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How to Play "Unmitigated Disaster"

Written By Brian Hicks

Posted July 14, 2008

Methinks those in charge have lost their minds.

Senator Dodd believes Fannie Mae and Freddie Mac are "fundamentally strong" and that "this is not the time to be panicking about this. These are viable, strong institutions."

"The economics are fine in these institutions and people need to know that," Dodd said. There’s no reason "to talk about failure," he added.

But if everything was fine, the Treasury Department wouldn’t have increased its existing line of credit to Fannie Mae and Freddie Mac, nor would the Treasury have asked for power to buy stock in the two embattled companies, and nor would the Fed board of governors vote to open its discount window to them.

We’re talking about two companies, which hold 50% of U.S. mortgages, or more than $5 trillion, that are teetering on the brink of disaster.

Everything is not okay, as Dodd would have the naïve believe.

The truth is that the mortgage lenders are "basically insolvent," says Jim Rogers. The Treasury’s plan to boost Freddie and Fannie is an "unmitigated disaster."

Taxpayers, says Jim Rogers in a article, will be saddled with debt if Congress approves Paulson’s request for authority to buy unlimited stake in and lend to Fannie and Freddie.

Not only does Rogers see further downside for the two companies, Goldman Sachs does, too. Analyst Daniel Zimmerman believes the two companies’ shares could fall another 35% and lowered his price estimate on Fannie to $7 from $18, and lowered Fannie’s from $17 to $5.

"These companies were going to go bankrupt if they hadn’t stepped in to do something, and they should’ve gone bankrupt with all of the mistakes they’ve made,” Rogers said. "What’s going to happen when you Band-Aid and put some Band-Aids on it for another year or two or three? What’s going to happen three years from now when the situation’s much, much, much worse?”

Short or buy put options on Fannie and Freddie and sit tight. This is going to get ugly.

If you want to play the demise of Fannie and Freddie, consider buying:

  • Freddie Mac January 2009 6 put (FREMQ)
  • Fannie Mae December 2008 9 put (NJWXH)

Hold these regardless of Fed interventions, etc.

Oh, and please ignore Dodd.