Why The Fannie-Freddie Bailout Will Fail
For years people pointed out the warning signs regarding Freddie Mac and Fannie Mae. Thing was, too many people in Congress and the government had a piece of the action. So rather than pursue any kind of reform that would ensure the companies were solvent, they bullied and intimidated the people who dared raise any warnings.
Now folks are wondering what this bailout might mean for the real estate market. Will mortgage rates go up? What happens if the international mistrust and fear afflicting Fannie and Freddie bonds infects U.S. Treasury bonds? Will foreign investors start dumping Treasury securities en masse, forcing Fannie and Freddie to pay much higher rates for their borrowings after all?
Why The Fannie-Freddie Bailout Will Fail
by Martin D. Weiss, Ph.D. 09-08-08
With yesterday's announcement of the most massive federal bailout of all time, it's now official: Fannie Mae and Freddie Mac, the two largest mortgage lenders on Earth, are bankrupt.
Some Washington bigwigs and bureaucrats will inevitably try to spin it. They'll avoid the "b" word with vengeance. They'll push the "c" word (conservatorship) with passion. And in the newspeak of 21st century bailouts, they'll tell you "it all depends on what the definition of solvency is."
The truth: Without their accounting smoke and mirrors, Fannie and Freddie have no capital. The government is seizing control of their operations. Their chief executives are getting fired. Common shareholders will be virtually wiped out. Preferred shareholders will get pennies. If that's not wholesale bankruptcy, what is?
Some Wall Street pundits and pros will also try to twist the facts to their own liking. They'll treat the bailout like long-awaited manna from heaven. They'll declare that the "credit crisis is now behind us." They may even jump in to buy select financial stocks. And then they'll try to persuade you to do the same.
The reality: This was the same pitch we heard in August of last year when the world's central banks made a coordinated attempt to rescue credit markets with massive injections of fresh cash. It was also the same pitch we heard in March when the Fed bailed out Bear Stearns. But each time, the crisis got progressively worse. Each time, investors lost fortunes.
Together, both Washington and Wall Street are trying to persuade you that, "no matter what, the government will save us from financial disaster." But the real lessons already learned from these events are another matter entirely:
Lesson #1. Each successive round of the credit crisis is far deeper and broader than the previous.
* In 2007, the big news was big losses; in 2008, it's big bankruptcies.
* In March, the failure of Bear Stearns shattered $395 billion in assets. Now, just six months later, the failure of Fannie Mae and Freddie Mac is impacting $1.7 trillion in combined assets, or over four times more. And considering the $5.3 trillion in mortgages that Fannie-Freddie own or guarantee, the impact is actually thirteen times greater than the Bear Stearns failure.
Lesson #2. Despite unprecedented countermeasures, Washington has been unable to stem the tide.
Yes, the Fed can inject hundreds of billions into the banking system. But if banks don't lend, the money goes nowhere.
Sure, the Treasury can inject up to $200 billion of capital into Fannie and Freddie. But if their mortgage portfolio is full of holes, all that new capital goes down the drain.
And of course, the U.S. government has vast resources. But if the $49 trillion mountain of U.S. debts and the $180 trillion pile-up of U.S. derivatives are beginning to crumble, all those resources don't amount to more than a band-aid and a prayer.
Lesson #3. Shareholders are the first victims.
Bear Stearns shareholders got wiped out. Fannie and Freddie Mac shareholders are getting wiped out. Ditto for shareholders in any of Detroit's Big Three that go belly-up, any bank taken over by the FDIC or any insurer taken over by state insurance commissioners......
A link that might be useful: