Sunday, September 7, 2008

Fannie and Freddie Under Federal Conservatorship

In a move anticipated over the last few days, but made official this Sunday morning, in the next major advance in the bailout saga of the financial industry, the Treasury Department has taken over Fannie Mae and Freddie Mac. Basically, the GSEs have lost their capital base through purchasing bad mortgages from banks, and are unable to acquire new capital through the sales of stock. They will continue to repay bonds with income acquired by repayments of the mortgages they service. When that income fails, which essentially it has, any deficit of bonds repayments will be backed through taxpayer money. Worse, Fannie Mae and Freddie Mac will continue to take on Mortgage Backed Securities from struggling banks through 2009. This move appears to allow banks to hand bad mortgages over to the treasury department for at least the next year.

In essence, the banks are being protected from their exhaustive malinvestments over the past 6 years that will cripple the general economy for many more years to come. Clearly, banks have no reason to fear making unwise loans because they can anticipate a taxpayer bailout every time.

Fannie and Freddie are the sacrificial lambs. They are going down such that the rest of the banking industry can live. They are taking it for the team. I think it is fair to say they will not be able to operate with any sort of private underwriting for a long, long time. As always there is political speak about this action preserving the “American Dream” and keeping the American economy strong, but this is unrelated to either of those two goals. It is squarely intended to keep the banking industry afloat.

In the end, this action merely delays a deflationary recession where prices of assets and commodities fall to affordable levels; that outcome is still going to happen, only a little more slowly now. Taxpayer bailouts only slow down the present economic correction in exchange for putting debt that our children will have to pay in to the pockets of the banking industry today.

More will be posted as details unfold.

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