Journal CauseWithoutARebel's Journal: Freddie macs taxpayers, whips them on the Fannie? 3
At this very moment, Freddie Mac is down more than 48% on the week, and Fannie May is down over 46%.
If you're an American taxpayer, and that doesn't scare the ever-loving hell out of you, you have no idea where your money goes each April.
The ostensible purpose of these two behemoths is to allow a government-sponsored private entity to absorb some risk in the mortgage market by allowing that entity to pick up the risk of losses on mortgage securities by guaranteeing certain types of "conforming" loans. In short, if a bank picks up a loan and sells it, the bank gets the profit, Mac or May collect a guarantee fee to assume the risks, and those risks are transferred to ignorant taxpayers (Bernanke and Paulson will say otherwise, and it technically true that they're not government-backed, but we'll get to that later).
I've seen it put, thusly: the profits of the transaction are privatized, while the risks are socialized.
We may be on the verge of seeing just how much of a catastrophe this twisted little shell game can cause once the game goes tits up on the casino floor. Fannie and Freddie hold enormous portfolios that they've built up by purchasing and packaging mortage-backed securities. These portfolios are so weighted down by these sorts of securities, in fact, that they have become ridiculously more leveraged than any investment bank out there. Basically, if those mortgages turn sour, Fannie and Freddie are history.
And that's just what has people spooked this week. As values of homes have plummeted in some areas and stagnated in others, and as the results of corrupt lending have crept through the industry and exposed on the surface like some sort of horrible disease, Fannie and Freddie's solvency has come into question. If they're too heavily leveraged, they may well be insolvent already, and that means nobody wants to touch their stock with a ten foot pole.
Which brings us around to Hank Paulson. The Treasury has been taking a lot of care in tip-toeing around the issue recently, partly trying to downplay the notion that FNM or FRE are insolvent and partly trying to remind everyone, ever so gently, that the government is not obligated to bail either company out.
He's right, they're not obligated, but there's little reason to believe that the government would be stupid enough to let them fail.
Here's the problem: MAC and May hold such obscenely large debts now that if they fail, they could bring the entire market down with them. They have become one of those businesses that are derisively called "too big to fail".
Basically, if Mac or May fail, they'll bring mortgage lending to a screeching halt. Few banks are willing to assume the full risk of a loan up front and prefer to transfer "conforming" loans to one of the GSEs. Without being able to do that, they can't purchase a guarantee, and they're FAR less likely to make as many loans. If that happens, entire banks may fail (some banks, like the old Bear Stearns, foolishly leveraged themselves heavily in real estate), and other institutions will see massive losses in revenue. The entire financial sector would be blighted and investors would see their investments in public financials almost completely erased in a matter of days, crushing the value of the banks and leading to a chain reaction of multiple bank failures.
In a worst case scenario, these two companies failing could pitch the U.S. deep into a full-blown depression and that could even spark a worldwide depression.
But, here's the problem: if the government bails out Mac or May, or both, who do you think eats the bad loans that are weighing the companies down?
Yep: you.
You effectively wind up taking on the risks associated with the loans that two large, private enterprises accepted, but if those risks turn out to be overinflated, you won't see any of the profit:
Socialize the risk, privatize the profit.
It's unfortunate that this sort of thing never becomes common knowledge until it's too late, but people are so wrapped up in their own lives that they don't pay attention to the minutia of everyday governance.
It's funny, however, how all sorts of little "not-so-bad" rule changes and legislative matters can add up to a sudden, screaming catastrophe.
Update: "Helicopter" Ben Bernanke says that Mac and May can use the discount window to stave off insolvency.
What this means is that the Fed will happily print billions in currency for Mac and May to borrow so they can meet their financial obligations. While not a direct bailout in the sense of taking taxpayer money, printing money like this to "solve" problems devalues all the existing currency, pushing up inflation, and causing other problems.
I don't know if this is better or worse than an outright bailout, but it's not good.
It's $75 billion and counting ... (Score:2)
The two GSEs have an overage in their exposure of $75 billion. The only thing that's saving them is that they don't have to eat it all at once, but only "as it comes back on the books."
When you're leveraged 200 to 1 (which is what their debt/capital ratio is right now) in a decining market, you're dead.
The feds are going to try to stretch things out as long as possible, rather than say "Okay, this is broken, we're closing them down and doing another "Resolution Trust" thing."
The reason? Massive deval
Re: (Score:1)
Exactly.
And, interesting comment regarding the foreign interest in U.S. assets as of late. It would be interesting to know how much of the current administration's and fed's economic and currency policies are driven by panic over the possibility that Middle Eastern investment firms might start buying up huge blocks of U.S. assets as a hedge against declines in oil consumption....
Re: (Score:2)
The middle east AND Asia (China and Japan) are in a position to buy a lot of stuff when the Feds start playing "The Price is Right!"
It's the only way they'll get value back for their USD reserves ...