[GJM] The Financial Tsunami: The Next Big Wave is Breaking Fannie Mae, Freddie Mac and US Mortgage Debt.
ecotort at gn.apc.org
ecotort at gn.apc.org
Wed Jul 16 17:49:37 MDT 2008
The Financial Tsunami: The Next Big Wave is Breaking Fannie Mae, Freddie
Mac and US Mortgage Debt
By F. William Engdahl
URL of this article: www.globalresearch.ca/index.php?context=va&aid=9588
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Global Research
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July 15, 2008
/The announcement by US Treasury Secretary Henry Paulson together with
Federal Reserve chief Bernanke, that the US Government will bailout the
two largest guarantors of housing mortgage debt—the Fannie Mae and
Freddie Mac—far from calming financial markets, has confirmed what we
have said repeatedly in this space: The Financial Tsunami which began in
August 2007 in the relatively small "sub-prime" high risk US mortgage
securitization market, far from being over, is only gathering momentum.
As with the Tsunami which devastated Asia in wave after terrifying wave
in December 2004, the financial Tsunami we are witnessing is a
low-amplitude, long-wave phenomenon of trillions of dollars of financial
securities being unwound, defaulted on, dumped on the market. But the
scale of the latest wave to hit, the collapse of confidence in the two
Government-Sponsored Entities, Freddie Mac and Fannie Mae, is a
harbinger of worse to come in what will be the most devastating
financial and economic catastrophe in United States history. The impact
will be felt globally.
/The Royal Bank of Scotland, one of the largest financial institutions
in the EU has warned its clients "A very nasty period is soon to be
upon us—be prepared." They expect the S&P-500 index of US stocks, one of
the broadest stock indices in Wall Street used by hedge funds, banks,
pension funds could lose almost 23% by September as in their term, "all
the chickens come home to roost" from the excesses of the US-led
securitization revolution that took hold after the dot.com bubble burst
and Greenspan lowered US interest rates to levels not sustained since
the 1930’s Great Depression.
This all will be seen in history as the disastrous Alan Greenspan
"Revolution in Finance,"—the experiment in Asset Backed Securitization,
a mad attempt to bundle risk in loans, "securitize" them in new bonds,
insure them via specialized insurers called "monoline" insurers (they
only insured financial risks in bonds), rate them thereby via Moody’s
and S&P as AAA, highest grade. All that was done so that pension funds
and banks around the world would assume they were high quality debt
paying even higher interest than safe US Government bonds. Fed in Panic Mode
While he is getting praise in the financial media for his "innovative"
and quick reactions to the un-raveling crisis, Fed chairman Ben Bernanke
in reality is in a panic mode with little short of hyperinflationary
tools at hand to deal with the crisis. Yet, his room to act is
increasingly bound by the soaring asset price inflation in food and oil
which is pushing consumer price inflation to new highs even by the
doctored "core inflation" model of the Fed.
If Bernanke continues to act to provide unlimited liquidity to prevent a
banking system collapse, he risks destroying the US corporate and
Treasury bond market and with it the dollar. If Bernanke acts to save
the heart of the US capital market—its bond market—by raising interest
rates, its only anti-inflation weapon, it will only trigger the next
even more devastating round in Tsunami shock waves.The real significance
of the Fannie Mae bailout
The US government passed the law creating Fannie Mae in 1938 during the
Great Depression as part of President Franklin D. Roosevelt's New Deal.
It was intended to be a private entity but "government sponsored" that
would enable Americans to finance buying of homes, as part of an
economic recovery attempt. Freddie Mac was formed by Congress in 1970,
to help revive the home loan market. Congress started the companies to
promote home buying and their charters give the Treasury the authority
to extend a $2.25 billion credit line.
The problems in the privately-owned Government "Sponsored" Entities or
GSEs as they are technically known, is that Congress tried to fudge on
whether they were subject to US Government guarantee in event of a
financial crisis as the present. Before now, it always appeared a
manageable problem.
No more.
The United States economy is in the early phase of its worst housing
price collapse since the 1930’s. No end is in sight. Fannie Mae and
Freddie Mac, as private stock companies, have gone to excesses in
leveraging their risk, most as many private banks did. The financial
market bought the bonds of Fannie Mae and Freddie Mac because they bet
that the two were "Too Big To Fail," i.e. that in a crisis the
Government, that is the US taxpayer, would be forced to step in and bail
them out.
The two, Fannie Mae and Freddie Mac, either own or guarantee about half
of the $12 trillion in outstanding US home mortgage loans, or about $6
trillion. To put that number into perspective, the entire 27 member
states of the European Union in 2006 had an annual GDP of slightly more
than $12 trillion, so $6 trillion would be half the GDP of the combined
European Union economies, and almost three times the GDP of the Federal
Republic of Germany.
In addition to their home mortgage loans, Fannie Mae has another $831 in
outstanding corporate bonds and Freddie Mac has $644 billion in
corporate bonds.
Freddie Mac owes $5.2 billion more than its assets today are worth
meaning under current US "fair value" accounting rules, it is insolvent.
Fair value of Fannie Mae assets has dropped 66% to $12 billion and may
as well go negative next quarter. As the home prices continue to fall
across America, and corporate bankruptcies spread, the size of the
negative values of the two will explode.
On July 14, symbolically the anniversary of Bastille Day, US Treasury
Secretary Paulson, former chairman of the powerful Wall Street
investment bank Goldman Sachs, stood on the steps of the US Treasury
building in Washington, a clear attempt to add psychological gravitas,
and announced that the Bush Administration would submit a bill proposal
to Congress to make taxpayer guarantee of Freddie Mac and Fannie Mae
explicit. In effect, in the present crisis it will mean nationalization
of the $6 trillion agencies.
The bailout by Paulson was accompanied by a statement by Bernanke that
the Fed stood ready to pump unlimited liquidity into the two companies.
The Federal Reserve is rapidly becoming the world’s largest financial
garbage dump as for months it has agreed to accept banks’ Asset Backed
Securities including sub-prime real estate bonds as collateral in return
for US Treasury bond purchases. Now it agrees to add potentially $6
trillion in GSE real estate debt to that.
However, the disaster in the two private companies was obvious as far
back as 2003 when grave accounting abuses in the two companies were made
public. In 2003 then President of the St. Louis Federal Reserve, William
Poole publicly called for the US Government to cut its implied guarantee
of Freddie Mac and Fannie Mae claiming then that the two lacked capital
to weather severe financial crisis. Poole, whose warnings were dismissed
by then Fed Chairman Greenspan, called repeatedly in 2006 and again in
2007 for Congress to repeal their charters and avoid the predictable
taxpayer cost of a huge bailout
As financial investors warn the Paulson bailout is not a bailout of the
US economy but a direct bailout of his Wall Street financial cronies.
What until recently had been the largest bank in terms of loans
outstanding, Citigroup in New York, has been forced to raise billions in
capital from Sovereign Wealth Funds in Saudi Arabia and elsewhere to
remain in business. In its May announcement, Citigroup’s new Chairman
Vikram Pandit announced plans to reduce the bank’s $2.2 billion balance
sheet of liabilities. However, he never mentioned an added $1.1 trillion
in Citigroup "off balance sheet" liabilities which include some of the
highest risk deals in the US real estate and securitization era it so
strongly backed. The Financial Accounting Standards Board in
Connecticut, the official body defining bank accounting rules is
demanding tighter disclosure standards. Analysts fear Citigroup could
face devastating new losses as a result with value of liabilities
exceeding the bank’s $90 billion market value. In December 2006 prior to
the onset of the Tsunami crisis, Citigroup had a market value of more
than $270 billion.
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© Copyright F. William Engdahl, Global Research, 2008
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