Bye Fannie, See Ya Freddie: Should the Rest of Us Get Ready to Kiss Our Butts Goodbye?

On my personal ranking of the news events of the past 100 years, the top three stories are (1) Hiroshima/Nagasaki; (2) The tearing down of the Berlin Wall; and (3) The current forcing of Fannie Mae and Freddie Mac into federal conservatorship.

The conventional wisdom, of course, is that Fannie and Freddie are “too big to fail”. Let us, then, explore the ramifications of the pending “bailout”.

My personal opinion is that the current resort to conservatorship is an act of near desperation designed, and hopefully well designed, to prevent the impending potential actions of the creditors of the United States Government, the creditors of our very nation, from creating a de facto conservatorship that would be forced on us. On this entire planet, the ultimate entity that is “too big to fail” is our government, our nation, but that does not mean that we are somehow immune from the consequences of our own economic excesses. It only means that heroic measures might well be taken on our behalf, and sometimes from the seemingly most unlikely quarters, but it does not mean that success is guaranteed, nor that the inevitable pain for us of this necessary process can be escaped.

Think about it! Fannie and Freddie were the original issuers of five trillion dollars worth of bonds that were collateralized by mortgages signed by U.S. homeowners. They were able to accomplish this feat only because essential features of their very existence told investors that their loans were being guaranteed by the U.S. government, i.e. by all of us. This paper was sold planet wide as the gold standard of investments. Now let me report a conversation recently held between a highly placed representative of a nation that is an important holder of U.S. debt instruments and a very highly placed person within our system. I can’t link to any source for this particular conservation, but I’ve found any amount of information that tells any informed observer exactly what has been going on recently. Foreign Big Shot, “Are you guys going to back up this paper, or what. Because if you’re not, we’re going to dump every last dollar we hold of it before it becomes good for nothing but toilet paper. We’re just giving you this heads up because we are such good friends of the U.S., and definitely not because we’re afraid of getting hurt by the planetary crisis, on nearly every level, that would occur if the U.S. government went into default.”

The response of our person was, of course, “Yes, we’re going to back not only this stuff, but all of our paper.” How could it have been otherwise?

Now evaluate the consequences of any other response. This five trillion was issued with “the implicit full faith and credit of the U.S. government” behind it. And next in line is the ten trillion plus dollars worth of bonds issued directly by the U.S. Treasury to finance our national debt (almost all of which was issued by Republic Administrations). How do we tell investors (read: Saudi Arabia, China, Russia, Japan etc.) that we can’t be trusted on our mortgage backed paper, but we can be trusted on our direct issue stuff? It ain’t happening! It’s an “all or nothing” deal, and anything less than “all” immediately results in absolute economic panic.

That, I’m convinced at the moment, is exactly where we are at. The five trillion of F&F debt was ready to sneeze, and the result would have been the ten trillion dollars of our actual national debt catching a cold. Would this have sent our country into insolvency? Almost certainly not. Even the total of fifteen trillion dollars of potential defaults is less than 1.5 years of Gross Domestic Product.

But would it have caused the current world economic system to have retrenched on its support of, and belief in, the primacy of the U.S. economy as the dominant engine of growth for the planetary economy? Yes, guaranteed! And from there the spiral down would take an untold number of years for the planet to sort out! The time frames of the downturn of the thirties spring readily to mind, except that now there are far more people far more economically dependent upon each other in the modern world than was the case on a largely agrarian planet so the overall level of misery and despair would be greatly magnified.

The context of this situation, then, is that a year ago pessimistic commentators were stating that as many as two million homes could be lost to foreclosure, with all of the negative consequences on real estate values and economic activity that such an outcome would create. The government and most mainstream voices, however, assured us in a very calming way that the problem would be of far lower magnitude, and would be readily managed. Today, the foreclosure avalanche has been at least as huge as negative forecasters feared, while the latest figures released state that there are still four million households in various stages of default on their mortgages. In other words the spiral down caused by foreclosure properties clogging resale markets, resulting in lower property values and sending more families into negative equity on their homes, is not only still spiraling down, but seeming to actually be doing so at a still increasing rate.

To me, this whole chain of events suggests two final points:

(1) The financial system of the planet is in the most precarious state imaginable, with the potential for grave damage to the rest of the economic structure.

(2) If you want to know how this problem is actually viewed in the inner circles of the highest levels of world power, pay far more attention to what is done than to what is said.

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4 Responses to Bye Fannie, See Ya Freddie: Should the Rest of Us Get Ready to Kiss Our Butts Goodbye?

  1. alrudder says:

    What I want to know is, what is Ronald Reagan thinking about Secretary Paulson?The Reagan ideology of constant deregulation is done

  2. Zak Carter says:

    The differences between McCain and Obama are minimal, when you consider that both believe big government can save you from yourself, and that we can save other nations from themselves as well. I will not play along with the game of lesser of two evils, as I believe that is part of what has plunged this nation into the mess we find ourselves today.
    Please visit and give liberty a voice in the Presidential debates and beyond.

  3. Stuart says:

    You can find this morning that the Global Markets boomed and interest rates dropped around the world, and they most likely will in the US today, after the government stepping in to support Fannie/Freddie.It is not a full takeover. They will remove much of upper management. At this point it is believed that all shareholders except preferred, will share equally in any stock market losses. The preferred is held by foreign interests, including China. The Fed will inject enough funds to keep Fannie/Freddie lending as they are the ultimate source of most of the loans in the US. A true failure of those giants wouldn’t be on Wall Street but on Main Street where home loans of every kind, including FHA, simply dried up.This is the best road that allows everyone to share the downside and keep the mortgage markets open. For every house going to foreclosure more are being sold. Having a working mortgage market is an absolute necessity.From Bloomberg this morning: Mortgage bonds guaranteed by Fannie Mae and Freddie Mac rallied the most since March, potentially reducing home-loan rates, after the U.S. government seized control of the companies and vowed to shore up demand.
    The difference between yields on Fannie’s current-coupon 30- year fixed-rate securities and 10-year Treasuries narrowed 27 basis points to 165 basis points, the lowest since May, data compiled by Bloomberg show. The spread hit 216 basis points on Aug. 18, the widest since a 22-year high of 238 set in March============
    Zak:Obama and McCain are worlds apart on everything. You can throw your vote away on Bob Barr, not because he doesn’t have a point of view, but because he has NO chance of impacting the outcome. Your vote for Obama has every chance of being a vote for a new way, which is actually a very old way, in Washington. Please consider the value of your vote.

  4. Darrell Prows says:

    Stuart: The narrowing of the spread is important but, as of right now, the market for Treasuries is way off. This means that mortgage rates have gone up substantially, just not as much as would have been the case at the higher spread.But ask yourself this. If uncollateralized Treasury borrowings yield X, what is the proper yield for Treasury borrowings that have the added safety of mortgage collateral, and an independent repayment stream? Previously implicit guarantees have now been converted into full guarantees.