But we’re not living in normal times, says Dan Denning in The Daily Reckoning Australia. What we’re experiencing is a financial quagmire caused by the loud popping of an unprecedented credit bubble.

The collapse of IndyMac (IMB) has been overshadowed by the threat of insolvency at Fannie Mae (FNM) and Freddie Mac (FRE). The rescue plan for the twin mortgage giants is nothing more than backdoor nationalization, says Dan. Expect runaway inflation as a result of the government’s meddling…

First, let’s report what Paulson said, in case you missed it. Paulson denied last week any support for a shareholder bailout of the two companies. But it’s not the shareholders he’s worried about. It’s the bondholders. You can tell that from how Paulson began his statement.

He pointed out the importance of the GSEs to keeping the American housing market going. This, of course, is true. While non-bank lenders collapse and other banks tighten up, Congress expanded GSE lending powers earlier this year to keep the mortgage market from going into deep freeze. The result is that GSEs wrote 80% of the loans originated in the first half of this year. If they cease operating, the American mortgage market ceases to function. Imagine what that would do for house prices?

Scary as this, it is not even the biggest concern. Here is what Paulson said early in his statement: “GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets.”

There is some US$7 trillion in GSE debt sloshing around the world’s financial system. Non-American investors own about US$1.5 trillion of it. The Treasury Department desperately wants to assure investors that Fannie and Freddie will not default on that debt. But it does not want to explicitly “guarantee” the debt. Instead, it has taken three steps, with the Fed taking a fourth.

First, the Treasury Department will increase the line of credit the GSEs have with it. Currently, that line of credit is a pretty miniscule US$2.5 billion. If the financial markets know the Treasury is willing to loan billions more to the GSEs, it might calm things down a bit. Or not.

Second, the Treasury Department will ask the U.S. Congress for permission to purchase equity in the GSEs. You can be sure it will not be common stock, but some kind of preferred shares that give the Treasury and the U.S. Taxpayer some special benefits. Both this and the first measure are designed to be temporary and not last more than 18 months.

Third, the Treasury will ask the Congress to craft legislation that gives, “the Federal Reserve a consultative role in the new GSE regulator’s process for setting capital requirements and other prudential standards.”

The Federal Reserve’s Board of Governors also met this weekend and agreed to give the New York Fed “temporary authority” to lend to the GSE’s “should any such lending prove necessary.”

That’s the policy response crafted to comfort markets ahead of a week of trading. Now, shall we translate it for you?

The Treasury gives the GSEs a new line of credit. But will it matter? Freddie Mac is set to auction a relatively modest US$3 billion in bonds this week. It’s short-term debt, 3-6 months. If yields blow out at the auction, we’ll know the market is treating the GSEs like lepers.

And besides, the GSEs may have credit with the Treasury, but the real question now is how much longer the Treasury has credit with the rest of the world. Watch gold and oil. They will tell you exactly what the market thinks.

As for the equity stake, this is pretty intriguing. It’s going to be nearly impossible for the GSEs to raise capital in the private sector. And don’t count on a Sovereign Wealth Fund to save the day. These companies have massive liabilities. The U.S. government doesn’t want to explicitly guarantee GSE obligations, though.

Instead, what we see is a back-door capital raising through a rights issue. That is, the Feds hope that talking is enough to stabilise things. But if it doesn’t turn out that way, we see the GSEs taking on the Feds as preferred shareholders and then doing a rights issue, offering the American taxpayer a large stake in the companies in exchange for billions in capital to shore up the balance sheet.

Call it what you’d like, but it’s a backdoor nationalisation. If it’s done cleverly, the Feds hope it will prevent a run on the dollar and run away oil and gold prices. If it’s done clumsily, it will still result in run-away inflation without solving the solvency problem for the GSEs.

Source: Aussie Banks Lift Rates

So, this morning, we write to you in a puddle of our own regret. We lacked foresight, and water-proof pants. We’ll try to exhibit a bit more of it as we map out where the money is today (foresight, not water-proof pants).

Foresight, of course, is a quality everybody wants and nobody has. Who couldn’t do with a little more of it? It’s one of those constants that you always need to constantly invest well…foresight, hard work, patience, a bit of luck here, some good timing there.

Meanwhile, the only news that matters in Australia today seems to be takeover-related…

Western Juniors Could Create 4th Biggest Iron Player in Australia

Here’s some foresight. Investors who jumped on the iron ore train are getting their dividends. Yesterday Murchison Metals (ASX:MMX) gave iron cousin Midwest (ASX:MIS) an all-share merger offer worth . The market loved it. Midwest leapt 12.3%. Murchison flew 8.3%.

Everybody won, except Sinosteel. The Chinese giant was closing the net around its prey, Midwest. The nerve of another prey to go and outdo it.

Together, the two iron diggers would have a market cap of AU$3.2 billion. That’s bigger than Portman (ASX:PMM), Mount Gibson (ASX:MGX) or the other second-tier contenders. It’d leapfrog the companies up to fourth place in the industry, behind Fortescue (ASX:FMG).

The structure of the deal, though, tells you a little more about the whole matter.

Sinosteel already has 19.9% of Midwest. That’s the maximum you can own without bidding.

In a direct response to the stake, Murchison has proposed a reverse-takeover. It has offered itself up as a sacrifice to the deity of iron ore. Under Australian corporations law, a reverse-takeover means the deal only needs 50% acceptance from Midwest shareholders to go through. Otherwise, a standard takeover would’ve meant a minimum of 75%.

Ergo…the two do not want to be bought. Not by China. Not at any price near what Sinosteel is offering. The Australian iron sector is combatting external consolidation with internal consolidation. Both mean share prices are going up. Here the five top juniors’ performance this year. They’ve made gains of between 21% and 65%.

Midwest’s management has recommended that shareholders accept the deal. You’ll find out in the next three months what they think of it.

You’ll also find out exactly how desperate China is to get its paws on our iron. The ball’s in your court, Sinosteel. The company will most likely withdraw, and reassess. Perhaps it’s content to pay huge spot and contract prices for iron in Asia. Or perhaps it’d like to own the next best producer after Fortescue.

St George Accepts Westpac Bid…Almost

A much bigger takeover is slowly plodding towards the finishing line. St George (ASX:SGB) signed a scheme of agreement with Westpac yesterday. It had prudence enough, though, to add some fine print to the contract. We’ll do a deal you, Westpac. As long as your shares stop dropping

So far, Westpac’s bid is 10% smaller than when it came into the world. The stock is at a year-low. If the fall that began last week in the All Ordinaries accelerates, Westpac’s shares may continue to erode. Maybe the finishing line is a little further away than we thought.

Two takeovers are evolving parallel to each other. There’s the iron story in the hard-asset market, and the banking story in the financial sector. Both are mergers, involving shares only. No cash. Analysts tell us that the prices are good. Yet the parties involved have reacted entirely differently.

Midwest said “Yes” and left it that. St George said “Maybe. Just don’t let your share price fall.”

Sadly, Westpac doesn’t have a lot of control over that. And those two reactions might reflect the underlying businesses, we reckon. Iron ore miners are willing to jump on the front foot. They’re merging to create more scale in a growing industry. Banks are on the back foot. They’re merging as a defense against falling earnings margins.

Westpac’s interest margin has fallen from 2.6% in 2003 to 2.25% last year. It won’t have improved since the last report, filed in November. Bankers aren’t making as much as they used to. That’s the bottom line. There are better companies to invest in.

Al Robinson
The Daily Reckoning Australia

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Source: The Fourth Biggest Iron Player in Australia