Fannie Mae and Freddie Mac sound like two characters out of the old West - with her in a gingham dress and him in a check shirt. But Fannie Mae is the Federal National Mortgage Association and Freddie Mac is the Federal Home Mortgage Corporation. They're both in big trouble and, if they're in trouble, so are we.
Fannie was set up in 1938 by President Roosevelt as part of his ‘New Deal' to guarantee mortgages by lending money to private banks, which were effectively broke as a result of the Great Depression. It was privatised in 1968. Freddie was set up in 1970 as another mortgage guarantee outfit.
Fannie's shares have fallen by 38% in a few days last week as panic set in. Freddie shares lost 45% at the same time. Fannie's shares have lost 80% of their value over the past year while Freddie's have gone down 86%. A third firm, IndyMac, has been effectively nationalised by Treasury Secretary Hank Paulson. The fate of Fannie and Freddie is currently in the balance.
Fannie and Freddie are, or were, huge. Home loans amount to about $12 trillion in the States and more than four-fifths have recently been guaranteed by Fannie and Freddie. Householders have been encouraged to switch to the big two as their guarantees are seen as bullet proof. As a result the two have acquired all the mortgages issued in the heady years at the peak of the housing bubble - since gone to bust. Fannie and Freddie are regarded as too big to be allowed to fail. 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 effectively be nationalised. Then it will be official - their shares are worth nothing.
The financial establishment has been alarmed for a year about the sub-prime mortgage crisis. They are aware that dodgy mortgages were sold to people who could not possibly afford them as the housing bubble was inflated. They hoped that they could isolate this toxic waste and deal with it over time. It is quite clear from the scale of the crisis that the poison has entered the bloodstream of the capitalist system.
Apart from the home owner who cops it when house prices fall? The mortgage guarantee companies. If your firm makes a living by guaranteeing mortgages and millions of people find themselves unable to keep up payments, as has happened in the USA over the past year, then the shares are going to go down. As the mortgage assets evaporate and liabilities mount, then the firm will go pear-shaped. Fannie and Freddie have lost $11bn in the past few months.
In conditions of negative equity a mortgage guaranteed for $300,000 may be worth only $200,000. Merrill Lynch is predicting a 30% fall in US house prices this year. The crisis makes houses worth less but it doesn't make them easier to acquire. The mortgage lenders, who've had their fingers burned in the sub-prime market, make it more difficult and expensive for new buyers to put a roof over their heads. Interest rates have gone up because of the credit crunch.
When Northern Rock experienced a run on its branches last September, Brown and Darling hurled £55bn of our money at the bank before finally being forced to nationalise it. By way of comparison IndyMac also saw depositors scrambling to get their money out and racked up a deficit of $4-8trn (£2-4trn) before Paulson moved in. This is between 2 and 4 times as much as the losses of our fifth biggest bank. Yet IndyMac is a minnow compared with Fannie and Freddie. How big a hole will their collapse punch in the financial system?
The big two have liabilities of $5.3trn outstanding. This is as big as the entire US national debt, which has ballooned under Bush's stewardship. Taking over Fannie and Freddie would double the national debt at a stroke.
IndyMac now has liabilities greater than its assets. It is insolvent - bust. That is why it has been taken over. Economists like to make a distinction between liquidity problems and insolvency. Illiquidity is seen as a temporary cash flow problem (‘The cheque's in the post, gov'nor, honest.') which is fundamentally different from insolvency, when the firm is finished as a going concern. So far the credit crunch has been passed off as a liquidity problem for the banks (lending just dried up) rather than insolvency (nothing there to lend any more). Fannie and Freddie are almost certainly insolvent, and so are big chunks of the financial system.
The crisis comes despite the hybrid nature of the mortgage guarantors. Though privately owned and issuing shares and (until recently) posting profits, Fannie and Freddie are government sponsored enterprises (GSEs). The government has guaranteed that, whatever happens to the two, the mortgages they underpin will not fall into the chasm. So Fannie and Freddie could do business with assets covering only 2% of its mortgage exposure. In normal times this is not a problem. We are not living in normal times.
The two have been pushed out of their depth by the regulators. Richard Iley, economist at BNP Paribas, predicted of Fannie and Freddie, "They've played a key role in keeping the housing market afloat, filling the vacuum created by the collapse of the private securitisation market, which has all but disappeared. The concern is, if they continue to push cash into the market, it will increasingly undermine their financial health and leave them requiring more and more capital, which is probably getting harder and harder to acquire."
How much more capital? Professor Kyle of the University of Maryland guesses "they probably each need about $100bn they don't have. So the authorities gambled that, if they loaded all the pressure on the crisis in housing on Fannie and Freddie, and if things didn't get any worse they might gradually be able to pull the economy up from the hole it was in. They have lost.
As Alan Greenspan, former head of the US central bank, commented. "The Bear Stearns rescue has eliminated any uncertainty as to whether the US government would stand behind the debt of Fannie Mae and Freddie Mac." His successor at the Fed, Ben Bernanke, will not thank Greenspan for dropping him in it, but that was always true. Bernanke earlier had to head the rescue of failed bank Bear Stearns. Taxpayers' money and guarantees from the public purse in effect gave Bear to its rival JP Morgan-Chase for a song. (See Bear Sterns - down and out)
"This [the rescue plan] highlights the continued risk to an already fragile financial system and brings home the point that the optimism that the credit crunch was over, which was occurring in the past quarter, was massively overdone," said Glenn Maguire, chief Asia economist at Societe Generale in Hong Kong. "It's like a boa constrictor credit crunch, a very slow drawn out process, slowly squeezing the life out of the market." Ruth Sutherland adds in the ‘Observer' (13.07.08), "Here we are in a toxic loop where the seizing up of the financial system has led to a plunge in house prices and a construction slump; this will feed back into more bad debts and more strain on the banks."
When the sub-prime mortgage crisis broke last year ‘Socialist Appeal' warned that this was more than ‘a little local difficulty'; it was the beginning of a general crisis of capitalism. When the Fed hastened to bail out Bear Stearns in the spring, the financial establishment hugged themselves, claiming ‘the worst is over.' This is a new, deeper stage in the ongoing crisis. The sub-prime mortgage scandal led to the credit crunch. The sub-prime crisis and the credit crunch pricked the house price bubble. As house prices fell off a cliff, housebuilding collapsed. Now share markets are heading south and one financial institution after another is under siege. There seems no end to the unravelling.
Up till a year ago 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.
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