Monday, July 14, 2008

Signs of the Economic Apocalypse, 7-14-08


Gold closed at 960.60 dollars an ounce Friday, up 2.7% from $935.50 for the week. The dollar closed at 0.6276 euros Friday, down 1.4% from 0.6367 at the close of the previous week. That put the euro at 1.5934 dollars compared to 1.5706 the week before. Gold in euros would be 602.86 euros an ounce, up 1.2% from 595.63 at the close of the previous week. Oil closed at 144.98 dollars a barrel Friday, up 0.6% from $144.18 for the week. Oil in euros would be 90.99 euros a barrel, down 0.9% from 91.80 at the close of the Friday before. The gold/oil ratio closed at 6.63, up 2.2% from 6.49 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 11,100.54 Friday, down 1.7% from 11,288.54 at the close of the previous Friday. The NASDAQ closed at 2,239.08 Friday, down 0.3% from 2,245.38 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.95%, down three basis points from 3.98 for the week.

Except for the 3% rise in gold against the dollar, market movements weren’t drastic last week. But that doesn’t capture the fear in the markets and in the media that things are close to getting much worse. The collapse of “IndyMac”, the near collapse of Fannie Mae and Freddie Mac (such cute nicknames!) stoked that fear at the end of the past week.

It began on Thursday when the stocks of Fannie Mae and Freddie Mac plummeted. Fannie Mae stands for FNMA or the Federal National Mortgage Association and Freddie Mac stands for FHLMC or the Federal Home Loan Mortgage Corporation. They are both so-called GSE or “Government Sponsored Enterprises.” What does that mean? Well much of the market power of these companies stems from the very ambiguity of those terms. They are publicly traded corporations that are not government owned or run, but their market value has always been propped up by the perception that when push comes to shove the government will bail them out in some way. Push seems to have come to shove over the last several days.

What do they do? In a nutshell they guarantee mortgage debt. $5 trillion of it. Half of all the outstanding mortgage debt in the United States. They also help securitize mortgage debt (bundling thousands of mortgages and selling shares in the bundles, basically). The reason there are two of them is that when the government made Fannie Mae go public in 1968 (it used to be government-run) they also launched Freddie Mac so there would be some competition. According to Wikipedia,
FNMA's primary method for making money is by charging a guarantee fee on loans that it has securitized into mortgage-backed security bonds. Investors, or purchasers of Fannie Mae MBSs, are willing to let Fannie Mae keep this fee in exchange for assuming the credit risk, that is, Fannie Mae's guarantee that the principal and interest on the underlying loan will be paid regardless of whether the borrower actually repays.

There’s the problem. As long as most mortgage holders are paying their mortgages off, the system works fine and Fannie Mae and Freddie Mac help free up lots more money for new mortgages, making house purchasing available and more affordable for people. But they are publicly traded companies. Their stock price in times like these, where it is not at all certain that people will be able to keep paying on their mortgages, can drop fast. If they are guaranteeing what cannot be guaranteed who will guarantee them? The U.S. taxpayers, of course!

But if things get worse, how can even the government guarantee $5 trillion dollars in bad debt?

But we’re getting ahead of ourselves here. On Thursday, stock prices for both companies went into a free-fall:

Fannie, Freddie stocks and bonds plummet

Thursday July 10, 10:18 am ET

Al Yoon

NEW YORK (Reuters) - A firestorm of anxiety over the ability of U.S. mortgage giants Fannie Mae and Freddie Mac to get the capital they need to survive sent their debt and stocks plummeting on Thursday.

Stoking concerns, former St. Louis Federal Reserve President William Poole said the two major U.S. mortgage finance companies were "insolvent" and may need a U.S. government bailout, according to Bloomberg News.

The outlook was so dire that Bush administration officials were meeting with regulators to discuss contingency plans should they be unable to raise funds and support the worst housing market since the Great Depression, according to a report in the Wall Street Journal.

Yield spread premiums for the larger Fannie Mae rose to the highest since the days before the Federal Reserve's orchestrated bailout of Bear Stearns Cos in March.
Shares in both companies plunged to their lowest since 1991.

The government-sponsored enterprises, or GSEs, are expected to need billions of dollars in capital to support their balance sheets to try to stabilize the mortgage market. They found strong demand as they raised some $20 billion since last fall, but the instability in share prices since raises doubts about new investor support.

"This is not an opportune time to have to increase liquidity with the stocks down so much," said Alan Lancz, president of investment advisory firm Alan B. Lancz & Associates in Toledo, Ohio. "These dilutive deals these companies are putting together are just increasing that downward spiral within the financials, not even to mention the confidence in the whole system."

Mounting doubts over the ability of the companies led Deutsche Bank analyst Mustafa Chowdhury, a former Freddie Mac executive, on a Wednesday conference call to float the possibility that share prices could go below $5…

By Friday there was talk of a government bailout. The problem is that in strong bailout scenarios, the stock wouldn’t be worth much (as in the Bear Stearns bailout). So then policymakers had to cool the bailout talk:

Treasuries Fall as Fannie, Freddie Bailout Speculation Eases

Sandra Hernandez and Daniel Kruger

July 11 (Bloomberg) -- Treasuries fell on speculation the government won't have to bail out Fannie Mae and Freddie Mac, easing demand for government debt as a haven from credit-market turmoil.

Government securities extended losses, pushing up the 10- year note's yield the most in almost four months, after President George W. Bush, Treasury Secretary Henry Paulson and Senate Banking Committee Chairman Christopher Dodd damped talk of a government takeover of the mortgage-finance companies.

“We're talking about a near-cataclysmic end-of-the-earth type situation,” said Glen Capelo, a Treasury trader at RBS Greenwich Capital in Greenwich, Connecticut, one of 20 primary dealers that trade with the Federal Reserve. “Now that's been relieved, at least in the short run.”

The two-year note's yield rose 21 basis points, or 0.21 percentage point, to 2.61 percent at 5:14 p.m. in New York, according to BGCantor Market Data. The price of the 2.875 percent security due June 2010 fell 13/32, or $4.06 per $1,000 face amount, to 100 1/2. The 10-year note's yield increased 17 basis points, the most since March 24, to 3.96 percent.

Treasuries extended losses after Reuters reported Fed Chairman Ben S. Bernanke told the mortgage-finance companies they can borrow money from the central bank's discount window. Fed spokeswoman Michelle Smith said there are no discussions about access to direct loans.

Dodd said Fannie Mae and Freddie Mac may have several options for capital and liquidity.

‘A Number of Things’

“There are a number of things, including things like the discount window, that they’re, I know, considering,” Dodd said at a Washington news conference today. “They are certainly examining what other means might be taken in order to shore up a situation should it become necessary.”

Government debt rose earlier this week, pushing yields on two-year notes to a one-month low, on concern Fannie and Freddie will need an infusion of capital to weather the worst housing slump since the Great Depression. The two companies own or guarantee about half of the $12 trillion of U.S. mortgages.

Two-year notes’ yields posted a weekly gain of 7 basis points, with their price falling 1/8, or $1.25 per $1,000 face amount. Yields on 10-year notes declined 1 basis point for the week.

Treasuries began falling today on speculation the government won’t allow the pair of mortgage-finance companies to fail, and on concern a bailout would require the U.S. to sell more debt.

‘Explicit Guarantee’

“The market’s starting to believe the government will make an explicit guarantee on” Fannie Mae and Freddie Mac’s debt, said James Caron, head of U.S. interest-rate strategy at primary dealer Morgan Stanley in New York. “If the government were to make Fannie and Freddie’s guarantee an explicit AAA rating, then that would cause the Treasury to need to raise capital by increasing Treasury supply,” he added.

U.S. government debt is “well within” the guidelines for an AAA rating even if the government is forced to rescue Fannie and Freddie, Moody’s Investors Service said.

“The amount of money required would not be so large that it would make us worry about the U.S. credit rating,” said Steven Hess, vice president and senior credit officer at Moody’s in New York.

Government debt also fell as the extra premium investors demand to own debt issued by Fannie Mae and Freddie Mac decreased, indicating declining perceptions of risk.

Ten-year debt issued by Fannie Mae yielded 0.69 percentage point more than Treasuries of comparable maturity, narrowing the yield gap by 0.19 percentage point from yesterday. The yield difference between Freddie Mac’s 10-year debt and U.S. 10-year notes was 0.75 percentage point, down 0.19 percentage point.

Bets on Fed

Traders increased bets Fed policy makers will keep the target for overnight loans between banks at 2 percent on Aug. 5, futures contracts on the Chicago Board of Trade showed. The chance of no cut in the rate rose to 91 percent from 86 percent yesterday. The rest of the bets are that the Fed will raise the rate a quarter-percentage point to curb inflation.

It’s nice to know that “near-cataclysmic end-of-the-earth type situation” has been avoided, as the bond trader quoted above put it, “at least in the short run.” So what did the government decide to do? On Sunday it was announced that the Federal Reserve will lend Fannie Mae and Freddie Mac as much money as they will need.
US spells out Fannie-Freddie backstop plan

Jeannine Aversa, AP Economics Writer

Sunday, July 13, 2008

WASHINGTON - The Federal Reserve and the U.S. Treasury announced steps Sunday to shore up mortgage giants Fannie Mae and Freddie Mac, whose shares have plunged as losses from their mortgage holdings threatened their financial survival.

The Federal Reserve said it granted the Federal Reserve Bank of New York authority to lend to the two companies "should such lending prove necessary." If the companies did borrow directly from the Fed, they would pay 2.25 percent — the same rate given to commercial banks and Big Wall Street firms.

Secretary Henry Paulson said the Treasury is seeking authority to expand its current line of credit to the two companies should they need to tap it and to make an equity investment in the companies — if needed. Such moves will require congressional approval.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owner companies," Paulson said Sunday. "Their support for the housing market is particularly important as we work through the current housing correction."

The Treasury's plan also seek a "consultative role" for the Federal Reserve in any new regulatory framework eventually decided by Congress for Fannie and Freddie. The Fed's role would be to weigh in on setting capital requirements for the companies.

Fannie Mae and Freddie Mac either hold or back $5.3 trillion of mortgage debt. That's about half the outstanding mortgages in the United States.

The department, the Fed and other regulators worked in close consultation throughout the weekend after investor fears about the companies' finances sent their shares plummeting in trading last week. Paulson is working closely with congressional leaders to advance his plan as soon as possible as one complete package.

The announcement marked the latest move by the government to bolster confidence in the mortgage companies. A critical test of confidence will come Monday morning, when Freddie Mac is slated to auction a combined $3 billion in three- and six-month securities.

Fannie and Freddie were created by the government to provide more Americans the chance to own a home by adding to the available cash banks can loans customers.

A senior Treasury official said any increase in the line of credit — now at $2.25 billion for each company_ would be at the Treasury secretary's discretion. The same would apply to any equity investment made by the government.

The official, who spoke on condition of animosity, also sought to send a calming message about Fannie's and Freddie's financial shape, saying: "There's been no deterioration of the situation since Friday."

If one or both of the companies were to fail, it would wreak havoc on the already fragile financial system and the crippled housing market. The problems would spill over in the national economy, too.

Paulson on Friday said the government's focus was to support the pair "in their current form" without a takeover.

Hoping to bolster confidence, Senate Banking Committee Chairman Chris Dodd, D-Conn., told CNN on Sunday that Fannie and Freddie are financially sound.

"What's important here are facts," Dodd said. "And the facts are that Fannie and Freddie are in sound situation. They have more than adequate capital — in fact, more than the law requires. They have access to capital markets. They're in good shape. The chairman of the Federal Reserve has said as much. The secretary of the Treasury as said as much."

Last week Fed Chairman Ben Bernanke and Paulson, appearing before the House Financial Services Committee, made a point of saying that the regulator of Fannie and Freddie, the Office of Federal Housing Enterprise Oversight, has found both companies adequately capitalized.

While technically correct, the reassuring statements of Bernanke and others shouldn’t overshadow the real problem. Even if the companies don’t fail and require a complete bailout, mortgages could get more costly and harder to obtain—at a time when the housing market is already collapsing.
The $5 trillion mess

Fannie Mae and Freddie Mac were created by Congress to help more Americans buy homes. Now their shaky condition threatens the entire housing market.

Katie Benner

July 13, 2008

NEW YORK (Fortune) -- They own or guarantee $5 trillion worth of mortgages­ - nearly half of all the country's outstanding home loan debt - and they're crashing. But not everybody is convinced they should be.

Fannie Mae and Freddie Mac are struggling with an investor loss of confidence so great that, while they're unlikely to go under, they could conceivably see their ability to function impaired. That would wreak yet more havoc on an already wrecked housing market - making loans tougher to come by and possibly pushing hundreds of billions of dollars in cost onto U.S. taxpayers.

The extent of their troubles is in debate. Several analysts and a former Federal Reserve governor have said the two companies desperately need to raise money to continue their business of buying and guaranteeing home mortgages.

Others, including Fannie and Freddie, their regulators, some Wall Street analysts, and Sen. Christopher Dodd, D - Conn., the chairman of the Senate Banking Committee, have defended the strength of the two companies.

"What's important are facts - and the facts are that Fannie and Freddie are in sound situation," Dodd said on CNN's Late Edition on Sunday. "They have more than adequate capital. They're in good shape. The chairman of the Federal Reserve has said as much. The Secretary of the Treasury has said as much."

The Treasury Dept. and the Federal Reserve on Sunday outlined plans that would provide capital to Fannie and Freddie if it were needed.

Still, inherent problems

How could the companies end up in such awful straits? Given the way they were created and run, a better question might be: how could they not?

The two companies are so-called government-sponsored enterprises, created by Congress in 1938 (Fannie) and 1970 (Freddie) to help more Americans buy houses.

Their mandate is to maintain a market for mortgages - buying loans from banks, repackaging them as bonds, and selling those securities to investors with a guarantee that they will be paid.

This makes lending more tempting for banks because Fannie and Freddie take on risks like missed payments, defaults and swings in interest rates.

But the companies are also publicly traded, with the usual mandate of trying to maximize profits for shareholders.

That effort, of course, involves risk, but as quasi-government programs, they've long carried an implicit guarantee that the feds wouldn't let them fail.

Their hybrid nature created both the opportunity and the temptation for the enterprises to take on more risk and to make themselves ever larger, more important and thus more profitable players in the mortgage market.

Very special treatment

The market and ratings agencies have treated Fannie and Freddie as bulletproof, even though the actual business of dealing with interest sensitive loans is very risky. This is in large part because of the very special perks granted to the mortgage giants, but to no one else.

Each may borrow up to $2.25 billion direct from the Treasury. They are exempt from state and local income taxes and from Securities and Exchange Commission registration requirements and fees. And they can use the Federal Reserve as their bank.

One result of all this special treatment was AAA credit ratings. That means Fannie and Freddie could borrow at super-low rates, a benefit they used to purchase - and hold -high-yielding mortgage loans. The spread between the two provided an irresistible earnings stream and the companies just kept getting bigger.

The mortgages they hold on their books alone total about $1.4 trillion, said Mike Stathis, managing Principal of Apex Venture Advisors, a research and advisory firm.

In the meantime, the companies were allowed to operate in this manner, piling on risk after risk, with virtually no capital cushion (Wall Street speak for the rainy-day piggybank financial companies keep should one of their investments blow up.) As the company's loan portfolio loses value and the mortgage market continues to crumble, it's easy to see why this was a fatal misstep.

Some saw the crisis coming before this week. For example, Alan Greenspan famously warned in 2004 that Fannie and Freddie's rapid growth needed to be curbed because their expansion threatened the financial markets.

Still, the cocktail of high credit ratings, domination of the mortgage securities market, and preferential government treatment led to the sort of shenanigans that go hand in hand with excessive privilege.

Fannie overstated its earnings by $10.6 billion from 1998 through 2004, and its chief executive Franklin Raines lost his job. Freddie Mac had understated its profit by nearly $5 billion from 2000 through 2002. Both companies missed earnings filings while their overhauled their books.

"If Fannie and Freddie had been created in the private sector, they wouldn't look like this," says Christopher Whalen, head of research firm Institutional Risk Analytics. "They have a public sector mission to expand housing and run what is essentially an insurance company. But they also have a conduit to securitize and sell loans, which is what broker-dealers like Lehman do; and they have an interest arbitrage piece (making money on the spread between interest rates) that looks like a hedge fund."

Robert Rodriguez, the founder of First Pacific Advisors, hasn't bought Fannie for Freddie bonds for over two years. "With the recent issuance of their financials, we were still uncomfortable with their leverage," Rodriguez says. "We believed there was considerable balance sheet risk in both of these companies.

Now the dwindling pool of mortgages, higher foreclosure risk, and a shaky interest rate environment have the companies on the ropes; and investors are beginning to lose faith in Fannie and Freddie.

Both firms told Fortune that they have enough capital to weather the storm and continue to support the nation's housing market.

And yet, Fannie has fallen 32% this week and 65% since the beginning of the year. Freddie plunged 47% so far this week and is down 75% since January.
Investors have lost faith that the companies can operate in their current incarnation without running into major problems.

If investors abandon these companies, what do we learn from this odd Frankenstein of a business model?

"Nobody every believed that Fannie and Freddie were truly private and they never should have been," says Whalen. "Now we will all have to pay for a company that has gone astray."

Now about the other cutely-nicknamed failing financial institution. IndyMac was a California-based mortgage lender that failed Friday.

IndyMac seized as financial troubles spread

John Poirier and Rachelle Younglai

July 12, 8:20 PM ET

WASHINGTON (Reuters) - U.S. banking regulators swooped in to seize mortgage lender IndyMac Bancorp Inc on Friday after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which specialized in a type of mortgage that often required minimal documents from borrowers, became the fifth U.S. bank to fail this year as a housing bust and credit crunch strain financial institutions.

The federal takeover of IndyMac capped a tumultuous day for U.S. markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac will reopen fully on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision, but tensions ran high as customers at a branch at its Los Angeles-area headquarters read a notice in the window saying it was closed.

At another branch down the road, a man who said he had more than $200,000 in an account -- twice what is normally FDIC guaranteed -- argued with a security guard who was closing up.

The FDIC, which will seek a buyer for IndyMac, estimated the cost of the bank's failure to its $53 billion insurance fund at between $4 billion and $8 billion.

"IndyMac is a company that was pretty much 100 percent invested in mortgage assets, and we're in a bad mortgage market, and it had no capital. It's not complicated," said Adam Compton, co-head of global financial stock research at RCM in San Francisco, which manages about $150 billion.

IndyMac joins top bank failures headed by the 1984 collapse of Continental Illinois National Bank & Trust Co.

The Office of Thrift Supervision (OTS) insisted IndyMac's failure was the second-largest bank failure based on FDIC figures. But the FDIC said its data showed it was third behind the collapse of First RepublicBank Corp in 1988.

Run On The Bank

The OTS, IndyMac's primary regulator, blamed comments by New York Democratic Sen. Charles Schumer for causing a run on deposits at the largest independent publicly traded U.S. mortgage lender.

Schumer responded quickly on Friday, blaming the OTS for not doing its job and allowing IndyMac's loose lending practices. "OTS should start doing its job to prevent future IndyMacs," he said in a statement.

Schumer questioned IndyMac's ability to survive the housing crisis in late June, and over the next 11 business days, depositors withdrew more than $1.3 billion, the OTS said.

"This institution failed today due to a liquidity crisis," OTS Director John Reich said. "Although this institution was already in distress, I am troubled by any interference in the regulatory process."

IndyMac was founded in 1985 by David Loeb and Angelo Mozilo, who also founded Countrywide, another big mortgage lender whose loans helped fuel the housing boom. Countrywide was taken over last week by Bank of America Corp.

FDIC spokesman David Barr said agency officials arrived at IndyMac's headquarters in Pasadena at 3 p.m. (2200 GMT).

The successor FDIC-run bank opens for business on Monday. Over the weekend, depositors will have access to their funds by ATM, other debit card transactions, or by writing checks, but no access via online banking and phone services until Monday.

Yet many customers were in the dark as branches shut on Friday. "I'm pissed. They should have let me know," said Elizabeth Ortega, a 29-year-old hairdresser who has a checking account with IndyMac.

IndyMac had said earlier in the week it was unable to raise new capital, would slash staff by 60 percent and had stopped making home loans. Its stock then tumbled, last trading at 28 cents on the New York Stock Exchange, down 95 percent in 2008.

The FDIC insures up to $100,000 per deposit and up to $250,000 per retirement account at insured banks.

At the time of closing, IndyMac had about $1 billion of potentially uninsured deposits held by about 10,000 depositors. The FDIC said it would pay those depositors an advance dividend equal to 50 percent of the uninsured amount.

The OTS told a conference call with reporters that it did not expect significant market impact from IndyMac's closure as the firm is not a systemic institution and does not have numerous counterparties. Reich also said he did not expect a larger thrift to fail.

If there won’t be “significant market impact” from the failure than why worry? According to James Turk the worry is that the failure may be multiplied and that the true value of many institutions’ assets may be less that half of “book value”

America's Second Biggest Bank Failure

James Turk,

July 12, 2008

Late Friday afternoon (July 11th) federal regulators swooped in on California-based IndyMac Bank and closed its doors. With $32 billion in assets, it is according to The Los Angeles Times the second largest bank failure in US history. IndyMac will re-open its doors on Monday morning as a ward of the FDIC.

Some background will be helpful to put this bank failure into perspective. IndyMac is ground-zero of the sub-prime crisis and the poster-child of imprudent lending. Founded in 1985 by Countrywide Bank, whose own recent failure was masked by its acquisition by Bank of America, IndyMac pioneered the issuance of so-called Alt-A mortgages to borrowers who do not fully document their income or assets, which typically means borrowers with blemished credit histories or real estate speculators looking to 'flip' houses during the bubble years. Alt-A mortgages were considered to be less risky than the subprime loans which started the current financial crisis last year, so IndyMac's plight may cause everyone to re-think that credit quality fairy tale.

IndyMac sold most of the loans it originated, but it also drank its own poison by holding some of these loans on its books, which is the important point. The liquidation value of IndyMac's assets may be instructive to help us understand what lies ahead for the unfolding financial crisis. By applying IndyMac's experience to the value of the questionable mortgage assets still within the global banking system, we can begin to understand the scope and magnitude of the problem.

IndyMac's $32 billion in assets are funded by $19 billion of deposits, with funding for the $13 billion balance having been provided primarily by debt and a little equity. About $1 billion of deposits are above the insured limit, so the FDIC is insuring about $18 billion of deposits, but here is the interesting - and scary - stuff. The FDIC press release states: "Based on preliminary analysis, the estimated cost of the resolution to the Deposit Insurance Fund is between $4 and $8 billion."

Think about this statement for a moment. After liquidating the bank's assets, not only will IndyMac shareholders and holders of IndyMac debt be wiped out, the FDIC's insurance fund will still take a "$4 and $8 billion" hit so that the $18 billion of insured deposits in IndyMac are made whole. So let's do a little math here.

After liquidating $32 billion in assets, the FDIC still has to add some $4 billion to $8 billion more to make sure $18 billion of deposits are made whole. So in the worst case scenario, the liquidation value of IndyMac's $32 billion of assets is $10 billion, or in other words, the true market value of IndyMac's assets is only 31% of their stated book value. In the FDIC's best case scenario, the liquidation value of IndyMac's $32 billion of assets is $14 billion, which is still only 44% of their stated book value.

So here is the all-important question. Can we infer from this liquidation analysis of IndyMac that the true value of sub-prime and Alt-A mortgage debt still in the banking system is something less than 50% of stated book value?

I don't have the answer to that question. If anybody does, it is the bankers themselves, and they aren't talking. They do not want to disclose how bad off they remain, even after already writing off more than $300 billion of assets globally (as reported by London's Financial Times). They no doubt must be panicked about what's yet to come.

So how big is the potential problem? My guess is that even bankers really don't know the answer to that question, but there are some estimates worth considering.

Investment guru John Paulson had his hedge-fund correctly positioned to benefit from the sub-prime meltdown, so given this record, his estimates of the problem are probably better than most. According to the Bloomberg he says that "global writedowns and losses from the credit crisis may reach US$1.3 trillion." That estimate seems reasonable in view of the IndyMac experience, given that at least $3 trillion of inferior loans probably remain on bank books at present. Keep in mind too that the amount of inferior loans will grow as economic conditions continue to weaken.

All of this does not bode well for the dollar. The federal government is readying the printing press to create even more dollars to plug the black-hole on bank balance sheets, but there is another black-hole that they need to begin worrying about.

The FDIC deposit fund only has $53 billion of assets, and around 10% or perhaps more of that is now going to be used to bail-out IndyMac. So how safe is the FDIC? How safe is the dollar, or more to the point, how safe is your wealth held in dollars? Not very…

The bigger picture is that we are entering a phase of re-regulation and increasing government takeovers of financial institutions. The problem is that the U.S. government is also broke thanks to tax cuts for the rich and disastrous, illegal wars.
Fannie Mae: The credit crunch meets the F-word

Paul Mason

12 July 08, 2008

The panic on Friday about the two US mortgage giants, Fannie Mae and Freddie Mac, is followed by the collapse of California's IndyMac, a regional mortgage lender. Customers at Indy have been told their money (up to a $100k limit) has been transferred to something called "IndyMac Federal Bank". The crucial letter in the acronyms that Freddie and Fannie are short for is F, as now also with Indy: the two giants are Federal institutions, as is - now - the busted Californian bank. Slowly but surely the state - not just in America but here too - is having to bail out the financial system, and I think this could have a big impact, eventually, on politics too....

Fannie Mae was founded in 1938 as the monopoly provider of mortgage loans. It was privatised in 1968, Freddie set up to expand the operation in 1970: they don't issue mortgages - they underwrite them for other institutions. Together they have underwritten $5 trillion of mortgages - half of all US mortgages.

On privatisation they received a bailout guarantee from the government and a direct line of credit from the US treasury; but they were listed companies - their shares traded on the stock exchange and they made a healthy profit. So healthy in fact that pure private capitalist banks had been baying for them to be unshackled from this part-private, half-life existence.

Thus Fannie and Freddie were sustained by one of those necessary fictions that underpin finance capitalism: that this $5 trillion was not really guaranteed by the US government at all. Now that fiction is collapsing (every step of the financial crisis has destroyed a necessary financial fiction) we are confronted with the emergence of something very strange: a state backed financial capitalism.

Consider this: right now the US legislature is about to pass a separate bill allowing the government to underwrite $300bn of mortgages for those whose homes are about to be repossessed; the US Treasury has already doled out in excess of $100bn cheap loans to banks to keep them afloat and "reinvented" a rule allowing it to underwrite the rescue of Bear Stearns by JP Morgan. Now it is faced with at the very least having to shoulder $40bn of Fannie and Freddie's debts (the two companies have insisted they are solvent and their is nothing wrong, but many analysts disagree, as does the market which has wiped 78% off their share value since January).
And one option being discussed is to take the whole of Fannie/Freddie's mortgage book into public ownership, Northern Rock style. It is an option that, as with Northern Rock, they will surely try to avoid - because $5 trillion is the size of the US national debt!

(Put another way, the annual GDP of the United Kingdom is about $2.5 trillion and the entire GDP of the world, nominally, just under $50 trillion!)

All over the word, slowly but surely, the state is becoming exposed to the debts and liabilities of the finance system. We've seen it here with Northern Rock - and with the Bank of England's special liquidity scheme, and with the expanded deposit guarantee. The words "too big to fail" - once uttered as a joke, about a theoretical situation in the dining rooms of the investment banking world - have now been elevated into a philosophy.

The strange thing is it's being done on the watch of governments committed to removing the state from the economy. It is being done, in other words, in defiance of the official ideology of governments, regulators, banks, business schools, accountancy firms, TV pundits, Nobel prizewinners and nearly every think tank on earth…

What does “state-backed financial capitalism” mean? Socialism for the banks and the rich and cut-throat capitalism for the rest of us. And we pay. Looking at it that way, it may not contradict the real ideology of neoliberalism, transferring wealth up the pyramid:

Bernanke, Paulson outline strategy to make working class pay for Wall Street crisis

Andre Damon and Barry Grey
10 July 2008

In speeches delivered Tuesday, Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson outlined the ruthless class policy being carried out to place the burden for the financial and housing crisis on the backs of working people.

Bernanke indicated that the Fed would extend its policy of offering unlimited loans to major Wall Street investment banks. The provision of Fed funds to non-commercial banks and brokerage firms, a departure from the Fed’s legal mandate without precedent since the Great Depression, is part of a policy of bailing out the banking system to the tune of hundreds of billions of dollars.
The Fed announced its loan program for investment banks last March when it dispensed $29 billion to JPMorgan Chase as part of a rescue operation to prevent the collapse of Bear Stearns.

In his speech, Treasury Secretary Paulson acknowledged that home foreclosures in 2007 reached 1.5 million and predicted another 2.5 million homes would be foreclosed in 2008. But he made clear that nothing would be done to save the vast majority of distressed homeowners from being thrown onto the street.

Paulson, the former CEO of Goldman Sachs, said that “many of today’s unusually high number of foreclosures are not preventable.” With a callous indifference reminiscent of Marie Antoinette’s “Let them eat cake,” he went on to say that “some people took out mortgages they can’t possibly afford and they will lose their homes. There is little public policymakers can, or should, do to compensate for untenable financial decisions.”

In other words, low-income home owners who were lured into high-interest mortgages by predatory mortgage companies and banks are getting their just deserts! Of course, the Wall Street CEOs and big investors who made billions of dollars by speculating on these loans, creating a vast edifice of fictitious capital that was bound to collapse, are not to be held accountable for any “untenable financial decisions.” On the contrary, they are to be subsidized with hundreds of billions of dollars of credit, ultimately to be paid for by public funds.

The two speeches, presented at a Federal Deposit Insurance Corporation forum on the housing crisis held in Virginia, underscore the real social interests—those of the financial aristocracy—that are being protected by the policies of the Fed, the Bush administration, and the Democratic Congress.

Bernanke made clear that his call for an extension of loans to big investment banks is part of a more comprehensive proposal to systemize and regularize federal subsidies and bailouts for troubled banking giants. Particularly significant was the following remark: “Because the resolution of a failing securities firm might have fiscal implications, it would be appropriate for the Treasury to take a leading role in any such process, in consultation with the firm’s regulator and other authorities.” The implication is that the US Treasury should be ready to fund bank bail-outs with whatever taxpayer funds are necessary.

In neither speech was there even a hint that the government has any responsibility to protect home owners, or that the people responsible for the “lax credit and underwriting standards” that led to the current crisis might be called to account by regulators, Congress, or the courts.

Essentially the same principles underlie the Democratic-sponsored housing bill currently under debate in Congress. The bill, which President Bush has threatened to veto, includes provisions to provide government insurance on mortgages in exchange for lenders writing down the principal by 15 percent. The main purpose of the bill is not to assist homeowners, but to prevent foreclosures from harming the balance sheets of financial firms by transferring risky mortgages to the government.

The bill is tailored to marginally reduce the flood of home loan defaults and foreclosures, at a minimal cost to the government, so as to stabilize the housing market and stem the losses suffered by banks and financial institutions from the collapse of subprime mortgage-backed securities. Home owners with subprime and adjustable-rate mortgages, who demonstrated their ability to pay off a refinanced loan, would have the debt converted to a thirty-year, fixed-rate mortgage, resulting in lower monthly payments.

The plan is entirely voluntary. No bank or mortgage lender would be required to participate, and the financial firms would decide which, if any, loans they refinanced in return for a government guarantee against losses. As a result, mortgage companies and banks that decide to participate will “cherry pick” the loans they refinance, choosing from among the loans which qualify under the terms of the bill only those they believe most likely to default.

The Congressional Budget Office (CBO) estimates that the measure would help a maximum of 500,000 home owners—that is, only 20 percent of the 2.5 million who, according to Paulson, will face foreclosure this year. It does nothing to help those who have already had their homes foreclosed, or block banks and mortgage lenders from carrying out new foreclosures. Lenders are currently filing foreclosure proceedings against more than 7,000 home owners a day.

The CBO estimates that the actual cost of the program—resulting from defaults of Federal Housing Administration-backed refinanced loans—would amount only to $2.7 billion over the next five years. This is less than the amount spent on the Iraq war every 15 days, and a billion dollars less than the 2007 earnings of the top hedge fund manager in the US. It is a tiny fraction of the nearly $1 trillion that the Fed has pumped into the financial markets since the credit crisis erupted last August.

The moves to further subsidize the banks coincide with the Fed’s announced policy of halting interest rate cuts and preparing to raise rates later this year. As Bernanke has made clear, the major consideration behind this policy shift is a desire to stem “inflationary expectations”—a euphemism for wage increases. The aim is to utilize the economic contraction to drive up unemployment and undercut any struggle by workers for wage hikes to compensate for soaring prices and ruinous levels of household and personal debt.

The eruption of the credit crunch last August was not anticipated by the Fed or government policy-makers, whose easy credit policies had fueled the housing bubble. They initially badly underestimated the seriousness and depth of the crisis, but soon responded with a series of interest rate cuts and massive injections of liquidity to bolster the banking system. This was bound to ignite inflationary pressures and further weaken the dollar.

By the time of the Bear Stearns rescue last March—carried out with the support of both parties and all of their presidential candidates—it had become clear to the Fed that the credit and housing crisis would have a protracted impact on economic growth and that the financial system would remain highly fragile for an extended period. A consensus emerged within the ruling elite in support of a brutal class policy to continue the bailout of Wall Street, while seeking to manage an orderly unwinding of the trillions of dollars in fictitious capital built up during the speculative boom—at the expense of the working class.

Now the strategy is to exploit the economic contraction to further depress wages. There is no support in either political party to allocate any significant resources to relieve the economic and social distress of working class families being hammered by job cuts, sharply rising gas and food prices, and the collapse of their home values.

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