The Financial Times has hailed the effective takeover of Fannie Mae and Freddie Mac by the US government as “what could become the world’s biggest ever financial bail-out.” Treasury secretary Henry Paulson has promised he will pump in ‘unlimited liquidity.’ Don’t you wish the government would grant you unlimited liquidity? When it comes to the food and fuel bills of the poor and the working class, the British and American governments find that the cupboard is bare. But now it’s not bare. Predictably markets all over the world have breathed a sigh of relief. Fannie and Freddie have effectively been nationalised – and big business thoroughly approves!
In the Financial Times (08.09.08), Clive Crook comments, in an article significantly entitled ‘Nationalisation in all but name,’ “The eventual cost to taxpayers is unknown. If the housing market rallies before long, it could be in the low tens of billions of dollars. If things keep getting worse, it could be in the hundreds of billions. But Fannie and Freddie have made themselves indispensable to any housing market recovery: the cost, whatever it is, will have to be paid.”
So who are these guys? Fannies and Freddie are private companies. They both have shareholders. But they’re also Government Sponsored Enterprises (GSEs). In that sense they are hybrids. Their activity has effectively been guaranteed by the government. That has been a blessing and a curse for them.
Fannie and Freddie don’t lend mortgages direct to the public. They guarantee mortgages. Who benefits from this? The banking system, of course. The banks are the ones who take the flak when the housing market heads south and people can no longer pay their mortgages.
The GSEs openly hit trouble in the summer. (See Why you should worry about Fannie and Freddie) From that time on Warren Buffet, the richest man in the world, has declared them ‘toast.’ Their share prices have collapsed. They are plainly insolvent – they owe many times what they own. Over the past year they have been haemorrhaging losses. A Congressional committee estimates their losses at $25bn. That is the sum US taxpayers are likely to have to stump up – to save the banking system. But for capitalism they had to be saved. As we predicted in July, “The government quite simply cannot let them go to the wall. Whatever form of words it uses and whatever devious plan it announces (a new word – conservatorship – has been coined for the occasion), they will be effectively be nationalised. Then it will be official – their shares are worth nothing.”
It was realised that, as Paulson declared “Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth. Or, as the London Metro headline puts it, “£3trn deal ‘to save the world’.”
There are $12trn worth of outstanding mortgages in the USA. Nearly half of them are with Fannie and Freddie. The downside of government sponsorship for Fannie and Freddie was that they had to do what the regulators told them. So, over the past couple of years 80% of mortgages have been guaranteed with the two GSEs. This is because capitalist banks have worked out that all was not well with the US housing market, and they wouldn’t touch the new mortgages with a bargepole.
As is well known, the housing bubble burst when it became known that mortgages had been handled out by borderline criminal financiers to people with no income, no job and no assets. Not surprisingly the borrowers were unable to pay these sub-prime mortgages, and their homes were repossessed. The federal government did not feel the need to intervene as these people were made homeless, for this was the magic of the marketplace at work! They’ll bail out the banks, but not the homeless.
But free competition and bankruptcy for people who can’t make ends meet is just for suckers and little people. Fannie and Freddie are too big to fail. Here’s why. The sub-prime mortgages did not remain just a little local difficulty for finance capital. The mortgages on the GSEs’ books were sliced and diced and sold all round the world in the form of fantastically arcane financial instruments. Some of these financial instruments ended up in the vaults of UK banks. That is why these banks are so pleased that Paulson and the Fed have saved their bacon as well. That is why their shares soared upon hearing the announcement.
What the financial authorities are trying to do is what they call de-leveraging. Basically this means they now realise that the past boom was based on unsound speculation and the blowing up of unsustainable bubbles, such as the house price bubble. They are trying to unpick this pyramid of ‘leveraged’ finance. They have to be careful. If they get it wrong the whole structure will collapse and crush everything beneath it.
Take Fannie and Freddie. According to Gretchen Morgenstern they have credit default swaps of $62trn to their names – twelve times their total holdings of $5.4trn in mortgages. This is a house of cards waiting to topple. It is also a measure of the US taxpayers’ exposure.
This sort of thing is typical of the banking sector. Most US banks have a capital adequacy ratio of about 8%. In plain English that means that they can lend about 12½ times what they hold in the vaults. In good times this multiplies their profits. In bad times it multiplies the losses. It means that if only one in twelve of their debtors default, the bank is dead in the water. The sub-prime crisis means that assets they thought they had in their vaults to cover their lending have just evaporated. They all need to recapitalise. It’s not a good time to be doing this. By the end of 2009 US banks need to roll over $800bn in medium term debts. The credit crunch is getting worse, not going away.
For Fannie and Freddie are that much worse placed. They are reckoned to be leveraged 50 times over on their fast-disappearing assets. This is equivalent to putting all your money on a 50 to 1 outsider. That means defaults on just 2% of their loan portfolio would put them in queer street.
John Mauldin comments, “Critics have said that Fannie and Freddie were nothing but hedge funds with an implicit government guarantee. This is an insult to hedge funds. Hedge funds don't pay hundreds of millions in campaign contributions so that they can risk taxpayer dollars, prop up their profits, and pay huge bonuses to executives. They risk their own capital with no safety net.
“Fannie and Freddie are banks that are levered between 40 and 50 times. I can think of two hedge funds, Carlyle Capital and Long Term Capital Management, that had leverage at those levels. They both went bankrupt, as will any such levered business.”
Since the credit crunch broke a year ago, we have been told several times that ‘the worst is over.’ On the contrary Kenneth Rogoff, former chief economist at the IMF, promises that "the worst is to come." He continues, "We're not just going to see mid-sized banks go under in the next few months, we're going see a whopper, we're going to see a big one - one of the big investment banks or big banks." He’s probably right.
There are now 8 million households in the US in negative equity. That means that over the past twelve months they’ve seen their house price drop below the price they paid for it. That means they’re stuck – they can’t move and they can’t really afford to stay. As unemployment rises (now officially over 6%), many of these people will be forced to default on their mortgages.
What we see is a classic crisis of capitalism reflected in the financial arena. As the sharp increase in American jobless figures reminds us, it won’t remain confined to finance but will spread to the real economy. As we pointed out in July, “It is quite clear from the scale of the crisis that the poison has entered the bloodstream of the capitalist system.”
Only a couple of years ago, we were all recommended to admire the genius of financiers. “O brave new world, that hath such people in it," as Miranda says in Shakespeare's The Tempest. As we commented in July, “Finance capital and the whizz kids in the City were held up to us as the masters of the universe, as ‘wealth creators.’ Now we see them as hapless bums always begging for a handout. It’s high time to nationalise the banks.” The establishment is being forced to take over banks to save the rest of their system. If it survives, all it promises working class people is more hardship. It’s time to take over the banks as part of a programme for the socialist transformation of society.
- Why you should worry about Fannie and Freddie by Mick Brooks (July 15, 2008)
- Hedge funds, speculation and capitalism by Mick Brooks (July 14, 2008)
- The dollar down the pan – monetary chaos to follow? by Mick Brooks (May 1, 2008)
- Capitalism beared by Michael Roberts (March 27, 2008)
- US slides into recession - who's next? by Mick Brooks (March 17, 2008)
- Financial meltdown: another day, another finance house bites the dust by Mick Brooks (March 17, 2008)
- 1929: Can it happen again? by Mick Brooks (March 17, 2008)