Monday, July 14, 2008

Freddie And Fannie - Another Government House Of Cards

People should have listened to Ron Paul even as late as last year (Nov 2007). He knew what was coming. Oh yeah, but he's the "nutjob".
The collapse of the housing market has served as a catalyst for the economy's latest bust. For years the federal government has made it one of its prime aims to encourage homeownership among people who otherwise would not be able to afford homes. Various federal mortgage programs through the FHA, Fannie Mae, and Freddie Mac have distorted the normal workings of the housing market.

The implicit government backing of Fannie Mae and Freddie Mac provides investors an incentive to provide funds to Fannie and Freddie that otherwise would have been put to use in other sectors of the economy. It was this flood of investor capital that helped to fuel the housing bubble.

Legislation such as the Zero Downpayment Act and the misnamed American Dream Downpayment Act made it possible for people who could not afford down payments on houses to receive assistance from the federal government, or even to pay no down payment at all, courtesy of the taxpayers. The requirement of a down payment has always helped to ascertain the ability of a buyer to pay off a mortgage. It requires the buyer to show hard work and thrift, the ability to delay present consumption in order to make a larger acquisition in the future.

When this requirement is minimized or eliminated, you introduce a new class of homebuyers, people who are unable to budget and save for the purchase of a home, or who should wait for a few years until they have saved enough to purchase a home. Federal policies have encouraged investors, lenders, and brokers to cater to these people, so it is no surprise that market actors came up with ever more sophisticated means of bringing these people into the real estate market.
I hope you'll read the rest of his analysis, as well as what he had to say back in 2003. He has always said that the Federal Reserve would cause this train wreck. Fannie Mae and Freddie Mac, back more than $4 trillion dollars in mortgages, and if they go under then we will see an unprecedented taxpayer-funded bailout the likes of which will make the Bear Stearns et al., bailout look like chump change.

Fannie Mae backs $2.6 trillion worth of single-family home loans, and yet the company has only $42 billion of capital (according to their SEC filing). Freddie Mac has $2.1 trillion in mortgages, and their capital to cover that is a similar $40 billion. If those loans fail, and many of them are risky loans, both company's capital could be decimated. Since they are guaranteed by the US government, guess who foots the bill. You and I will be covering all of that red ink, because again....They are too big to fail. Both are swimming in losses and foreclosures just like some of the other banking firms that started this house of cards to tumble down.

This is a very bad omen for this economy, and even though Treasury Secretary Hank Paulson is coming to the rescue with some dough, there is much damage that has already been done. His $15 billion dollar injection of capital into Fannie Mae and Freddie Mac is hoped to head this avalanche off at the pass, but Citigroup is expected to reveal further writedowns of about $8 billion with its second-quarter results, and Merrill Lynch is forecast to report writedowns of some $4 billion. It doesn't look good at all. No doubt we'll be bailing them out as well.

The problem is that houses were allowed to be purchased by people who just couldn't afford them. Higher energy prices, taxes, and food prices were the straws breaking this camel's back, and now these mortgage companies are swimming in red ink.

So now we have the potential for runs on banks, skittish foreign investment and all the financial mischief that comes with it all. It's going to affect everything.

Ron Paul has been preaching sound monetary policy for years and no one has listened, because he's the nutjob.

Maybe Ron Paul needs that Verizon guy...."Can you hear me now"? or how about this new ad: "Got Gold?"

The media pretty much ignored the R3volution march in Washington DC this weekend ... and by the way, speaking of revolutions: Happy Bastille Day