR's Chris Arnold, have followed up on their original story about Freddie Mac allegedly betting against homeowners being able to refinance their mortgages. To summarize without getting too deep into risk-mitigation instruments and complex financial jargon, Freddie was using these things called "inverse floaters," and more or them than Eisinger originally reported ($5 billion), to...well, what exactly? Eisinger argues that they were being used to bet against homeowners refinancing out of high interest rate mortgages — a neat trick, given that Freddie could set the refinancing rules.
Some bloggers, myself included, have asked whether this really what was going on. Eisinger posted a lengthy comment on my blog and also Felix Salmon's blog at Reuters, helpfully addressing many of the issues that the debate over the story has raised. Felix fires up his analogy-o-matic and provides a good, simple explanation of what Freddie was up to (it involves, cleverly, a real-estate hook). Ultimately, he agrees with Eisinger:
Facebook founder and CEO Mark Zuckerberg speaks during a news conference at Facebook headquarters on October 6, 2010 in Palo Alto, California.
This information is all over the place, but I got it from the Globe and Mail:
Facebook generated about $4.3-billion in revenue last year, according to estimates from the research firm eMarketer, with advertising accounting for nearly 90 per cent of that amount. This year, the company should post revenue of nearly $6-billion, eMarketer forecasts.
And one assumes that 90 percent of that $6 billion will also come from advertising. And when Facebook makes $100 billion, many years after its IPO, 90 percent of that will come from advertising.
This week, Facebook is expected to file with the Securities and Exchange Commission, for an IPO later this year. So everyone will finally get a look behind the curtain of how the business is run, financed — and where the revenues really come from. But let's be honest. It's all going to depend on advertising, advertising, advertising. This could be a problem for Facebook's long-term growth and profitability because Facebook might have already signed up just about everyone it can. That's a huge audience — and that audience spends LOTS of time on Facebook — but they're not on Facebook for the same reasons they're on Google.
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SACRAMENTO, CA - DECEMBER 08: California state controller John Chiang (D) looks on as California governor-elect Jerry Brown speaks during a briefing on California's state budget on December 8, 2010 in Sacramento, California. With less than one month before being sworn into office, California governor-elect Jerry Brown held a bi-partisan meeting on California's state budget. (Photo by Justin Sullivan/Getty Images) *** Local Caption *** Jerry Brown;John Chiang
If anyone is tired of the daily European soap opera with surrealistic tragicomic overtones, they can simply shift their gaze to the 8th largest economy in the world: the insolvent state of California, whose controller just told legislators has just over a month worth of cash left. From the Sacramento Bee: "California will run out of cash by early March if the state does not take swift action to find $3.3 billion through payment delays and borrowing, according to a letter state Controller John Chiang sent to state lawmakers today. The announcement is surprising since lawmakers previously believed the state had enough cash to last through the fiscal year that ends in June."
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Refinancing is a key way for homeowners to improve their bottom lines. But did Freddie Mac prevent borrowers from pursuing refis so it could make more money?
Yesterday's NPR/ProPublica story about Freddie Mac's refusal to refinance mortgages so that it can make more money on some high-risk parts of its investment portfolio has divided the blogosphere. As I noted yesterday, Matt Levine at Dealbreaker thinks that Freddie was absorbing a refinancing risk that it would find difficult to pass on to investors. Felix Salmon at Reuters disagrees and disagrees profoundly, basically saying that we should call a duck a duck and conclude the Freddie was putting its own returns above the needs of homeowners.
Arnold Kling thinks not, dismissing the idea that Freddie was engaged in pure speculation:
The authors describe this as only being bad. It is bad for homeowners because it reduces Freddie's incentive to refinance loans. It is bad for Freddie Mac because it means taking on more risk from these instruments.
There is another possibility. In its normal course of business, Freddie Mac buys mortgages and issues debt, giving it a duration mismatch. These inverse floaters seem to have negative duration, which helps to offset that mismatch.
The article does not discuss the duration issue at all. Instead, it acts as if inverse floaters were a pure speculative play by Freddie Mac, which I think is unlikely to be the motivation.
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Pep Boys has been purchased by The Gores Group, a private-equity firm in Los Angeles.
Manny, Moe & Jack are going private: Aftermarket auto parts chain Pep Boys is selling itself to Los Angeles investment firm Gores Group for $791 million in cash.
Expansion-minded Pep Boys executives say the total enterprise value of the deal is about $1 billion. The $15-per-share price reflects a 24% premium on Pep Boys’ Friday closing price of $12.08.
Philadelphia-based Pep Boys, which has benefitted from a trend of drivers holding on to their existing cars rather than buying new ones, watched its stock jump 23% to nearly $15 during midday trading Monday.
This is both interesting and worrying. First the interesting. The Gores Group has been around since 1987 and has made, as may private-equity firms have, many millions if not billions of dollars between now and then. The firm closed a third fund early last year, amounting to $2 billion. Now it's buying Pep Boys, all in cash (debt brings the value of the deal up to $1 billion). As the Wall Street Journal points out, the purchase price amounts to $15 per share, but it's been more than two years since Pep Boys closed at that level.