Countrywide and Bear Stearn's were the first shoe to drop. The other shoe, the really big one, is Fannie Mae and Freddie Mac. In large part, our entire economic system is based on the foundation of home mortgages and over $5T of those mortgages depend on Fannie and Freddie.
For those who blame the Bush administration for all evils should know that Fannie and Freddie are largely examples of Democratic pork and corruption going back to the Clinton presidency. It is very hard to trust the Bush administration about anything but the Republican's have had some of the best leadership on reforming these two agencies and limiting the risks they pose to our financial system.
Keep your eye's peeled for stories on Fannie and Freddie. Just today there were two articles in the WSJ. It is looking more and more like these two companies will default before the end of the year if left to themselves. The question now is what the government should do and whether it will be willing to do it.
U.S. Mulls Future of Fannie, Freddie
Administration Ramps Up Contingency Planning as Mortgage Giants Struggle
Wall Street Journal
July 10, 2008
The Bush administration has held talks about what to do in the event mortgage giants Fannie Mae and Freddie Mac falter, according to three people familiar with the matter, as the stock prices of both companies continue to fall sharply.
The shares of the two companies have plummeted for several reasons. Investors are worried they will suffer bigger losses as housing prices continue to fall and mortgage defaults rise. Stock-market investors are also worried they will need to raise significant amounts of capital to cover those losses. For stock investors, that means the value of their ownership stakes in the company will be cut. Bond investors continue to lend to both companies, though they are also demanding slightly higher interest rates.
Fannie and Freddie's health is of deep concern to policy makers because of the critical role they play in the housing market. The two companies own or guarantee about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding. The government has increasingly leaned on the companies to provide critical stability to a housing market crippled by falling home prices and banks too nervous to lend.
The current credit crisis has prompted some unprecedented thinking from national policy makers about how to maintain the integrity of the financial system. Since the near-collapse of investment bank Bear Stearns Cos. earlier this year, both the Treasury and the Fed have been pondering how to unwind a failed institution in an orderly way.
A WSJ op-ed. Add 1/3 to the national debt? Yikes.
The Price of Fannie Mae
July 10, 2008
Wall Street Journal
As opposed to GM or Ford, most Americans have never heard of Fannie Mae and Freddie Mac. Yet the insolvency of either mortgage giant would have far more profound consequences for every American taxpayer than the bankruptcy of those car companies. It's time Americans understood the price they could soon pay for the Beltway's confidence game with these high-risk "government-sponsored enterprises."
These columns have warned about Fannie and Freddie going back to 2002, and our fate has been to climb a wall of denial and hostility. This week reality began to set in. The duo's share prices tanked nearly 20% on Monday on fears that their capital levels may not be adequate. They rallied on Tuesday as their regulator played cheerleader, but they sank again yesterday to prices in the teens, compared to more than $60 a share last October. Investors are saying that a Bear Stearns-like run on the companies is a real possibility, and they're right.
What Americans need to know is how damaging such a failure would be. This wouldn't merely be a matter of the Federal Reserve guaranteeing $29 billion in dodgy mortgage paper, a la Bear Stearns. Fannie and Freddie are among the largest financial companies in the world. Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion....
To put that in perspective, consider that total U.S. federal debt is about $9.5 trillion, compared to a total U.S. GDP of $14 trillion. About $5.3 trillion of that debt is held by the public (in the form of Treasury bonds and the like), while $4.2 trillion is intragovernment debt such as Social Security IOUs. This is the liability side of America's federal balance sheet, and its condition influences how much the government can borrow and at what rates.
The liabilities of Fan and Fred are currently not on this U.S. balance sheet. But one danger is a run on the debt of either company, putting pressure on the Treasury and Federal Reserve to publicly guarantee that debt to prevent a systemic financial collapse. In an instant, what has long been an implicit taxpayer guarantee for both companies would be made explicit – committing American taxpayers to honoring as much as $5 trillion in new liabilities. U.S. debt held by the public would more than double, and the national balance sheet would look very ugly.
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Our own proposal, made months ago, is to require a more honest form of socialism by injecting taxpayer money now into both companies (say, in the form of subordinated debt or preferred stock) to recapitalize them enough to weather the current storm. This would help prevent a U.S. balance sheet debacle, and it would force the politicians to acknowledge the mess they have created. Then as the crisis passed, the taxpayers would at least get something for their money, while regulators could work to unwind Fan and Fred's liabilities and shrink these monsters to a less dangerous size.
This would be real "change" in Washington. Instead, the political class continues to promote the status quo illusion that Fannie and Freddie are risk-free purveyors of the American housing dream. It is one of the great political scandals of our age, and it has unfolded in broad daylight. As usual, the American taxpayer will get stuck with the bill.
