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The Washington Post reports that Hank Paulson plans to turn the back of his hand to people who hold common shares of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) in his "rescue" plan. But Paulson may bailout the holders of their preferred shares -- which currently pay a dividend yield of about 20%.

Why does Paulson prefer the preferred to the common shareholders? That's because the common shareholders are big mutual funds with lots of small shareholders who have no importance to the economy in his judgment. The preferred shareholders are regional banks whose capital he thinks would sink dangerously if he wipes out their dividend.

Below is a list from the Post of the big Fannie and Freddie preferred holders:

• Regions Financial (NYSE: RF) which has an estimated $200 million,
• M&T Bank (NYSE: MTB) with $161 million, and
• Astoria Financial Corp. (NYSE: AF) with $83 million.

BusinessWeek reports that Boeing Co. (NYSE: BA) has repeated its threat not to bid on the $35 billion competition to supply an airborne refueling tanker to the Air Force. This is a competition that pits a Republican presidential candidate and his lobbyist former finance chair on the dole of a French aircraft company and its Alabama partner against the future prospects of a Democratically controlled Congress and White House that would tend to favor Boeing -- which has many workers in Washington state.

By threatening not to bid, Boeing is taking many big risks. The Air Force may decide to keep the terms of the competition the same -- bids due October 1 -- and contract wrap up before New Year's Day. If Boeing does not bid and the competition proceeds, EADS, parent of Airbus, and Northrop Grumman (NYSE: NOC) -- with many of its workers in the Republican-leaning Alabama -- would win the bid uncontested. If the Air Force extends the process another four months -- which Boeing would prefer -- there is a chance that the Air Force would still end up choosing the French company.

But Boeing is gambling that the odds of a more favorable outcome are greater if it threatens not to bid. Boeing thinks that Congress will not want only one bid for the Tanker and that Congress and the White House are likely to be controlled by the Democratic party in January. With the French lobbyist-backed candidate in the Senate minority, Boeing will be in a better position to shape the Tanker competition in a way that favors its victory.

The New York Times reports that since we've had such a catastrophic run with home mortgages, it's time to watch the collapse of commercial ones. The same names surface when it comes to the collapse of our financial system -- in the case of commercial mortgages Deutsche Bank (NYSE: DB) ($25.1 billion), Morgan Stanley (NYSE: MS) ($22.1 billion), Lehman Brothers (NYSE: LEH) ($40 billion in commercial mortgages and property), and Citigroup, Inc. (NYSE: C) ($19.1 billion) are among the biggest holders. They are also big names in Auction Rate Securities (ARS).

Why do people think that commercial real estate could be tanking? Here are four reasons:

• Declining property prices. The Times reports that the Moody's/REAL Commercial Property Price Index has dropped 12% since its peak last October.
• Commercial mortgage write-downs. According to the Times, Morgan Stanley reported commercial mortgage write-downs of $400 million and Wachovia (NYSE: WB) said it would take at least $1 billion worth of such write-downs.
• Potential Riverton default. The Times reports that Riverton, a 1,230 unit Harlem development, was premised on the idea that developers could convert "lower-priced rentals to apartments priced closer to the higher market average." But the Times reports that Monday Fitch "issued a negative watch on part of the Riverton Apartments trust" since the developers had not made much progress -- threatening commercial mortgages that Citi and Deutsche Bank hold.

Lehman Brothers Holdings Inc. (NYSE: LEH) stock is up over 10% as of 9:44 a.m. on reports that Korea Development Bank (KDB) is "open to" acquiring Lehman, according to Bloomberg News. Can you say short-covering?

Bloomberg reports that KDB said, "We are studying a number of options and are open to all possibilities, which could include (buying) Lehman." But this statement requires some context. Bloomberg reports that The Financial Times wrote yesterday that "Lehman failed to sell a 50 percent stake to [KDB] and China's Citic Securities Co. The buyers walked away after deciding Lehman demanded too high a price."

Meanwhile, this announcement must be scaring those who bet that Lehman would not be able to pay its bondholders. "Credit-default swaps protecting against a default on Lehman's bonds dropped 74 basis points today to 315," according to Bloomberg. Who knows where this latest chapter in the Lehman saga will lead?

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

It's not clear how big the bailout of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) will be but it is becoming clearer who it is for. Yesterday, I appeared on CNBC's Power Lunch to discuss the winners and losers from the collapse in their common and preferred equity. But today, Bloomberg News reports that one of the biggest beneficiaries of the bailout will be the government of China.

In addition to buying most of our consumer goods from China, our government could use as much as $800 billion of our tax dollars to assure that China and other holders of Fannie and Freddie assets don't suffer any losses. Bloomberg interviews Yu Yongding, a former adviser to China's central bank who said, "If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic. If it is not the end of the world, it is the end of the current international financial system."

That sounds like a pretty strong statement to me. I am not sure why Yu made it or what it means. So I will throw in a mixture of fact and fiction to offer my interpretation. Bloomberg reports that China holds $376 billion worth of "long-term U.S. agency debt [which] is mostly in Fannie and Freddie assets." CLSA estimates that the six biggest Chinese banks hold $30 billion worth of such paper, according to Bloomberg. Those are the facts, now comes the fiction part.

Now eight large brokerage firms have settled with Auction Rate Securities (ARS) investors. This afternoon Bloomberg News reports Goldman Sachs (NYSE: GS) and Deutsche Bank settled with state regulators. Merrill Lynch & Co., Inc. (NYSE: MER) announced another prong of its settlement earlier in the day.

What are the terms of the settlement for the latest two? Bloomberg writes that "Goldman will buy back $1.5 billion of the securities and pay a $22.5 million fine. Deutsche Bank will redeem $1 billion of debt and was fined $15 million." In addition to the rogues gallery of big ARS issuers who have yet to settle, investigators are targeting medium-sized brokers -- Charles Schwab (NYSE: SCHW), Fidelity Investments and E*Trade Financial Corp. (NYSE: ETFC).

This leaves major ARS issuers lagging behind their peers. Here are three holdouts (with their 2007 municipal ARS issuance in parentheses):

• Bank of America (NYSE: BAC) ($3.7 B)
• RBC Capital Markets ($1.2 B)
• Lehman Brothers (NYSE: LEH) ($1.1 B)

What are they waiting for?

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Bloomberg News reports that Merrill Lynch & Co., Inc. (NYSE: MER) has extended its Auction Rate Securities (ARS) redemption offer in response to what I thought was pressure from New York Attorney General Andrew Cuomo who threatened to take Merrill to court. But what is interesting is that Massachusetts Secretary of State William Galvin was the one who announced the settlement.

While the politics of this intrigue me, those who held Merrill ARSs (pun intended) care about the terms of the settlement. Bloomberg reports that Merrill "will begin the buyback on October 15 for individuals, nonprofits and small business with $3 million or less on deposit. Redemptions for clients with $100 million or less start on January 15." This Merrill deal adds to the one it announced on August 7 -- a voluntary buyback of $10 billion worth of ARS. Merrill has a total of "30,000 clients who held an estimated $12 billion" according to Bloomberg.

This leaves many major ARS issuers lagging behind their peers. Here are four holdouts (with their 2007 municipal ARS issuance in parentheses):

• Goldman Sachs (NYSE: GS) ($4.3 B)
• Bank of America (NYSE: BAC) ($3.7 B)
• RBC Capital Markets ($1.2 B)
• Lehman Brothers (NYSE: LEH) ($1.1 B)

What are they waiting for?

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

I am not sure that Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) will make it through the month as public companies. Barron's quoted an anonymous senior official -- who sounds an awful lot like Hank Paulson to me -- that unless Fannie and Freddie could raise at least $10 billion each, the government would bail them out while wiping out common shareholders and eliminating the preferred dividend. Since then, investors have been dumping shares of Fannie and Freddie like there's no tomorrow.

Who wins and who loses if Fannie and Freddie's shareholders are wiped out? As I said on CNBC's Power Lunch this afternoon, the winners are investors who shorted Fannie and Freddie years ago and are now reaping enormous profits. I also think that some Wall Street investment banks will win big as they get the job of selling off Fannie and Freddie's pieces. The losers are their biggest common and preferred shareholders -- including some well known mutual funds.

The winners are:

• Jim Rogers, Rogers Holdings - Rogers originally shorted Freddie and Fannie in March 2006 and appeared on Bloomberg on November 20, 2007 to discuss why he did it and where he thought their stocks would go.
• Doug Noland, Prudent Bear - As I posted, since the late 1990s, Noland's research has concluded that Freddie and Fannie would "shudder" when the US credit bubble eventually burst. Noland has profited from the short bets he made -- but he says it is emotionally painful to watch them fail.

Upset about paying $3.80 a gallon for gasoline? Hank Paulson, former Goldman Sachs Group (NYSE: GS) CEO, argued that it was all supply and demand so quit your bellyaching. I thought speculation was playing a big part -- traders who bought oil and sold the dollar to drive up the price. Indeed, a few months agao I found a source who thinks 60% of the volume was from speculators.

Seems even that was too low an estimate. The Washington Post reported Wednesday that the Commodities Futures Trading Commission (CFTC) has analyzed the books of oil traders and calculated that 81% of oil trading volume was conducted by speculators.

Guess who broke open the opportunity for oil speculators to trade oil in a loosely regulated fashion? Goldman. The Post reports that In 1991, its J. Aron unit argued that "it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms."

It should come as no surprise that banking is a cyclical business. After the bubble bursts, there is always lots of hand wringing and vows to be more rigorous in underwriting. Then the bubble refills and people start to worry more about losing market share to companies with less disciplined underwriting approaches. This leads to a free-for-all as everybody scrambles for market share by lowering their credit standards. The bad loans don't get paid back and the cycle starts anew.

In the past, the Fed has been able to recapitalize banks during the down times by cutting interest rates. Since banks were tightening their credit terms, the interest rates on loans remained high or got even higher. But with the lower interest rates, the amount that banks paid depositors immediately dropped. As a result, the spread between loan and deposit rates widened and the resulting net interest revenue helped to replenish banks' capital.

That is sort of happening now. Since the Fed cut rates from 5.25% to 2%, banks' net interest margins have widened. A look at Citigroup Inc.'s (NYSE: C) most recent quarterly statement reveals that between Q2 2007 and Q2 2008 its net interest margin climbed from 2.41% to 3.18%. During that same time, the average amount Citi charged for loans declined slightly from 6.41% to 6.21% but the rates it paid depositors fell much more -- from 4.42% to 3.30%. Unfortunately, I said it's sort of happening now because the wider spread is not generating enough additional capital to offset Citi's writedowns.

Henry Paulson is maneuvering himself into the history books by forcing Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) into a spiral of doom from which they can't recover. He had plenty of help from the directors and executives who sit atop them. But it's becoming clear that since Saturday's Barron's article, laying out the path to failure, events are spiraling out of Fannie and Freddie's control.

The anonymous senior government source in the Barron's article said that unless Fannie and Freddie could raise at least $10 billion each, the government would bail them out while wiping out common shareholders and eliminating the preferred dividend. This would lead to a sell off of bad loans, a split into smaller pieces, and maybe selling those pieces back to the public. All these activities are a government gift to Wall Street, which will get to do all these deals.

Events are following this predicted pattern as Fannie and Freddie struggle to raise capital. The New York Times reports that investors are not enthusiastic about the most recent efforts to raise capital by Freddie Mac. It reports that on Tuesday, Freddie Mac raised $3 billion in five-year debt but the "1.13 percentage points [premium] over the rate the federal government pays for comparable borrowing" was more than double the "0.6 points" premium it paid earlier in the year.

Recent reports reveal a surprising amount of criminal activity in the mortgage business. This is particularly true in states whose names end in the letter A, such as Florida and Nevada. Two particular forms of illegal behavior are the licensing of mortgage brokers with criminal records and homebuilders' use of bribes -- or 'incentives' -- to encourage people to buy over-priced houses without disclosing them to lenders as required by law. Think I'm kidding?

DSNews reports that last week, Florida's mortgage commissioner resigned after it was revealed that he granted mortgage brokerage licenses to people with criminal records. Specifically, DSNews wrote that Don Saxon, who had been Chairman of the Office of Financial Regulation (OFR) had "allowed more than 10,000 people with criminal histories – including bank robbers, racketeers, defrauders, embezzlers, identity thieves, and tax evaders, among others – to work in Florida's mortgage lending industry between 2000 and 2007. These convicted felons had expropriated more than $85 million from lenders and homeowners during that time."

Meanwhile, things were not much more legal in Nevada. That's where the Wall Street Journal reports that the Las Vegas, NV branch of home builder Centex (NYSE: CTX) paid off the credit cards and mortgages of potential borrowers to entice people to buy homes priced from $350,000 to $550,000. The FBI is investigating allegations that Centex did not always disclose these 'incentives' to lenders as required by law.

The Wall Street Journal (subscription required) reports that producer prices launched upward at a 1.2% monthly rate in July. The rise in the PPI -- which was 0.7 percentage points faster than the 0.5% rate economists expected -- was the result of rising wholesale prices for energy spreading to "automobiles, prescription drugs and capital equipment."

Since the price of oil has dropped 24% from $147 to $112, should we all be relieved that July's number is a temporary blip? Let's hope so, because if not, rising wholesale prices make it even harder for businesses to make a profit when consumer demand is weak.

These higher wholesale prices mean that businesses have two options to maintain profits: keep prices the same but cut costs in other areas by finding productivity improvements, cutting back on payrolls and salaries and the likes, or raise prices to offset those rising costs.

It's been over a year since I last posted on liar loans -- these are mortgages which the borrower obtains despite offering no documentation on their income, employment or assets. These liar loans were also known as Ninja loans -- which is short for no income, no job, and no assets. The Associated Press reports that such liar loans will add $100 billion to the losses our economy is already suffering thanks to $400 billion worth of losses from subprime mortgages.

The problem we face as an economy is that it's hard to see where the liar loans end and the collateralized debt obligations (CDOs) and other asset-backed securities begin. In a sense, they are all liar loans. In the case of the mortgages, borrowers created paperwork that was inconsistent with their actual financial condition so they could get the money. In the case of CDOs, the issuing investment bank bought a AAA rating from a rating agency which created the illusion that the security was safe. Conceptually, there is little difference -- both depended on essentially forged paperwork to make the loan go through.

Why did banks issue liar loans? They were afraid to lose market share. But that doesn't make it right. As my mother used to say to me, if the other kids jumped off the Empire State Building, would you do it too? AP brings this to life in an interview with David Zugheri, co-founder of Texas-based lender First Houston Mortgage who said, "Everybody drank the Kool-Aid. They knew if they didn't give the borrower the loan they wanted, the borrower could go down the street and get that loan somewhere else.''

Lehman Brothers Holdings Inc. (NYSE: LEH) is poised to lose $2.6 billion and it's trying to dump $40 billion worth of real estate from its books. The Wall Street Journal reports that Guy Moszkowski, a Merrill Lynch & Co., Inc. (NYSE: MER) analyst thinks Lehman could lose $2.6 billion -- while others expect a mere $1.8 billion loss. Lehman normally reports in mid-September but it may pre-announce earnings this month.

I always find it interesting when analysts -- particularly those who work for banks with their own problems -- offer bearish earnings outlooks for their competitors. But I have met Moszkowski and I found him to be both very smart and a straight shooter. The Journal reports that he "more than doubled his loss projection to $2.6 billion and predicts that Lehman will take a $4.5 billion hit from write-downs." It quotes him as saying that an additional markdown up to 20% related to Lehman's remaining $64 billion in mortgage and commercial real-estate exposure "seems like a lot but can't be ruled out." If that were to happen, Lehman might need to raise more capital.

Speaking of that real estate, FT.com reports that Lehman is in talks to dump $40 billion worth of commercial real estate assets and securities. FT.com reports that there is a wide gap in what the potential buyers -- Blackstone Group (NYSE: BX) and BlackRock (NYSE: BLK) -- and Lehman think those assets are worth. It also reports that the assets in question consist of mortgages and mortgage-backed securities that Lehman valued at $29.4 billion at the end of May and real estate assets then valued at $10.4 billion.