morningstar

Never been to one of these. But a 14x LBO of a hot dog stand seems like a sign we are near a peak

Seems like there are several ways the preferreds could wind up being exchanged for common... either something like the Fairholme plan where the preferreds wind up with fair value or better, or a coercive exchange stripping the dividend blockers for the benefit of the common.

How do we know this to be true? It's not like there is a marginal cost of labour with a running computer program. What's stopping them from attacking every single spread and every single order they can get information on? Why is TD Ameritrade's order flow the most profitable? The biggest way we know this to be true is that most liquid stocks, where HFTs are active, trade with incredibly small spreads - often a penny, basically the smallest spread retail investors will ever get by law. Just look on your brokerage site at midday quotes on a big stock and its likely to be something like 3 bps. And in retail size, you will generally be able to hit that bid or offer. Note that were it not for the SEC's rules against sub-penny orders and quotes, HFTs would likely drive these spreads even tighter. TD or Fidelity order flow is profitable for the obvious reason, it is information-lite. Citadel knows when it buys orders from Fidelity to internalize them, that it's not trading across from someone like Icahn whose trades are predictive of stock price movement. So it's easy to clip the spread on that order flow (the 1-2 cents/share).

Of course slowing down orders so they hit all exchanges at the same time works. Why would you think that represents a flaw in the system? Previously, the broker was doing the following steps: #1 - clearly indicate to players on the NYSE a strong interest in purchasing stock (through activity on another exchange), #2 - deliver an order for stock to the NYSE. Naturally, it turned out better for RBC to do #2 before #1. That's the sign of a healthy interaction across exchanges. Of course I'd like to be able to buy an unlimited number of shares and not have my previous, visible activity factor into the market price. Buffet and other big stock buyers would like this even more! (Is it "front running" to buy WFC on the basis I suspect Buffet will likely buy some in the future - or perhaps has an order in transit right now?) You don't have a right to this, however.

The problem is this is a bad definition of front running. What we are talking about here is using widely available information, finding a market where that information is not currently reflected, and acting on that information. Because the information is widely available (not necessarily free, but also not particularly exclusive) basically anyone with some capital to put up can do this. The fault here, if any, would seem to lie with the BROKER (the one with duty of best execution), not the HFT. In Katsuyama's story, his firm has selected vendors so slow that in the time it takes his order to reach the NYSE (a market where he knows he wants to act), somebody else is completing a loop that involves another entire exchange and getting ahead of him. In Lewis's own piece he comes up with a solution to this that seems to basically solve his problem. The prior belief they seem to be using is that their order to buy $1.5 million of stock should somehow not be news - that is, that the market shouldn't respond and they should be able to fully execute at whatever pace they like. But unfortunately activity in a stock IS news... as soon as Katsuyama's activity is visible to the first player in the market, it will begin reacting.

One possibility is that by the time you get the sweep undone, the firms are in relentless winddown and have no prospect of future earnings growth. Right now say the preferred offers a ~135% return to whatever date it gets taken out at par, in its upside case. To offer a similar return FMNA common would need a $50 billion market cap at the time of resolution, assuming no new shares are issued - the actual value might be higher or lower than this figure. While I agree that the common shares offer more upside optionality, this isn't coming cheaply when you are buying Fannie at a $20bn market cap. There's also the fact that if the sweep is undone, something needs to happen to maintain the strong credit ratings of the GSEs. Undo the sweep amendment and you have massive balance sheets, only limited Treasury support and no book equity... not a formula for Treasury-like credit ratings. The companies might need to raise very large amounts of capital, so you could see meaningful dilution of the stock.

To your question #1, the value to shareholders would still be dependent on some sort of unwind of the sweep amendment from 2012, without which it will be really hard to have any recovery. But assuming that happens, shareholders would probably still have plenty of value even if this reform is executed. If you unwind the sweep and revert to the 10% dividend, Fannie's got a total capital stack (remaining gov't prefs + market prefs + equity market cap) of something like 70bn, and is earning perhaps 20bn/year in NIM and fees on its existing portfolio (which would be in full runoff if this reform is implemented). Depending on the speed of runoff and on credit losses, you could have plenty of value in the common. To your #2, it's not clear to me that this is so stupid for the average Joe. Yes, he will perhaps pay more for his mortgage (maybe marginally so... if the last 90% is government guaranteed, the private capital first 10% can be pretty expensive and still produce a cheap result overall). But he's also paying taxes, and those taxes were (in the end very visibly) subsidizing risk-taking on behalf of Fannie's private shareholders. I also doubt the 30-year mortgage will disappear; the primary risk Fannie and Freddie reduce is the credit risk in mortgages which is generally not too much higher in a 30-year fixed structure than in other structure. I'd expect it would be moderately more expensive, as would almost all other conforming mortgages.

It's much less of an issue in taxable accounts since you can generally claim a US credit to offset excessive foreign withholdings. This doesn't work for tax-advantaged accounts (i.e. you can't take the credit).

Typically debt issued as investment grade has few covenants that would prohibit such transactions, which of course are mostly bad for creditors. So SHLD has a lot of freedom to spin out assets. Yes, there could be a fraudulent conveyance issue if the company ended up going bankrupt, but in addition to having to go bankrupt within a reasonably near timeframe, it would also have to be determined that the spinoff left Sears in a certain amount of financial distress. Which would be challenging to prove in a court, I think, with Sears at a 5bn market cap and Lands End just a small fraction of that value. If they were worried about fraudulent conveyance, Sears could also end up using the same tactic as in the Orchard spinoff where they raised debt at the new entity to pay a dividend up to Sears, to provide some deleveraging to offset the spin. High yield bonds/leveraged loans typically have covenants restricting spinoff transactions and other restricted payments to shareholders, junior creditors, etc. So that's what prevents spinoffs in a lot of cases.

High yield is much more like equities than traditional fixed income, so I think you'll continue to have ample opportunities to apply the equity-type analysis you enjoy doing. I think your boss is probably right describing this as an opportunity and you would be making a mistake not to take it. I expect that this is a vote of confidence in you and even if this HY experiment is unsuccessful (a distinct possibility given how perilous 2014 looks for high yield) they will want to keep you around if you do a competent job with it.

About 66 for Fannie and 51 for Freddie (market value); 42 and 27 book value ... Bloomberg #s for FY 2006.

Precisely... Fannie/Freddie contribute $34.6 billion in "corresponding assets" in exchange for the cancellation of the preferred shares. I assume that these assets would not be in cash but in securities, and would also include whatever operational assets the NewCo investors need for their planned business model. I think there are many challenges to implementing a plan like this, but it's an interesting idea.