I don't think that the general public realizes how the impending collapse of Fannie and Freddie is a game-changer. Bear Stearns, Enron, IndyMac, those are all small potatoes in comparison to the massive size of the GSE's.
The inevitable failure of these institutions is so epic that when the epitaph of the American Empire is composed it will be Fannie and Freddie that are written large.
However, some people are shouting warnings now.
"If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic," Yu said in e-mailed answers to questions yesterday. "If it is not the end of the world, it is the end of the current international financial system."
"The seriousness of such failures could be beyond the stretch of people's imagination," said Yu, a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences in Beijing.
Believe it or not, this warning is not the one that scares me. It is the warning from Warren Buffett that is truly frightening.
Fannie Mae and Freddie Mac, the two largest mortgage finance companies, "don't have any net worth," billionaire investor Warren Buffett said.
"The game is over" as independent companies said Buffett, the 77-year-old chairman of Berkshire Hathaway Inc., in an interview on CNBC today...
The two mortgage companies recorded almost $15 billion in combined net losses in the past four quarters as delinquencies rose to record levels, shrinking their capital. The swoon sparked concern they may not be able to weather the worst housing slump since the Great Depression and prompted Paulson to step in with a rescue plan.
Fannie, down 95 percent in the past year before today, advanced 34 cents to $5.19 at 9:32 a.m. in New York Stock Exchange composite trading. The stock was trading at almost $70 a year ago. Freddie, down 91 percent this year, added 24 cents to $3.40...
Former Federal Reserve Chairman Alan Greenspan and Richmond Federal Reserve Bank President Jeffrey Lacker have called for the companies to be nationalized. William Poole, former head of the St. Louis Fed, said last month Freddie is technically insolvent and Fannie's fair value may be negative next quarter.
And if that wasn't bad enough, Fannie and Freddie have to roll over $223 Billion in questionable debt before the end of September. If Fannie and Freddie were healthy this wouldn't be a big deal. But since terrified foreign investors are running away from them, this is going to be a problem. The bond market just might freeze up.
And just yesterday, Moody's cut the rating of Fannie and Freddie nearly to junk.
Fannie and Freddie account for about half of the $12 Trillion real estate market.
How did we get into this mess?
Like most economic catastrophes of this decade, it started right about the time George Bush came into the White House.
Lies, Cover Ups, and the Making of a Disaster
When the Federal Reserve panicked in 2001 and cut interest rates down to 1%, Wall Street was flooded with cheap money. So what do you think happens when you mix cheap money with Wall Street bankers?
for years, observers have wondered how Fannie could manage its inherently risky portfolio without a whiff of volatility. Now, thanks to Fannie's regulator, we know the answer. The company was cooking the books. Big time.
Lay and Skilling at Enron were amateurs compared to the boyz at Fannie Mae and Freddie Mac.
As part of a scandal that's been running nearly two years, Fannie Mae has "misstated earnings" to the tune of $10.8 billion. That's some tune.
Freddie Mac had their own $5 Billion scandal. The accounting scandal was so large that even Fannie and Freddie didn't know what was in their portfolio. They failed to register with the SEC for at least eight quarters.
Considering the massive size of this scandal, how did Fannie and Freddie manage to avoid being heavily regulated or even nationalized? They spent $170 million lobbying Congress and another $19.3 million in direct campaign contributions. In other words, they legally bribed the people who were supposed to be regulating them.
Now let's fast forward to March 2008.
The housing bubble had burst. The economy was melting down. Real leadership was needed, so the Bush Administration swung into action.
By reducing the extra cushion of capital the two companies have been required to hold since 2004, the regulator, the Office of Federal Housing Enterprise Oversight, is enabling the companies to invest $200 billion more in home loans. In essence, the companies are being allowed to take billions of dollars that had been used as a reserve against possible further losses and invest that money now in the housing market.
But critics said that if the housing market continued to decline, the move could put the two companies on a less sure footing and ultimately require a huge taxpayer bailout.
"I think it’s very dangerous and it’s a sign that people are very frightened," said Thomas H. Stanton, an expert on the two companies who teaches a course on credit risk at Johns Hopkins University. "At a time in which finance companies are holding questionable assets and facing losses, regulators typically require more capital, not less."
""Additional capital will enable the companies to help more homeowners and will strengthen the underlying fundamentals of the mortgage market."
- Treasury Secretary Paulson
The Bush Administration had Fannie and Freddie cut their capital reserves to buy assets which were collapsing in price, even while the GSE's were entering a period where they were going to take massive losses.
Freddie Mac and its fellow GSE Fannie Mae are now financing more than 80 percent of all mortgages in the U.S., up from 40 percent a year ago.
"We are nearly the only game in town, and we think we are going to be able to enjoy that position for a number of years," Piszel said.
It was a risky gamble, and it failed. Spectacularly.
That's not to say that Fannie and Freddie are going down without a fight. They fought back with their best weapons - accounting trickery.
Freddie said Wednesday its first-quarter earnings beat Wall Street expectations, but it also reported that the "fair value" of its net assets fell to negative $5.2 billion at the end of March from 12.6 billion dollars at the end of December. That reflected a drop of nearly 32 billion dollars in value for its mortgage assets and credit guarantees that did not affect the company's net income.
With their portfolios in free fall, Fannie and Freddie hemorrhaged money all through the first half of 2008. The Bush Administration stuck to their guns and as late as July 11 assured everyone that there would be no bailout of Fannie and Freddie.
Less than a week later Treasury Secretary Paulson was pushing through a bailout of Fannie and Freddie.
It seems that the thin layer of cash reserves left over after the Bush Administration cut it 6 months earlier, wasn't enough to cover their massive losses. Yet the financial media failed to note that the Bush Administration was partly responsible for this enormous calamity.
But the Bush Administration was going to make it right now. They were going to backstop Fannie and Freddie and calm investors...at least that was the plan.
"If you have a bazooka in your pocket and people know it, you probably won't have to use it."
- Secretary Paulson displaying his ignorance of how the markets work
The powers Paulson won from Congress last month enabling a government rescue of Freddie Mac and Fannie Mae -- authority he likened to a weapon whose mere existence made it unlikely it would have to be fired -- may end up making a bailout more likely, say analysts and investors.
They say the threat of government action is creating uncertainty that is raising the companies' borrowing costs and increasing the odds Fannie and Freddie will need taxpayer funding.
The problem with the bailout plan is that Paulson is the implied threat of a de facto nationalization of the two mortgage giants. This would leave existing shareholders with pennies on the dollar.
Thus the bailout plan that Bush and Paulson assured us that they would never have to do, caused stock prices of Fannie and Freddie to crater. This reduced their capital reserves even further, increasing the chances of a taxpayer bailout.
To make matters worse, the taxpayer bailout is likely to cause collateral damage.
"The common shareholders will probably be completely wiped out," Paul Miller, an analyst at FBR Capital Markets, said in a Bloomberg Television interview. "Preferred will also see a lot of pain. But that is up in the air because a lot of banks own the preferred. You put a lot of banks in trouble if you just wipe out the preferred also."
And so, once again, the Bush Administration has lurched from one disaster to another, making each one worse with their every action.
The size of the bailout is anyone's guess, but since the bailout bill came with a mandatory raising of the national debt by $800 Billion, you can bet that it won't be cheap.
CNN called it the trillion-dollar mortgage time bomb.
Where exactly is a nation with a savings rate of zero going to get that kind of cash?