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Why The Fannie-Freddie Bailout Will Fail

Posted by dreamgarden (My Page) on
Mon, Sep 8, 08 at 17:03

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:

www.moneyandmarkets.com/Issues.aspx?NewsletterEntryId=2198


Follow-Up Postings:

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RE: Why The Fannie-Freddie Bailout Will Fail

dreamgarden, do you agree with weiss? Why/why not?


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RE: Why The Fannie-Freddie Bailout Will Fail

weiss is just ignorant.
Freddie and Fannie have ~99.5% performing debt.
The 0.5% of non-performing debt (pushed on them by the Clinton administration to increase "under served markets) is bonds from the sub-prime debacle.
The issue us that 0.5% of $5 trillion is still $25 billion.

Exactly who is getting 'bailed out'?
The stock holders will see their remaining equity further eroded.
The executives are already gone.
The bond holders will still see their money since 99.5% of the assets are still performing.

The 'crash' is a market freeze up brought on by the sub-prime debacle.
Freddie & Fannie cannot raise capitol for new mortgages.
Mortgage rates are already being pushed up by the higher bond premiums being paid.


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RE: Why The Fannie-Freddie Bailout Will Fail

More gloom and doom. I really don't know where he pulls some of the figures from. $49 trillion in US debts? Maybe he is referring to obligations that are are not covered for the next 50 years - that is so hypothetical. A real issue but certainly nothing that effects capital today.


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RE: Why The Fannie-Freddie Bailout Will Fail

Given that many of those bondholders are foreign govt trusts--i.e., our trading partners and therefore our creditors--this was a completely necessary step. It may be distasteful, but the fact is that for years, the F-F duo have been pretending that their issues are backed by the federal govt. And these foreign govts (and plenty of pension funds too) have believed them and invested 'safe' money. Now, if the govt lets the companies fail, pointing out that the legislation that created them specifically states they're on their own, all these creditors are going to lose faith in the US financial system and start pulling out wholesale. Treasuries included. Which would be a complete disaster for the country, and would basically make us no longer a first-world country, financially. Talk about dollar devaluation.

People should wind up in prison over this. It's unacceptable to allow this sort of disaster to happen and let those who engineered it get away scot-free. But that won't happen. I don't see an end to the practice of privatizing profits and nationalizing losses anytime soon.


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RE: Why The Fannie-Freddie Bailout Will Fail

Brickeyee,

I also read and believed that statistic about FNMA/Freddie Mac's performing debt ratio. That is, until I read the New York Times article on Saturday,

From the New York Times, September 6, 2008, "Mortgage Giant Overstated the Size of Its Capital Base":

"...Finally, regulators are concerned that the companies have mischaracterized their financial health by relaxing their policies on when to recognize a loss on a defaulted loan, according to people familiar with the review. For years, both companies have effectively done that when a loan is 90 days past due. But, in recent months, both companies said they would extend that to two years.

As a result, tens of thousands of loans that previously would have been marked down have maintained their value. The companies have injected their own capital into pools of securities, arguing that new business policies are helping greater numbers of borrowers.

Under conservative accounting methods, such a change in policy should not have any impact on the companies books. However, people briefed on the accounting inquiry said that Freddie Mac may have been using their new policy to delay recognition of losses."

With sadness, I don't see an end to privatizing profits and nationalizing losses, either. It is a shame and a scandal of epic proportions.


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RE: Why The Fannie-Freddie Bailout Will Fail

Hi housenewbie,

People should wind up in prison over this. It's unacceptable to allow this sort of disaster to happen and let those who engineered it get away scot-free. But that won't happen.

So very true... when was the last time we imprisoned our own politicians? (Current Motown scandal excepted.)

I don't see an end to the practice of privatizing profits and nationalizing losses anytime soon.

Prior to this, there was a very serious expectation (in fact, guided multiple times by statements from Alan Greenspan) that F&F explicitly would NOT be bailed out should they stumble and fall. As soon as the overall markets realize that the US Government has completely supplicated to socialism, that's the end... the gig is up.

It may happen now much sooner than you think.

Dave


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RE: Why The Fannie-Freddie Bailout Will Fail

Im trying hard to understand what is happening and what it all means. As someone who wants to buy a home, I have a vested interest in doing so. But the truth is, I dont understand most of what all of you talk about.

As soon as the overall markets realize that the US Government has completely supplicated to socialism, that's the end... the gig is up.

It may happen now much sooner than you think.

Dave would you mind explaining this please??? :-)

Jeri


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RE: Why The Fannie-Freddie Bailout Will Fail

Hi Jeri,

But the truth is, I dont understand most of what all of you talk about.

Apologies... on these threads, especially the big-picture macro-economic topics, some of us can spin off into directions that have everything to do with everything, and nothing really to do with the basic concern on-the-street.

On a micro-economics basis... the stuff that matters to you while prepearing to buy a home in the here & now... you ought to have low costs of leverage (mortgage) for quite a while... at least if our economic system remains stable (which it actually quite is yet.)

To explain the statement you asked about;
As soon as the overall markets realize that the US Government has completely supplicated to socialism, that's the end... the gig is up.
It may happen now much sooner than you think.
Dave would you mind explaining this please??? :-)

Realize that up until the last 100-125 years or so the United States had been digging itself up out of what we would now call a "third world economy." The reasons why we've risen to become the global dominating economy were because of a rugged (some would even say "sometimes cruel") individualistic and fiercely independent "bootstrap" economic culture that roughly treated everyone equal (emphasis on "roughly.")

The people who populated our country DESIRED this degree of true populism... that every man and woman had equal opportunity and equal risk, and because of this no person would get preferential treatment... neither due to their being a pauper, nor a king.

As our hard-scrap industrialism bore fruit, and we began to become self-aware of our economic superiority, we simultaneously (instantaneously) began our descent back into mediocrity... by beginning to design discrimination and collectivism into our economic systems.

In short, from generation to generation, we've gradually begun to become more and more economically spoiled and lazy, and the corruption that comes along with it has become more and more deeply rooted into our systems.

As individuals (to address you, and your concerns) we can learn to be strong, individualistic, economically mature... and succeed despite the ongoing decay of our economic society around us. Doing so is an emotional challenge however... as it means constantly "swimming against the tides of social popularity."

Hope that clarifies.
Dave Donhoff
Leverage Planner


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RE: Why The Fannie-Freddie Bailout Will Fail

Dave Thank-you for taking the time to respond with such a thorough reply. The book "Atlas Shrugged" comes to mind. I read that a life time ago and it had a big impact on me.

Can you point me to blogs or other web sites (or ???) that would perhaps help to educate me on all that is going on? I watched with interest all weekend about F & F and was surprised when the stock market went up on Monday. This tells me I dont have a clue


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RE: Why The Fannie-Freddie Bailout Will Fail

Hi Jeri,

I watched with interest all weekend about F & F and was surprised when the stock market went up on Monday. This tells me I dont have a clue

Oh... don't sell yourself short. If you watched the whole debacle unfold, and you guessed that the stock market would tank (sell off) you would be in a very large crowd of very well informed and highly opinionated market watchers.

There are more & more BLOGs on market economics... none of them being perfcect, and each with its own bias & spin.

Mike Shedlock (aka "Mish") is a friend of mine, and has developed a very large following;
http://globaleconomicanalysis.blogspot.com/

Mark Thoma is a new blogger I've begun reading regularly... don't always agree with him, but that's good too;
http://economistsview.typepad.com/economistsview/financial_system/index.html

Cheers,
Dave Donhoff
Leverage Planner

(PS. hmm... which I knew the HTM code to make the URLs live inside the body here... anybody able to share that skill? Thanks in advance!)


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RE: Why The Fannie-Freddie Bailout Will Fail

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RE: Why The Fannie-Freddie Bailout Will Fail

"I also read and believed that statistic about FNMA/Freddie Mac's performing debt ratio. That is, until I read the New York Times article on Saturday..."

And we all know how reliable the New Your Times is.
F&F have plenty of capital for the existing debt and defaults.
What they do not have is enough cash to continue making mortgages without selling bonds.

Wall Street has managed to freeze the bond market based on the banking failures of Indymac and other lenders who made high risk loans and then sold bonds.

The mortgages they made would not satisfy the 'conforming' rules, so instead of selling them to Fannie they created their own bonds. These banks have now defaulted on the bonds when the underlying mortgages became non-performing.

Has the Times made an issue over the lenders who precipitated this problem?
Have they pointed out the greed on Wall Street that though t you could get better returns without more risk?

The higher bond rates being demanded have already pushed mortgage rates from Fannie up about one point.
They have dropped back now since Fannie has funds to lend.

Fannie could easily sit back and stop buying mortgages, but that would simply exacerbate the mortgage crunch and the resulting housing crunch.


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