The huge threat to the US economy

[BridgeTheGap]

Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs) are too big to fail.

The U.S. Treasury and the Federal Reserve recognize that taxpayers will have to pay whatever it takes to keep these two players in the mortgage game. With $5 trillion in financial paper in the markets tied to these two companies, a failure at one or the other would panic the U.S. and every other financial market in the world.

We wouldn't have to wonder about whether the U.S. economy would slip into a recession because we'd be in one -- and looking a depression straight in the eye.

Fannie Mae and Freddie Mac are also just plain too big. It's incredible that two companies could be so large that their troubles could threaten the U.S. and global economies.

Creditworthiness of the country at stake
It's their very size that has turned the current financial crisis into something affecting much more than the mortgage market or even the U.S. banking sector. What's at stake now is the credit of the United States itself.

http://articles.moneycentral.msn.com/Investing/JubaksJournal/TheHugeThreatToTheUSEconomy.aspx

[Hydra]

1. Hahaha!

They finally said the "D" word.

"We must bail them out and help no US homeowners or we are all SCREWED!!!"

Bet no one is held accountable for this.

------------------
Edit:

Now that I'm reading this, it's an AWESOME article. I think a great journal entry is going to come out of it. Kudos!

[BridgeTheGap]

2. They're BIG, so they must be bailed out...so, small = screwed

Where's the risk for the BIG players? They don't need to change anything at all, do they?
If one us poor slobs fucks up, we get the back of the hand or a boot in the ass!

[Hydra]

3. Oh, that's nothing

There was a GREAT gem in this article:

"The $5 trillion in owned or guaranteed mortgages at the two companies is backed by less than $100 billion in actual capital. That's leverage of 50-to-1."

Everyone who insists they need a bailout are assuming this was financed by private capital. This was funded by Federal Reserve funny money- 4.9 trillion of it.

Meanwhile, as the author pointed out, the Gov't may have to take that entire $4.9 trillion on as public debt paid for by us, or lose credibility overseas.

Can anyone say, "SCAM"?

I was going to write a journal entry on this, but I'm just too upset, and I think it would go over the heads of our less financially literate here(which I just got into a fight with).

*sigh*

[BridgeTheGap]

4. This "house of cards" is quivering like crazy!!! n.t

[On the Road]

5. All Banks and Mortgage Companies are Highly Leveraged

and their loans are many times the value of their assets. It's the foundation of fractional reserve banking, and has allowed the kind of long-term growth we've experienced in the US. Nothing about it that's a scam. Full-reserve accounting is not commonly practiced today.

It does makes the lenders more subject to failure, and it requires greater government oversight. The previous Fed Chairman and other regulators were either blind to the situation or for other reasons did not do thier jobs.

The federal government certainly has the legal option of not financially backing FNMA's and FRMC's debt obligations. That could result in a depression -- an unecessary one.

[Hydra]

6. Fractional reserve has limits

This is unlimited.

Also, given these facts, banks should be offering loans at zero interest to encourage growth...but instead they got greedy and choked the system.

Given that the loan holders have no backing except for us, they can be nationalized and the people who were making huge profits off of minimal investment can sell out at current market rate.

[On the Road]

7. Sorry, I Misunderstood Your Comment

Yes, 50-to-1 is very highly leveraged. Is it true that there are no legal limits on these two companies?

I don't understand the comment about zero-interest loans. A private corporation would not do that and I wouldn't want the federal government taking the resulting losses. Could you worse than subprime.

If you were proposing that the FNMA and FMRC be nationalized, I agree that's not a bad idea. I would think it should be implemented immediately if and when they actually miss an interest payment.

[Hydra]

8. Gov't policy is no fractional reserve required

I'm not positive because I'm not in the business, but I think the Fed tells the banks how much they are allowed to lend at a given time.

As for the zero interest loans, why not? The bank is making pure profit on the loan- they create the funds on the spot for it.

I think they should be nationalized if they count as "too big to fail." Once they are in that category, they have no business being a private entity in any way, shape or form.

[On the Road]

9. Profit Comes from Interest

Zero interest is an automatic loss: zero profits minus the cost of doing business as well as the bad loans.

I don't know if you can draw a hard line as to what's too big to fail. Some legitimately private companies might fall under that definition, too. I do think there ought to be some upside for the federal government in the way of stock, interest, or something else.

[Hydra]

10. Profit actually comes from payback on money you didn't have to loan

That's the definition of the 50-1 leverage- that money was not backed up by anything and any payments made back were pure profit from that $4.9 trillion of nothing. At that point, Interest is icing on an already HUGE cake.

As to the "Too big to fail," I agree with you. Some private companies with worldwide reach should be left alone. Others that are doing so with Gov't support(Haliburton, for instance) need to be absorbed.

[A HERETIC I AM]

12. Fascinating.

I find it interesting that as much as you think you do, you actually have no clue what you're talking about.

Everyone who insists they need a bailout are assuming this was financed by private capital. This was funded by Federal Reserve funny money- 4.9 trillion of it.

Bullshit. Prove this assertion or it is complete and utter bullshit. This statement along with others you made in this thread clearly indicate you do not understand how Fannie and Freddie work, what they do and where the money actually comes from.

Read this carefully;

They create and SELL BONDS. The money is NOT created out of "thin air" as you apparently like to think. The Federal Reserve DOES NOT simply give money to these two institutions. The money that flows from Freddie and Fannie to the Mortgagor, be it a local Bank or Credit Union, the money that actually buys the house for the new home owner comes from the sale of bonds. Bonds that you and I can buy, bonds that your Aunt Alice probably has, and if you have a Bond Fund in your IRA or your 401(K), there are probably some in there, too. Bonds that are purchased with actual, real dollars that result from someone being paid for labor. With very few exceptions, these bonds have a "Par" value of $1,000.00 each, are purchased at or near this par, they pay a certain interest rate to the bond holder and have a specific maturity date. When they mature, the purchaser receives his thousand dollars back (as I said, there are exceptions, such as with a "Pass Through" security or a "REMIC" Bond). Some are retired early and some go all the way out to 30 years. The average "duration" of a Mortgage backed Bond is 15 years, because home loans, more often than not, get paid off early. When people sell their house, the loan gets satisfied. If they re-finance, the loan gets satisfied, etc. Each loan that is satisfied RETIRES or matures the series of bonds used for the purchase in the first place. The holders of the bonds get their thousand dollars back. That's how it works in a nutshell. This process happens daily and constantly. It isn't fucking "funny money". It's damned serious money to the many millions of Americans who purchased the bonds. They rely on the steady stream of interest payments these bonds provide and the safety inherent in them.

Given that the loan holders have no backing except for us, they can be nationalized and the people who were making huge profits off of minimal investment can sell out at current market rate.

Who are these "Loan Holders making huge profits off of minimal investment"? Are you referring to the mortgage originators? They've already gotten their slice and they aren't "holding" a god damned thing. If a mortgage gets backed by Freddie and/or Fannie, the "holders" are people and institutions that bought the bonds and the bonds are HARDLY purchased for a "minimal" investment. They are marked to market regularly and their price rises and falls with the pressures of the bond market in general. The reason they bought the bonds is because they were, up until only recently, seen as having virtually zero risk, with a yield often better than a 30 year Treasury. If you want to park money in something that is safe and pays a decent interest rate, Mortgage backed bonds have historically been EXTREMELY safe, with an incredibly low default rate. It seems you have this idea that there is a group of people, sitting around smoking cigars, raking in the billions having made no investment. It is an idea not at all based in fact and a complete misunderstanding of the bond market, how bonds are created, how they are priced and how they trade.

Fannie Mae and Freddie Mac Bonds don't even have a classic credit rating given to them by the issuers of such ratings to almost all other debt (S & P, Fitch and Moody's Ratings Services). Their credit rating is "Agency" which is tantamount to that of a United States Treasury Bond. While this simple but extremely important distinction may be lost on you, it is undeniably something that must be preserved if at all possible.

Posting Wikipedia entries about "Fiat Currency" does NOTHING to further your argument because it is COMPLETELY IRRELEVANT to the current difficulties Fannie Mae and Freddie Mac are currently in.

Also, that film "Money as Debt" is not the answer to every difficult economics question that you can't get your head around. Erase that stupid, fact flawed movie from your favorites and read up on the Bond market instead. Then you might actually be able to resume "Teaching people economics and other neglected subjects" from a position of actually knowing what the fuck you are talking about.

Because at the moment, you clearly don't.

[Common Sense Party]

15. Gonna leave a mark.

:applause:

[Hydra]

18. Nice rant

Except for one thing:

They used their access to cheap money to build up huge mortgage positions without raising much actual capital from investors. The $5 trillion in owned or guaranteed mortgages at the two companies is backed by less than $100 billion in actual capital. That's leverage of 50-to-1.

Apparently the window dressing doesn't follow all the facts.

http://en.wikipedia.org/wiki/Fannie_mae

The Federal National Mortgage Association (FNMA) (NYSE: FNM), commonly known as Fannie Mae, is a government sponsored enterprise (GSE) of the United States federal government. It is a shareholder-owned corporation authorized to make loans and loan guarantees.

<snip>

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 even if the borrower defaults.

Alan Greenspan and Ben Bernanke have spoken publicly in favor of greater regulation of the GSEs, due to the size of their holdings and the public belief in a government guarantee that does not exist.

<snip>

Fannie Mae has looser restrictions placed on its activities than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Specifically, regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The lowest required capital/asset ratio is 3%, ratios below which are prohibited.<18> FNMA, however, is exempt from this requirement and maintains only a 1.2% ratio. The additional leverage allows for greater returns in good times, but at the risk of insolvency in bad times, such as during the recent subprime mortgage crisis. Second, FNMA is exempt from state and local taxes. This benefit is estimated to have been worth $690 million in 1999.<19> Finally, and this list is by no means exhaustive, they are exempt from SEC filing requirements, saving an estimated $280 million in compliance costs.

Boldface is mine

So Mr. Financial Guru, please explain my error in seeing this as another private, for-profit banking institution using the rules of elastic currency with even fewer restrictions than most other institutions, who would never pay the taxpayers a cent, but now may require a bailout to preserve their profit margin?

[A HERETIC I AM]

20. You know, I like Wikipedia. It's a great resource for information. But it is not always current,

and sometimes either blatantly wrong, biased or contains outdated and superseded information. "Window dressing" or not, one most certainly has to look carefully at Wikipedia entries because they are for the most part, not written by professional researchers.

Case in point:

You cite the following section out of the paragraph titled "Federal Subsidies;

Fannie Mae has looser restrictions placed on its activities than normal financial institutions: e.g., it is allowed to sell mortgage-backed securities with only half as much capital backing them up as would be required of other financial institutions. Specifically, regulations exist through the FDIC Bank Holding Company Act that govern the solvency of financial institutions. The lowest required capital/asset ratio is 3%, ratios below which are prohibited.<18> FNMA, however, is exempt from this requirement and maintains only a 1.2% ratio. The additional leverage allows for greater returns in good times, but at the risk of insolvency in bad times, such as during the recent subprime mortgage crisis. Second, FNMA is exempt from state and local taxes. This benefit is estimated to have been worth $690 million in 1999.<19> Finally, and this list is by no means exhaustive, they are exempt from SEC filing requirements, saving an estimated $280 million in compliance costs.<20>

Did you bother to look at the footnotes offered for citation? The section offers as citations numbers 18, 19 & 20.

Let's look at them, shall we?

#18 is from the FDIC website. http://www.fdic.gov/regulations/laws/rules/6000-2200.html
Interestingly enough, the Federal Deposit Insurance Corporation concerns itself WITH BANKS. Fannie and Freddie are NOT banks.

#19 I found really interesting. It is from the Citizens Against Government Waste website, a fine organization, I'm sure. The thing is, it is a .pdf formatted document with no date. So I went looking on their website and found when it was published. That article is EIGHT YEARS OLD. Here's the page on which the article appears. Scroll down about 2/3's of the way and you will see it was published in 2000. I'm not suggesting that the author is right or wrong on any points he makes, but it is after all, an opinion piece that is cited by the Wikipedia entry as proof of a claim. An opinion piece that is, as I mentioned, 8 years old.

#20 Is also an older piece, written in December of 2004 and found on the website of the "Affordable Housing Institute". This is little more than a Blog entry. Again, the author may or may not be correct on every point, but this is a dubious citation at best. The founders of the Encyclopedia Britannica must be spinning in their graves.

So Mr. Financial Guru, please explain my error in seeing this as another private, for-profit banking institution using the rules of elastic currency with even fewer restrictions than most other institutions, who would never pay the taxpayers a cent, but now may require a bailout to preserve their profit margin?

First of all, your error is seeing this "as another private, for-profit banking institution" because Fannie and Freddie ARE NOT FUCKING BANKS. That's your error.

Second, regardless of why they need financial assistance (fine...a bailout), do you not see the service they provide? Do you not understand that allowing them to fail outright would make it so that many millions of average, hardworking Americans would have a more difficult time gaining access to an affordable mortgage? Is your distaste for the idea of them getting vitally needed funding under the current economic climate so vast that you would rather "burn Freddie and Fannie to the ground" as you stated in this post rather than seeing to it that they are financially sound?

Again, please give up on the bullshit and totally irrelevant information you learned from watching "Money as Debt". It has NO BEARING on this subject. NONE.

They aren't perfect. There has been fraud and bad accounting, to be sure. But allowing them to fail is a perfect example of throwing the baby out with the bathwater.

[On the Road]

13. I Can't Understand How Any Public or Private Enterprise

could make money on zero interest loans regardless of leverage, fractional reserves, or any other condition except for buying the loan at well below face value.

The lender puts out the money up front and hopefully gets it back. Without interest, all they get is some upfront fees which covers sales, administration, and a few other expenses. What they lose includes the cost of equity or borrowing for the capital backing up the loans, the opportunity cost of using that capital for something else, operational and administration expense, the declining value of the equity over the life of the loan and absorbing the loss from forecloses. Fractional reserve banking only multiplies the loss. Even lending at the lender's cost of equity results in a loss because it only addresses one of those factors.

Am I missing something?

[A HERETIC I AM]

14. No, you're not missing anything

No one loans money for free. OK, maybe family members.

The poster above is laboring under a misapprehension.

[On the Road]

16. Not to Mention the Fact That

the problem the banks are facing is the result of a bubble driven by low interest rates and inflated asset prices.

One way to make the situation worse would be to lower interest rates to zero in nominal terms (negative when inflation is factored in) and to bail out borrowers who have gotten in over their heads. Now that would result in an even greater boom and bust, and much bigger losses for the government.

[Hydra]

17. You are missing something

But it's not your fault that you don't- this is an open secret.

Let's go back to fractional reserve for how this works:

http://en.wikipedia.org/wiki/Fractional_reserve

Now, in fractional reserve, there is a logical limit to how much a bank can lend out vs. what they hold in reserve. In the wikipedia example, 20% reserve creates 4x net funds to lend out.

This isn't what we do here in America. The article stated that the reserve vs. lending was 50-1. That means for every invested dollar, they were loaning out 50.

Now, I was once as skeptical as you. Then, a couple of things happened. First thing is that I started working as a commissioned salesman for Citi. You wouldn't BELIEVE the commissions they were offering. That got me to thinking about why banks had all this money to throw around. After all, if they were making only 3-5% net interest on monies they've loaned out, how could they pay me like that and have 3 branches in the same small town?

Now, the difference in fractional reserve and what we do is that instead of loans being tied to deposits currently held, the two are now simply not related. The Fed in some way controls the total currency created(And as I said, I don't own a bank, so I don't know how that works) as a way to control inflation/deflation, but beyond that, Banks create money by this spawning method to create growth...but they get more back for it even though they didn't actually have the money to start with.

I hope this helps you understand the structure and where the profits are coming from.

[On the Road]

21. I Understand That Fractional Reserve Banking

multiplies profits. But the profit itself is only made on the spread between the interest they charge their customers and their cost of capital (interest paid to depositors, other debt interest, and dividends). If they make half a percentage point on each loan, a 50-to-1 ratio equates to a 25% operating profit before foreclosure losses.

Which is great if you can maintain it. But of course a small loss or excessive foreclosures can turn that into a huge loss just as quickly. And zero-interest would be a disaster.

You seem to be suggesting that the new commercial money created is simply gravy for the bank, and that simply paying off the principal results in the bank keeping the principal as profit. But as the Wikipedia article you referenced says:

"For an individual bank, the deposit is considered a liability whereas the loan it gives out and the reserves are considered assets. The deposit will always be equal to the loan plus the reserve, since the loan and reserve are created from the deposit. This is the basis for a bank's balance sheet."

It's especially true of FNMA and FRMC (if that's possible), since they are secondary agents and purchase blocks of loans at a market price.

[IrateCitizen]

11. Except that part of the equation was changed...

Banks that issue the mortgages don't actually HOLD them, thanks to the elaborate money-creating instruments designed by Wall Street (CDO's and the like). They made their money from the closing fees rather than the interest payments.

This, of course, provided incentive for them to issue as many mortgages as possible rather than actually giving a damn about whether or not the money would ever be repaid. That was the concern of some other schlub down the line.

As it turns out, that schlub is the U.S. taxpayer. :grr:

[crazymans economics]

19. The bottom line from all of this is that we're finding out...

That we're holding a lot more paper with a perceived value than there is actual money to exchange for it. And as Boomers start retiring and cashing in that paper with a par value of "0.00" and finding no buyers, then we haven't begun to see a panic.