Fannie Mae and Freddie Mac.

Kind of the same topic: Indymac bank has officially failed. It has just been shut down by regulators. It is the 7th largest mortage originator in the U.S.

http://www.cnbc.com/id/25642869

Paper by Mankiw on Fannie and Fred

N.G. Mankiw wrote:

By charter, the housing GSEs enjoy privileges including exemption from state and local income taxes and from Securities and Exchange Commission registration and disclosure requirements. The US Treasury is authorised to extend limited credit to them and some of their directors are appointed by the president. The direct monetary benefit from these privileges is modest but their symbolic value is significant.

The privileges feed a market perception that GSE debt is backed by the US government. This is inaccurate - the charters do not require the federal government to bail out a troubled GSE. Yet, given the perception, investors are willing to accept a lower yield on GSE debt than on that of other private companies. A recent study by Fed staff estimated that the interest rate on the debt of Fannie and Freddie averaged 40 basis points below that on comparable securities. In financial markets, such a funding advantage is enormous.

Of course, any such legislation would merely be affirming what is destined to happen anyway.

Oh, and back to the original point. This is a disaster for the American economy. I didn't think things were this bad. How were things allowed to go this far before being noticed, its like no one was monitoring these activities.

Ah, thats quite a surprise actually. In fact, since this whole thing started over a year ago it has badly exposed just how little regulation there is in the financial system, stateside. It will be interesting to see the reaction to this once/if it all calms down. Regulation is one of my favourite areas in economics.

Well it basically boils down to a choice: a great inflation/devaluation; or a great depression. Neither are pretty, though one is infinitely preferable.

Looks like Nostrodamus might be right then about the old powers rising up if US fail

mike65 wrote: »

Nope not an elderly couple in Wisconsin but the names of the underwriters for 50% of US mortgages are on the verge of insolvency, they are so big they cannot be allowed to go bust, indeed it is part of the underpining legistation that created them in the 1930s thay they must be rescued by the federal government at a certain point.

That point has been reached as they have lost about 85% of thier market value and together both firms have less than 80 billion dollars in capital reserves to ensure losses on more than 5.5 trillion dollars in mortgage debt*. The minimum cost of a buy out/bail out is unknown but is likely to be several hundred billion dollars, the dollar is already a weakling and will only go one way.

The USA GDP was estimated at $13.13 trillion in 2006, the US owes 6.5 trillion
dollard to the rest of the world. If/when the government takes over Fannie and Freddie US debt will double to about 45% of GDP which is small by the standards of many countries but for the worlds economic engine its bad news for all.

I think I have that right.

Mike.

*trillion is 1000 X billion so 5,500,000,000,000 loans guaranteed by 80,000,000,000 assets.

There are some inaccuracies in your post. The statement that the mortgage giants are the on the verge of insolvency is not really accurate--at least, there's no evidence to support the claim right. Both companies were adequately capitalized. The problem was what would happen if the company had to raise more capital. The stock prices were in free fall, so the equity markets--a traditional route--is unavailable. The move by the Treasury Department was an effort to shore up confidence in the banking system, particularly in the wake of what happened to IndyMac Bank. Neither Freddie nor Fannie was on the verge of insolvency when the Treasury Department acted, but there were genuine concerns that if the current climate in the financial markets continued, then both companies could be in trouble.

There is also no evidence to support the claim that the companies will need an infusion of several billion dollars. Unlike IndyMac Bank or Countrywide Financial which dealt in Alt-A and subprime mortgages respectively, the Macs deal with traditional mortgages. The future extent of the current mortgage problem is a matter for speculation; no one really knows how severe the problem could be. There will be write downs, but it remains to be seen what the ultimate extent of this problem will be.

Finally, the US national debt is about $7.5 trillion or about 36% of GDP. Only one quarter of the national debt is financed by foreign entities. The US government holds most of the debt itself: most of these holdings are for savings programs such as social security. In the US, individual investors, state and local governments, banks and insurance companies, etc. hold the rest of the debt--three quarters of the national debt is financed by Americans or US companies or other entities.

If the US government were to assume complete control over Freddie and Fannie--something which is extremely unlikely to happen--it wouldn't make any difference if the debt were officially transferred to the Treasury. There is an implicit guarantee that the government will back both entities--in essence, the government has been on the hook for the debt all the time. Unlike the current debt, the notes that the banks--Freddie and Fannie--hold are backed by hard assets. This debt is not in the same league.

silverharp wrote: »

my main logical disagreement here is that if easy money created the problem in the first place then the solution can't be to throw more money at the problem. Japan did what you are suggesting but it didnt work. At some point the pushing on a string argument comes into play. it comes down to the basics that if assets or risk is mispriced the market must be allowed to find the correct value, central bank intervention only drags out problem.

The repricing of the housing stock has been ongoing for over a year now. One ratio that I watch carefully is price to income (average home price to average household income). For many years, this ratio has hovered around 1.89 to 1.90--it has dipped as low as 1.81 and gone as high as 1.97; however, in 2002, this ratio started to soar and peak at 2.39 in 2005--it was a clear, unambiguous indication to me that we, in the US, were in the middle of a housing bubble. Over the past fifteen to eighteen months, this ratio has rapidly adjusted back to 1.91. I suspect that it is going to fall lower. Here's why:

Housing prices are still stalling--the latest numbers signaled another decline. There is close to twelve months of inventory; the percentage of unoccupied homes is also at a multi-year high. The rent to buy ratio is still out of kilter--the ratio of the cost or renting a house to buying a house--renting still makes sense in many markets. While a lot of the excess has been wrung out of the system, there is probably still more to go: it's possible that housing prices could fall another ten to twenty percent.

I too hope that the government is circumspect in how it approaches the issue.

silverharp wrote: »

A long way to go, from history one must remember also that bubbles don't correct to the mean, you can tack on another 10%/20% below mean. The advise I've been hearing from the smart money is to wait unit price comes down to about 100 months rent before considering buying.

as a aside watch out for MaMu over the next few months

below is a credit default swap graph of Washington Mutual, it is now above the level (mid 800's) when Bear Sterns went belly up.

http://bp2.blogger.com/_nSTO-vZpSgc/SIosrkD8whI/AAAAAAAAC-E/eI2g3BvT2Cg/s1600-h/WaMu-CDS.png

Yep, it's what I said. It's impossible to know where the bottom of any market lies; we just know we're closer every time the stock drops.

I am actually watching WaMu (NYSE:WM) very closely. I bought the company over a week ago and sold it a few days later--the dip that it took on July 14 wasn't rational, nor was the recovery later that week: the stock essentially doubled in value in four days; that's just nuts. Management at WM claims that their liquidity is fine, which is what one would expect them to say. I am still waiting for things to settle down--in fact, I am waiting for the fourth quarter write downs before I make a major commitment.

WM will likely have liquidity issues; it can't go to the equity markets to raise cash right now--at least, not on favorable terms. However, WM doesn't have the same exposure to sub-prime or Alt-A mortgages as did Countrywide Financial and IndyMac Bank. In this sense, WM is in a better position than either of those two companies. Finally, IndyMac suffered its travails in no small part thanks to the words of Chuck Schumer, a US senator, who made public some scathing comments on the stability of that institution. It triggered something akin to a run on the bank which drained it of liquidity and forced the FDIC to act. No one can say what would have happened had Schumer said nothing. The bank was in trouble, but it may not have needed action by the FDIC.

WM is attractive to me for a number of reasons: (i) it has a huge chorus of critics; (ii) it has exposure to real estate markets on the west coast of the US where there are real problems and (iii) the stock price is volatile. There is, clearly, a lot of uncertainty out there about the stability of this institution. The exposure in California is probably a good thing. Unlike other states, in California owners in default are handled pretty quickly. There isn't a long, drawn-out process of change of control of an asset. Chances are that the housing market in California will stabilize and perhaps start to recover faster than in other parts of the US. Having said that, in Los Angeles County, housing prices are still 25 to 30% higher than they would have been had there never been a bubble. There is some downside. I haven't bought WM yet; just traded it. I don't trade very often--I am a long-term investor--but what happened to WM was just too irresistible.

I have spoken to the investor relations department of WM and asked a few questions--I haven't gotten answers yet, but I am told they're researching the questions. I want to know the percentage of loans that are in trouble, quarter-by-quarter, for the past year. I want to know the default rate on mortgages, quarter-by-quarter for twelve months. I want to know the percentage of conforming (loans that could easily be sold on) loans to non-conforming, I asked about the exposure to synthetic CDOs and finally, I want to know the average equity that borrowers have. (It's about 50% for the Fannie Mac/May; if it's higher than 80% for WM, I'd probably start to be concerned.)

Here's a link to a radio program broadcast in the US this weekend. It's non-commercial radio, so it's probably appropriate for this forum. It's a nice synopsis of how the mortgage problem occurred.

I think banks in the US, Ireland and Spain look very attractive. I believe that any bank--with a sold, long-term history and a good balance sheet--with exposure to this mortgage mess is a potential candidate for purchase. I am waiting for the dust to settle.