When I got home last night, my wife demanded that I take her someplace expensive. So I took her to a gas station.

“Daddy, what is ‘short selling’?”

“Well darling, short selling is when you sell something, usually a stock, without owning it. The SEC issued an emergency order to stop the short selling of mortgage financiers Fannie Mae and Freddie Mac, beginning next week. In this case, the SEC said it will require traders to borrow Fannie and Freddie stocks before selling them short, and they will be required to deliver the stocks at settlement. Darling, Fannie and Freddie own or back $5 trillion worth of mortgage debt, or half the U.S. market, so they are very important. Not only can folks not sell short Fannie & Freddie, but the SEC order prevents the short selling of BNP Paribas, BofA, Barclays, Citigroup, CSFB, Daiwa Securities, Deutsche Bank, Allianz, Goldman Sachs, Royal Bank, HSBC, J.P. Morgan Chase, Lehman Brothers, Merrill Lynch, Mizuho Financial, Morgan Stanley, and UBS.”

“Thanks. What channel is Sponge Bob on?”

Interestingly, not on the list above is Wells Fargo, the biggest bank on the West Coast. Wells reported second-quarter profit that topped analysts' estimates as gains in insurance revenue and credit card fees kept losses from home loans in check. Net income dropped 23% percent to $1.75 billion, but it was still better than forecasts. Earnings have declined for three straight quarters, but Wells is still profitable (as opposed to Citigroup and WaMu, who have reported losses, and lenders Countrywide and IndyMac, who are now bought or gone). Stockholders still have seen Wells’ shares drop 32% percent this year, compared with a 41 percent decline for the Standard & Poor's 500 Financials Index.

As a reminder, Fannie Mae and Freddie Mac are the largest buyers of home loans in the U.S. They buy home loans from lenders, and then either hold them in their portfolios or repackage them into bonds.

Freddie & Fannie guarantee all the loans that they sell to investors, and for this service they collect a “guarantee” or “guarantor” fee from lenders. So if a homeowner defaults on a mortgage, Fannie and Freddie will step in and make good on the loan. The law that created Fannie and Freddie explicitly says the government does not guarantee the loans, but it is agreed that Fannie and Freddie are too important to allow them to fail. As mentioned above, together they hold or guarantee about $5 trillion worth of mortgages. Already they've posted combined losses of $11 billion, and investors are worried there's much more to come. If the government takes them over, as some have suggested, shareholders are likely to get nothing, and that is one of the reasons their share prices are down 80% from a year ago.

I don’t know what happened to Reg A-Y, but Reg Z is one of the major consumer protection laws that regulate our business. The Federal Reserve is the agency charged with writing and updating Regulation Z. Here is the latest: http://www.federalreserve.gov/newsevents/press/bcreg/20080714a.htm. We will have both high cost and high priced loans, there will be seven new deceptive or misleading advertising practices and all first mortgages must be closed with escrows by the year 2010. There will also be a disclosure requirement to provide a good faith type document earlier in the process. The other key points include:

• Prohibits a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value.  A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice."
• Require creditors to verify the income and assets they rely upon to determine repayment ability.
• Ban any prepayment penalty if the payment can change in the initial four years.  For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.
• Require creditors to establish escrow accounts for property taxes and homeowner's insurance for all first-lien mortgage loans.
• A loan is “higher-priced” if it is a first-lien mortgage and has an annual percentage rate that is 1.5 percentage points or more above this index, or 3.5 percentage points if it is a subordinate-lien mortgage.  This definition overcomes certain technical problems with the original proposal, but the expected market coverage is similar.

The market got hit today with the Consumer Price Index news, so anyone locking yesterday looks great to their borrowers. (30-yr mortgage prices are worse by roughly .250 in price.) U.S. consumer prices in June rose by the biggest amount since 1982, mostly due to gasoline. The Labor Department announced that the CPI was +1.1% during the month, much higher than the 0.7% expected, and up 5% from a year ago - the biggest year-on-year rise since 1991. The core rate, excluding food and energy prices, rose by 0.3%, higher than the 0.2 percent gain expected. Anyone with a F150 truck or a Lincoln Navigator will be pleased to know that energy costs accounted for roughly two-thirds of the overall monthly increase in consumer prices. But the increases are spread around, with no single component to blame: apparel, education, communications, and tobacco all showed somewhat faster increases.

An attractive blonde arrived at the casino and bet twenty-thousand dollars on a single roll of the dice.

She said, “I hope you don't mind, but I feel much luckier when I'm completely nude.”

With that, she stripped from the neck down, rolled the dice and yelled, “Come on, baby, Mama needs new clothes!”

As the dice came to a stop, she jumped up and down and squealed “YES, YES, I WON, I WON!”

She hugged each of the dealers and then picked up her winnings and her clothes and quickly departed. The dealers stared at each other dumbfounded.

Finally, one of them asked, “What did she roll?”

The other answered, “I don't know - I thought you were watching.”

Rob