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| 2008 | |
| July | |
| Sun Jul 20 22:06:30 2008 Fannie and Freddie |
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| Sun Jul 20 22:06:30 2008 Fannie and Freddie More seizing up! |
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| The latest US economic crisis is centered on
Fannie Mae and Freddie Mac, our hapless mortgage resellers. That article uses my favorite phrase,
noting that the entire mortgage industry could
seize up if the two companies aren't bailed out with taxpayer money.
As a relevant aside, read this great overview of Freddie and Fannie, written by a History News Network intern in 2003. One prescient quote:
What happened? Fannie and Freddie make a business out of lending money to people to buy homes, and then bundling and reselling most of the resulting mortgages. The idea is that investors will pay hard cash to the firms now, and then take the loan payments for themselves. Fannie and Freddie can then use that investment money to make more loans. That works great as long as very few people default. Investors will keep buying mortgage securities if they think they'll get most of the loan payments they are owned. With a low default rate, buying mortgage securities is like a bond: you invest a chunk of money, and then earn interest as mortgagees pay back their principal and interest. However, we are now seeing mortgage defaults on the order of 10% or higher--enough to wipe out any potential returns due to interest. Since interest rates for mortgages are low (less than 7%), mortgage securities are already lean returns. With a 10% default rate, they are guaranteed money-losers, and no one will touch them. That has spooked many people. Investors (shareholders in the two companies) think they could collapse, or at the very least, need to dilute shareholder value to raise cash. That has sent the stock price into a tailspin. Now international investors are worried because they hold large investment positions, all with the assumption that the US Government will bail them out if either institution fails. At the moment, the Federal Reserve is proposing that we spend untold billions to rescue the two companies. My take? Let them fend for themselves. There are two reasons for that. First of all, no one is sure how bad the situation really is. I admit: it could be as bad as some doomsayers predict. A collapse of Freddie and/or Fannie may trigger a large recession or worse. However, we don't know that for sure, and all a bailout will do right now is reward poor management of two critical companies. Secondly, this attitude that the US economy is very fragile and must be constantly propped up is dangerous and historically bogus. Dangerous because simple minds can be led to believe that minor financial sleight-of-hand can somehow fix massive structural problems. Historically bogus because the economy is a machine with many trillions of dollars flowing through it. Multiple governments tried to prevent the currency collapses of 1992 and 1997. In every case, the markets did what they wanted to do, and anyone that got in the way was run over--including the governments which lost billions in the process. The short answer? If you really have a system built on a house of cards, the earlier it collapses the better. Don't keep trying to prop it up. Comments |
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