Tuesday, September 09, 2008

Fannie and Freddie, ad nauseum

So, the goverment has taken over operation of the America's two giant, government sponsored mortgage brokers, Fannie Mae and Freddie Mac. News reports say ominously that the bailout "could cost taxpayers tens of billions of dollars".

Tens of billions? Who are they kidding? Fannie and Freddie's liabilities were in the trillions (btw, a trillion is a thousand billions). At the rate that American mortgages are defaulting, tens of billions are not going to fix anything. It's hundreds of billions if we're lucky, probably well over a trillion dollars that the government will have to pay. Remember that Fannie Mae was notoriously resistant to audits, and the SEC kept letting them postpone their statements? No one knows the true mass of the black hole at the center of the mortgage galaxy.

Supposedly the holders of GSE debt (collateralized debt obligations, mortgage backed securities, etc) are relieved that the US Treasury will guarantee the monthly interest payments on this debt. Not to worry, the freshly printed notes will keep arriving in the mailbox on schedule.. but something is different here. Think of what those bonds used to represent. All those people going to their jobs, bringing in paychecks, making mortgage payments to banks.. that was a lot of economic activity. That was the process of wealth creation. Now that those homes have foreclosed (not all of them of course, but a lot of them) and mortgages defaulted, the treasury will simple write out a check to cover the mortgage - even though the people who originally borrowed the money no longer even own the home! What economic activity does that represent? Not a lot. No equity is being accumulated, no wealth is created, or value added. The government simply prints the money. The government could try to cover the cost with increased taxes, but that would only suppress economic activity even more (not to mention cause riots). These bailouts are simply the next stepping stone to hyper-inflation.

In the end, who owns all those homes? Bond fund PIMCO does, and the government of China, which are both huge holders of Fannie and Freddie debt. These are the owners of American homes, along with many others. And if those homes go into foreclosure, the mortgages will still be paid by the USA. In soon-to-be-worthless American dollars.

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