Topic: Monetary Policy
Federally Backed Mortgage Financing and Refinancing Is Destroying America Fannie Mae and Freddie Mac, those quasi-governmental guardians of financial fraud in the name of universal home ownership, abetted by the Federal Reserve System, are crashing on Wall Street.by Walt Thiessen
(libertarian)
Friday, July 11, 2008
There is a spectacular crash taking place right now on Wall Street that has been gaining attention over the past few days. It's actually been going on for months and years, but it's become particularly acute lately. It's not just causing residential mortgage holders and refinancers to shake in their shoes. This is a crisis that could ultimately lead to the undoing of the Federal Reserve System and our entire financial system.
Fannie Mae's Stock Prices Over 5 Year Period
Fannie Mae and Freddie Mac are in serious trouble. Today alone their stocks are down 35-40% so far...and the trading day has barely begun. Yesterday, they slipped another 50% in value. In fact, over the past year, their respective stock values have plummeted so far that they have lost around 90% of their previous value!
Freddie Mac's Stock Prices Over 5 Year Period
A year ago, Fannie Mae's stock was valued at about $70 a share. Today, as I write this article, it's valued at about $8 a share. A year ago, Freddie Mac's stock was valued at about $60 a share. Today, as I write this article, it's valued at about $4.40 a share. Who knows how low they'll go today before trading is done?
This crash isn't just about home loans made to people with bad credit, so-called "subprime" loans. This is about the overall basket of loans that have been made for mortgages over the past 5-10 years to all manner of buyers.
What's particularly frightening is that these two "firms" are financially responsible for $5 trillion in total mortgage debt. That's trillion with a "T." This is debt that the two companies have guaranteed, and the $5 trillion is equal to roughly one-half of the entire current national debt for the entire country! The Bush administration, according to a New York Times article that has appeared today, is now considering a takeover of these two companies, which would include an explicit government guarantee of the $5 trillion albatross hanging on the necks of Wall Street investors and firms.
When the government starts talking about massive bailouts...watch out! It means that really, really bad times are ahead.
What's particularly distressing about all this is that these two privately financed firms were originally created by the federal government. Fannie Mae was created during FDR's New Deal administration, under the name Federal National Mortgage Association. Its initials, FNMA have long been pronounced "Fannie Mae." Similarly, Freddie Mac was originally the Federal Home Loan Mortgage Corporation. Its initials, FHLMC don't exactly pronounce well as "Freddie Mac," but I guess the people who decide how to pronounce acronyms decided that Fannie Mae needed a younger brother. At any rate, Freddie Mac was created in 1970 by Congress to expand the secondary market for mortgages in the United States by providing competition to Fannie Mae.
Writing four years ago for The Motley Fool, Bill Mann wrote a particularly poignant article in which he claimed (correctly, in hindsight) that Fannie Mae and Freddie Mac could not be properly evaluated for investment. He went on to give a very useful description of what exactly they do. Take a look at this excerpt:
Fannie's full name is the Federal National Mortgage Association, and it was founded in the 1930s and privatized in the 1960s. It is a federally chartered corporation, owned by shareholders, that serves as a quasi-governmental agency. The company's charter gives it the objective of making sure there is money available for Americans who want to buy a home to get mortgages, but you cannot simply call up Fannie Mae and ask its loan officers about the going rate on a seven-year ARM; it doesn't loan money to retail home buyers. Instead, it provides liquidity for lenders by providing liquidity in the secondary mortgage market.
It works this way. Let's say that you get a mortgage on your new home from Wells Fargo Bank (NYSE: WFC). Wells Fargo, like any bank, has limitations on how much money it can lend as a function of its asset base. If your loan sits on Wells Fargo's books, it constricts how much the bank can loan. But if Wells Fargo sells the rights to Fannie Mae, it turns that loan back into cash, which it can then go out and loan again. You keep making your loan payments to Wells Fargo, and it passes these funds on to Fannie Mae. Fannie Mae makes money because it can borrow funds at a lower interest rate than you can. So instead of a single loan tying up Wells Fargo's capital, it can turn around and make multiple loans all from the same original capital base. This, the theory goes, increases banks' willingness to loan in good times and in bad. As a result, nearly 70% of American families own their homes.
Both Fannie Mae and Freddie Mac are known as "government sponsored enterprises." As such, their stocks are not regulated by the Securities and Exchange Commission the way truly private stocks are regulated. Don't be surprised if such new regulation becomes an issue in the days and weeks ahead, as the government once again claims to be fixing a problem it originally created through the smoke-and-mirrors of regulation.
The much bigger problem is the question of how the Federal Government is going to take on another $5 trillion in debt. Bear in mind that Federal mandates over the next 20-30 years are already far beyond what the government can possibly hope to honor. Throwing in these two mortgage monoliths only makes a nearly impossible problem worse.
What does the Federal Reserve System have to do with this mess, you might ask? Well, all the funds that were made available over the years to finance this form of investment suicide have come from the Fed's stimuluses of the economy. Mann noted that the banks have limits placed on them as to how much money they can lend out. Those limits are placed by the Federal Reserve Board, which has been engaging in an ongoing effort to make more and more capital available to markets via the Fed's ability to "create money out of thin air." This "thin air money" is created by expanding the amount of money banks can lend out based on the amount of assets deposited with them. So the mortgage crisis has been created by the double-whammy of irresponsible Federal Reserve monetary system stimuluses combined with irresponsible federal government programs intended to expand the ability of the average person to buy a home at higher and higher prices.
I have written numerous articles in the past 6-8 months discussing the devastating role the Fed plays in propping up easy-money lending. With today's financial events, we're now hearing the piper's tune more clearly than ever before, and he always demands to be paid.
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Posted By: Christopher Espinal
Date: 2008-07-11 19:54:04
For once, I almost agree with you! However, I'm still not sure about just how much contributions the Fed has made to financing that institution among the other things I believe you claimed the Fed financed. The other things I speak of would include the War in Iraq and Health Care.
And about that Debt crisis people are talking about these days: the reason we have so much money borrowed is because foriegners want to put their money in a secure investment - like the United States. The US Government of course is happy to borrow if foriegners are happy to lend. We will certainly face a crisis if the US government doesn't put that money towards institutions that help the US grow.
Now that idea is debateable because some people believe that government can't put money towards helpful institutions - or doesn't know how. On the other hand, today's mainstream economists would argue quite differently. I'm not sure if I understand things enough to oppose the former or the latter.
Posted By: Walt Thiessen
Date: 2008-07-12 03:39:06
You're not sure how much contribution the Fed has made, yet you claim that if foreigners want to loan money to the U.S. that's a good thing. Where do you think the money comes from for them to borrow? It comes from the Fed! Every dollar created out of thin air that the Fed thereby makes available to foreigners is a dollar that is used to put Americans further in debt to foreigners.
Why shouldn't we keep going into debt? If you have to ask that, you've never had to completely and successfully pay off a loan.
Posted By: Jake, the champion of the constitution
Date: 2008-07-12 16:43:18
Walt - A quote if I may
"Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."
Posted By: Christopher Espinal
Date: 2008-07-13 11:46:34
Sure, our printed money goes abroad, but why: because we trade with people and we use American currency to do so (even though it's not the only way to purchase US government bonds from abroad). Otherwise, the money wouldn't go abroad. All in all, there has to be a demand for foreign goods in order for US currency to go abroad.
"It comes from the Fed! Every dollar created out of thin air that the Fed thereby makes available to foreigners is a dollar that is used to put Americans further in debt to foreigners."
Every election cycle there are people that always say once we pass X amount of percent of borrowed money in relation to GDP the economy will fail. Reagan pushed the US way past several benchmarks and nothing happened.
If we don't manage our debts to become "good debts" then we will be in a serious problem. We can theoretically use money loaned to us by foriegners for "good debt" purposes. It's debateable whether or not we can. Credit can be very useful for businesses and countries to expand. But again, it depends on the efficiency of how we utilize those debts.
We are in debt to foriegners but it doesn't have to make a difference. Trump was billions of dollars in debt and then managed himself carefully. If it applies at that level, why shouldn't it apply at the macro level. Credit is important, but credit management is just as important. You may disagree, but I'm confident this nation can make proper decisions.
Chris, you think in the box. I've read many of your articles and responses and you sound like a book; which is not good in this circumstance. I'm from Chicago and I understand you are probably an economic 'genius' considering you go to U of C. However, as a result of your academic wisdom, it seems you rely on scenarios and books to argue in the real world, when in actuality it just doesn't work that way. I have a degree in Economics although I would not argue economics with you. But, to be frank, you seem like an asshole with denial that republican economic policies are terrible and not working. I mean, you state that all the conspiracies are false and it is absurd if you believe them because it is pure entertainment. Why is it so absurd to think that the greediest and richest people in the world (the government) would not want to arrange things in their favor? I mean, the rich continue to seperate themselves from the poor in this country every day. Income tax is a scam, a central bank is detrimental to sum it up, and the government is a private organization in the end. Its not that crazy to think powerful people want more power, but for some reason it is to you. As a commercial lender, I must agree that there is good debt from both points of view. Debt is an important tool. But the government and the big corporations thought it would be a good idea to give it to everyone. Why make money from those who 'qualify' for this important tool, when you can make money from everyone! Now, we are ruined and they will have to 'save' us. Save us with what, more debt, more policies, more restrictions, and more control over us because the average American thinks we need help when it was the governments policies and actions that put us in this position. I understand the economy has a cycle, but this one is unnatural and artificially created. There is no real argument against it if you really care. Economic policies go only so far in capitalism until you actually have to start caring about people. Morally, your economic policies are terrible. I'm tired to seeing the rich get richer and paying no taxes and elected officials still proposing tax cuts for the rich. We also need to stop electing people who don't have any interest in helping the average American. We elect ALL rich people and we need some different representation. Your economic theories and policies are all fine and dandy, but it doesn't work when the people implementing them are worried about their money first. We have the most corrupt government and monetary system on the planet, bottom line. We should know best, we're from Chicago. Stop fighting for what is and fight for what could be.
Sorry if this was jumbled, with how many things are going bad nowadays, I don't even know where to start or what to think about.
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