Monday, July 14, 2008

Freddie and Fannie

“The dogmas of the quiet past are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise with the occasion. As our case is new, so we must think anew and act anew.” - Abraham Lincoln

Lincoln's message to Congress in 1862 was discussing the emancipation of slaves. It was a purely redemptive message in how to save the soul of the union. Obviously, the nation was already at war with itself, with the eventual loss of over half a million men under arms, and a country devastated both physically and emotionally.

However, Lincoln was prescient in his notion that we must think anew. The times called for sweeping change of perspective. Our time calls for thinking anew on many, many things. Our economy is perhaps the one area that is on most Americans minds at this time.

We have our own Stormy Present now. The various situations we are facing today are new for the most of us. The generation who lived through the Great Depression as children are passing on, and the lessons they learned seemed to have been lost on the rest of us.

We have an economic situation that is continuing to worsen. Last week, Wall Street displayed it's confidence in the economy by seeing the equity markets lose value yet again. The DOW Industrials dipped below 11,000 on Friday and then rallied somewhat to post just above the mark albeit with a 120 point drop for the day. While Wall Street is not the only indicator of economic fitness, it is the proverbial "canary in a coal mine". When the value of the markets continues to drop and trading sees more sellers than buyers, then there is obviously a problem.

The problem that caused the most recent drop in equity value was the revelation of troubles at Freddie Mac and Fannie Mae, the largest holders of mortgage debt in the country. So why does Freddie and Fannie get the credit for the most recent dip in the market? NPR has a great piece explaining the matter. Here's an excerpt. Click the link above for the whole story.

Why are investors so worried now about Fannie Mae and Freddie Mac?
Fannie Mae and Freddie Mac are the largest buyers of home loans in the nation. They buy home loans from lenders, then hold them in their portfolios or repackage them into bonds — known as mortgage-backed securities — that are traded on Wall Street.


But the big thing they do is guarantee all the loans that they sell to investors. So if a homeowner defaults on a mortgage, Fannie and Freddie will step in and make good on the loan. Right now, they are guaranteeing trillions of dollars' worth of loans.

Of course, now homeowners are defaulting and being foreclosed on at alarming rates, so Fannie and Freddie are being forced to make good on those guarantees to investors. Already they've posted combined losses of $11 billion, and investors are worried there's much more to come.

Ok, everyone knows about the sub-prime mortgage mess. Now, the government is considering stepping in to bail-out Freddie and Fannie and guess who gets the bill? That's right, you and me. Additionally, Ben Bernanke has posited that the Fed needs more powers to regulate the economy. Now, here's where my head starts to spin. All the bloviating right-wing, free market disciples who lined up to support the appointment of Bernanke to Fed Chairman haven't made a peep about this. It should be considered heresy for a conservative to recommend more regulation of financial markets. (Oh, they don't mind doing it when it comes to social issues).

What's happening here is the core value of the big money players (Goldman, Lehman, etc. etc) is disappearing. The economy in this country has for years been propped up on two things: Housing and consumer activity. The more we bought, the more capital flowed. The more houses we build, the more mortgages were available for selling, then selling again, then bundling into bonds that could be sold yet again and backed by the security of the US Government. Well, guess what? We really don't know how to fix this except to let the matter run its course and bottom out. When will the housing market bottom out? No one really knows, but some say in the next 13-18 months. What does that say for the markets? Well, unless you like selling short, I'd recommend getting out of anything supporting mortgage backed securities.

The Stormy Present indeed.


Tell me what you think.
regards,
Dennis

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