Stock in Fannie Mae and Freddie Mac are down more than 85% in the past year. As government-sponsored enterprises, there has always been an implicit federal backing. Recent moves make it look more like an explicit federal guarantee. The logic is clear - Fannie and Freddie own or guarantee about half of the mortgages in the U.S. market, approximately $5 trillion, and they must not be allowed to fail at any cost. But what are the real costs and who will bear the burden?
Treasury Secretary Henry Paulson has a plan. He has asked Congress for the authority to increase the amount of money the Treasury can lend to the GSE's beyond the current $2.25 billion, each. He would also like to be able to buy equity in the companies, which they do not expect to need, as a "back-stop" to be used on an "as-needed" basis.
Bud Light presents Real Men of Genius. Today we salute you Mr. Spending Other People's Money Guy. Your unlimited, federally guaranteed, taxpayer funded gold card will never be declined. Sure there will be inflation, but you have a six-figure salary working for our Uncle Sam. You don't have to worry about involuntary down-sizing, or paying $5 for a gallon of gasoline. So, keep on throwing good money after bad - it's not your money. You have nothing to fear Mr. Spending Other People's Money Guy.
Despite the fact that Fannie Mae has raised more than $14 billion in new capital since November, and Freddie Mac's claim that they "are adequately capitalized, both organizations are in dire straights, according to an article on Bloomberg.com.
Freddie Mac is already insolvent under fair value accounting rules, and Fannie Mae is likely to follow, former St. Louis Federal Reserve President William Poole said in a recent interview. Fannie Mae and Freddie Mac raised a combined $20 billion since December to cover losses of more than $11 billion generated since the credit crisis began last year.
This is a game of "borrowing short" and "lending long." It is a sophisticated Ponzi Scheme that can't go on forever. When the short supply of money is interrupted, it becomes more difficult to meet long-term obligations. This is what the government is attempting to avoid by putting in place access to more short term capital.
Making cheap money available to the mortgage market has helped spur growth in our economy, but it has also created a mess that is likely too large for the government to handle. The Bear Stearns bailout transferred billions of dollars of risk from the private sector to the government, and ultimately to the taxpayers. Now, the expansion of the GSE's will do more of the same.
An article on Financial Times.com, Goodbye Capitalism, explains that the government is stepping in to prevent capitalism from operating efficiently.
In a capitalist economy, losers are expected to take losses and winners to gain. Private enterprise is best able to allocate capital efficiently and, where it fails to do so, markets make adjustments and capital is reallocated to efficient users. This basic tenet supports good and productive assets moving from the hands of weak players to stronger. Where this is not possible, the US system gives the government a hand in fostering that move through an efficient process called bankruptcy or reorganisation.
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Our elected officials have repeatedly demonstrated that even equity holders, who are supposed to have the most subordinated claims on assets, cannot be allowed to take losses and instead believe we should all communally share in losses that result from poor allocation and risk management decisions.
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Given the choices we have seen from officials, who obviously have little faith in the ability of capital markets or our system of law, we will see the continued nationalisation of bad assets, placing the burden on the shoulders of the already overburdened American taxpayer.
This causes inflation and as the dollar declines against foreign currencies, even our largest American companies are subject to cheap buyouts by foreign investors. Anheuser Busch recently announced that it is being purchased by InBev, the Belgian brewer of Becks and Stella Artois. Many American companies are seeing stock prices drop and the weak dollar makes them all the more attractive to foreign investors. The Dow Jones Industrial Average is down more than 21% from its high in October.
So, crack open an ice cold Bud Light, Mr. Spending Other People's Money Guy, while it is still brewed in the great U.S. of A. Or, maybe you prefer pricey imports to the golden elixir from Ft. Collins, Colorado . After all, you can just print more money when you need it. So keep those printing presses running, O' Master Money Maker. Your going to be working over-time.
Some experts question whether we need Fannie or Freddie at all, according to an article on Forbes.com.
Despite the worry that the companies are too big to fail, Martin Hutchinson and Lauren Silva at Breakingviews.com suggest that they could be killed off, albeit slowly, by simply running them into the ground through higher fees to customers and reduced pay to their workers.
"Market forces probably would replace them within five years," they write, as banks that were pushed out of the mortgage securitization market by the Fannie Freddie monopoly come back. According to Hutchinson and Silva: "Politically it is an unlikely outcome, but by 2013 or so, it could be possible to close Fannie and Freddie - at least to new business - with scarcely a ripple."
If the private sector could take over the secondary market, maybe it is time to consider phasing out the mortgage giants before it pulls down our entire economy. At the very least, we need to keep the risk where it belongs and not on the taxpayers.
This Bud's for you, Mr. Spending Other People's Money Guy. Most taxpayers feel they are already overburdened, but you don't think so. Truly an evolutionary, a forward-thinker, a man with a plan, you think that everyone should shoulder the burden of the failing private companies that loaned money to every Tom, Dick, and Harry with a pulse. If they could fog a mirror, you can buy their bad debt. Why? Because you don't believe in Capitalism. So this Bud's for you, Mr. Spending Other People's Money Guy.... we hope you choke on it.
If you aren't familiar with the "Real Men of Genius" series of commercials, here is a sample for you.
We do have to do something about our financial market problems, but the answer isn't throwing good money after bad or shifting the risk of bad loans to the taxpayers. Propping up a broken system isn't going to cure the problems. The bankruptcy laws need to be changed to allow for relief from residential mortgage debt and we need to implement new lending guidelines to prevent this from reoccurring.
Best,
Robert A. Franco
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