Tuesday, September 9, 2008

Fannie & Freddie..............What A Royal Mess This Will Be

Uncle Sam Lends Freddie and Fannie a Hand...
Score another short-term victory for the global financial system. Unfortunately, taxpayers will be paying for this latest "victory" courtesy of the U.S. government.The United States entered the mortgage lending business on Monday, when they officially nationalized Fannie Mae (NYSE-FNM) and Freddie Mac (NYSE-FRE). Combined, these two giants are responsible for more than half of all mortgage lending or about US$6 trillion. As I've said before, Fannie and Freddie were simply too big to fail. The U.S. government knows this. Fannie and Freddie's participation in mortgage lending combined with their habit of passing out massive credit (bonds) would literally topple the financial system if they defaulted. In fact, just the possibility of Freddie or Fannie defaulting would have undoubtedly had global systemic consequences. Let me put it this way: It would have made the Bear Stearns' bailout look like a peanut in comparison. Yes, Fannie and Freddie are that significant.At the root of the credit crisis - now 13 months old - are the problems still widespread in U.S. housing. From 2003 - 2007, the world's largest real estate market - Wall Street - enjoyed a bull market in U.S. housing values. These Wall Street fat-cats took advantage by introducing all sorts of synthetic securities tied to residential housing across the country. They then sold those instruments - including asset-backed securities - to investors around the world. That party is officially over. Many U.S., Canadian and European banks are now stuck with those illiquid securities on their books. As a result, these banks have plummeted in value and caused widespread losses. To date, global write-downs tied to mortgage-backed securities and other securities linked to sub-prime and busted credits have already cost US$500 billion. Paulson and the White House, including members of Congress, must have been sweating over the last several weeks over the rising fears in the credit markets. China, the biggest investor in government agency debt has been reducing its position since August. Meanwhile, the Japanese and other Asian banks have also pared Fannie and Freddie debt. All totaled, the politicians were staring at a "snowball" effect whereby the dumping of mortgage agency debt by dozens of banks was rapidly becoming a possibility. So of course, they had to act. But what are the implications of this move (beyond tax payers having yet another bailout bill)? See my comment tomorrow to find out.

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