Revealed: The $145 Billion Hole No One Noticed

$145 billion isn't what it used to be. On Monday, a U.S. company announced a first quarter net loss of $11.5 billion and a deficit in shareholders' equity of $145 billion, and the news went almost completely unnoticed. Admittedly, compared to the $1 trillion European Union-IMF bailout program announced the same day, the sums involved here are trifling.

What's a few billion between friends?
Why stir up the pot? On the basis of Generally Accepted Accounting Principles, mortgage giant Fannie Mae's (NYSE: FNM  ) negative net worth was just $8.4 billion -- hardly worth mentioning at all these days (except by Fannie itself, which had to go hat in hand to the U.S. Treasury for that same amount in order to top up its shareholders' equity and remain technically solvent).

So where does the $145 billion come from? It is derived from balance sheet values established from market prices. In fairness to Fannie, it is impossible to know whether the losses implied by market prices will eventually be realized; however, it would be unwise to dismiss the market-based figures out of hand.

Speaking of things that aren't what they used to be, I realize a single U.S. dollar isn't worth all that much anymore (and its value is dwindling inexorably), but why anyone would want to throw it away on the purchase of one share of Fannie Mae stock is puzzling. By my reckoning, the shares are worthless, as are those of Fannie's brother, Freddie Mac (NYSE: FRE  ) , which announced a first-quarter net loss of $6.7 billion last week. Even if they're not worthless, there is no sense in which one can consider them an investment. (I would put that other ward of the state, AIG (NYSE: AIG  ) into the "speculation" bucket, also -- too difficult to assign an intrinsic value.)

A financially reckless sugar daddy
Speaking of over-leveraged, deficit-running institutions, Fannie's losses are being backstopped by the U.S. government (including the latest request, the government will have sunk $85 billion into Fannie). Given the abysmal state of the U.S. finances and the fact that, to quote David Roche of Independent Strategy, the U.S. government is "in denial about the extent of [its] debt burden," Fannie's loss is a timely reminder that investors should steer clear of U.S. government and agency bonds. It isn't so much an outright default I'm concerned about as much as the long-term inflation risk.

Avoid government bonds, prefer high-quality corporates
With that in mind, products to avoid include (but are not limited to) the iShares Barclays Agency Bond ETF (NYSE: AGZ  ) and the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT  ) . If you must have income and safety/stability of principal, I prefer high-quality corporate credits -- investors can own their bonds through the iBoxx $Investment Grade Corporate Bond ETF (NYSE: LQD  ) .

The credit crisis has turned the investing landscape upside down, with advanced economies' balance sheets now looking more like that of a banana republic. In that context, Tim Hanson explains how to make more in 2010.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.


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  • Report this Comment On May 11, 2010, at 3:48 PM, gjeddis wrote:

    quality and timely comment. in addition to LQD i prefer vanguard's BLV to ishares TLT for >10 year duration because it includes corporates to round out the treasuries risk that you noted. what do you think of BLV?

  • Report this Comment On May 11, 2010, at 5:06 PM, oldengineer wrote:

    Another high quality article by Mr. DuMortier that is well worth reading.

  • Report this Comment On May 11, 2010, at 5:57 PM, TMFAleph1 wrote:

    gjeddis,

    I don't much like Vanguard's Long Term Bond ETF (BLV) for precisely the reason you point out: At the end of March, 43.4% of fund assets were invested in Treasury/ Agency bonds.

    Best,

    Alex D

  • Report this Comment On May 11, 2010, at 6:08 PM, TMFAleph1 wrote:

    oldengineer,

    Thanks again for your kind comments.

    By the way, I come from a long line of engineers (well, my father and grandfather, at any rate) and I came very close to following that path also.

    As an aside, I think it is a great shame -- and a growing problem -- that engineering doesn't command the same respect here that it does in some other cultures. It's rather odd too, since there are few, if any, disciplines that have contributed as much to the advancement of human society. Perhaps the credit crisis will push students and fresh graduates to (re)discover the joy of building things rather than pushing money around.

    Best,

    Alex D

  • Report this Comment On May 12, 2010, at 11:48 AM, mountain8 wrote:

    I wouldn't buy dust from anybody that advertised in these comments.

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