Topic: National Debt
Freddie and Fannie: whom are we saving? As these two Government Sponsored Entities move closer to the brink of collapse, it may be more merciful to let them go.by DigitalBob
(Libertarian)
Thursday, July 17, 2008
To most Americans, Freddie Mac and Fannie Mae sound like an R&B and country music duet. Recently, both these massive companies are making the news because of their possible collapse. Lawmakers and bureaucrats are scrambling to keep them in business. According to Jim Rogers of Rogers Holdings, it will cost the American taxpayers perhaps $5 trillion ([link edited for length]) to save these companies and cover their mortgages. That's right. In one month, the U.S. Treasury is considering increasing the national debt by 50%, if it decides to rescue these two private companies.
What we're witnessing the biggest abuse of federal power and fiscal irresponsibility in our nation's history. It is the culmination of decades of market tampering by the federal government.
President Bush is pushing a proposal through Congress to make sure these companies survive in any event ([link edited for length]). He believes that these companies deserve to exist in their present form, just with more regulations. The scariest part of this announcement is where he says that "the newly proposed authorities are temporary, and will only be used if needed." (In his comments later in the video, he admits he doesn't have a magic wand for oil prices. I can't make this stuff up.)
This bailout is supposed to save the secondary market for home mortgages. The function of these two companies is to ensure that mortgage money is available to banks, by reselling mortgages in bundles to investors. By ensuring this secondary market exists, banks and mortgage companies should have enough confidence to make low cost loans to Americans.
The fatal flaw in this plan began when mortgages quit being generic 10-year, 15-year and 30-year fixed term agreements. With ARMS and balloons, risk was severely underestimated. When a borrower couldn't make his house payment, he no longer knew who to go to for help. It's not unusual for a borrower to make payments to a loan servicer who had nothing to do with the loan's origination. Fannie and Freddie are now stuck with a huge exposure because of record loan defaults.
Fannie Mae was created in the 1930s, when foreclosures were wide-spread after years of credit-based trading on the stock market. Under the Johnson administration, Fannie Mae was privatized in an effort to get its liabilities off the federal budget. It still provided its original function, but as a regulated monopoly. Freddie Mac was created years later to provide competition. But since they both did pretty much the same thing, they operated as the Bobbsey Twins. Over the last 20 years, their stock prices track as if they were the same company ([link edited for length]). In the last year, they've both lost about 90% of their value.
As private companies, U.S. government does not guarantee what they sell. It's been thought that their size was big enough to weather some loan defaults. For a long time that was true.
The government is trying to instill confidence in these two companies, so that a bad economy doesn't get worse under this administration's watch. And that means making a deal with the current investors so they don't all start dumping shares at once. Let's take a look at which investors.
The biggest one is Capital Research Global Investors. CRGI owns about 10% of Freddie Mac, currently (7/15/08) valued at $1.6 billion and 11.7% of Fannie Mae, valued at $3 billion. The other billion-plus investors include AXA insurance, Legg Mason Capital Management, Capital World Investors, FMR LLC, and Barclays Global Investors. In the hundreds of millions, you have Citigroup, Vanguard, Morgan Stanley, and several others. Last year the analyst from Citigroup made a wishful-thinking BUY recommendation on Fannie. Oops.
Compared to the size of their other investments, FRE and FNM make up a small part of their portfolios. Combined, the current market capitalization of these two companies totals about $11 billion. Microsoft was trying to buy Yahoo for several times that. None of those investment companies will go under if either Fannie or Freddie's shares went to zero. They would just find something else to invest in.
New victims in all this will be the American taxpayer. If the U.S. Treasury goes through with a buyout, you and I and our children will be stuck with the liabilities of this disaster for years to come. With liabilities in the trillions, no private company would touch either, unless there was an external guarantor. It would be more merciful to let the market run its course.
Banks and mortgage companies would actually have to evaluate risk themselves, instead of assuming a mythical creature in the back room will do it for them. It might actually lead to responsible lending. What a concept.
After Freddie and Fannie are gone, mortgage companies and banks could still form a market to trade mortgages. The mortgages would have to be standardized contracts, like bond or treasury note futures.
If the marketplace really needs a secondary market for mortgages, it will form one out of necessity - - not because the government says it has to. Even if that market isn't formed explicitly, the insurance companies will do what they've always done: hedge their bets.
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2008 DigitalBob, all rights reserved.
Published: Thursday, July 17, 2008
Last modified: Thursday, July 17, 2008
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As an engineer I've studied math, algebra, geometry, trigonometry, calculus and differential equations. But I must admit to being somewhat baffled by the numbers behind the mortgage mess. The combined market cap of Fannie and Freddie is about $11 billion as you point out. But the dollar value of the mortgages they deal in is alledged to be in the trillions. Although when I look at their balance sheets I don't see any numbers in the trillions.
From what I understand Freddie and Fannie buy mortgages, repackage them as interest bearing investments and sell them to investors. I think they also "insure" the investments. My guess is that many of these "investments" are held in various cash reserve accounts at brokerage firms, as well as in CDs and money markets.
If the mortgages go into foreclosure who loses? Do Fannie and Freddie lose because they insured the investments? Or do the purchasers of the investments lose? Or does the taxpayer lose because the government bails out the failed investments?
When someone defaults on a mortgage the mortgage holder gets the house. The house may not be worth as much as the mortgage, but it is still worth a large fraction of the mortgage. So where do the trillions of dollars in losses come from?
Could it be that I need a better background in mathematics to understand this? Or is it difficult to grasp because the people behind it want it to be that way? I'm betting on the latter.
Obfuscation is the order of the day. These companies show hundreds of billions in debt, and on they're trying to issue new bonds to stay afloat. Normal math on this issue loses its meaning after nine zereos. T
he Motley Fool had an article today about Bernanke's Utter Failure where the government is in the business of privatizing profit and socializing risk. And this administration calls itself "conservative?" Makes one sick.
By the way, I have an electrical engineering degree, half an MBA, and formerly held three securities licenses and an expired insurance license. My day job is being a software consultant. I still don't get it. -dB.
Just a thought. I do not have the math background of either of you. My simple understanding is based on market cap, they were allowed to write X amount of loans. Though this guideline, was probably never followed the gse's were allowed to way over leverage themselves. It was the leveraging of their market cap that allowed the number to get into the trillions.
Posted By: Michael McDonnough
Date: 2008-07-17 18:25:42
It seems like the W administration is trying to wreck the US and world economy. If all of this is just coincidence as some of those “coincidence theorist” insist then this administration must be cursed or something. Everything they touch seems to turn to crap.
Posted By: Jake, the champion of the constitution
Date: 2008-07-20 05:45:20
DigitalBob - great article. big fan of Rogers, like normal he's just talking common sense. would trade him for paulson in a heartbeat. i wonder what % of the american public realizes what could happen when the national debt goes up by 5 trillion, but its really just like the fed rate - damn if they take on the debt and the dollar/agency rating goes down, kill the taxpayers and postpones the pain, damned if they pass on the debt and the economy suffers a short-term shock. Knowing congress and bush, postpone the pain will be the choice, although I happen to agree with Rogers. That said, we've got some creative dudes at the Fed, the move to make short selling financials more difficult was pretty interesting to watch, lets see what our "gods of copybook headings" (Kipling) come up with - Jake
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2008 DigitalBob, all rights reserved.