Fannie Mae & Freddie Mac in Trouble

Most people living in the US are fully aware that we are currently in the middle of a crisis. What kind of crisis is a more slippery sort of topic, but even the most optimistic (read: delusional) pundits tend to agree this crisis has something to do with money, and that it started a couple of years ago when US financial institutions put sanity and common sense aside to write mortgage loans on properties with badly inflated appraised values, for people who couldn’t afford them.

Then, just to make things interesting, all these bad loans were chopped up and repackaged into investment vehicles and sci-fi securities that were traded with such abandon that at some point it became impossible to even figure out who owned the bad debt and who owned the good debt.

Fast forward to July 7, 2008 and what we have now are the two biggest government-backed mortgage lenders, Fannie Mae and Freddie Mac, unable to back up the loans they’ve made with adequate cash. As a result, stocks for each of these major lenders (at this moment) have plunged 18% in a single day.

This free-fall was kicked off when Lehman Brothers announced that a pending accounting change would require both lenders to raise an additional $17 billion. In May, Freddie Mac promised to raise an additional $5.5 billion but has not done so yet. As its stock plummeted today, a Freddie Mac spokesperson declined to comment on its ability to raise funds until second the quarter earnings for the mortgage giant are announced. It’s not likely that the second quarter earnings announcement will be a happy one.

What does all that mean?

It means the economy is in a really, really bad mess and no one knows how to fix it.

Basically, that’s it in a nutshell.

Currently, the US Congress has been locked in a battle to pass some kind of too-little-too-late help for homes in foreclosure, a measure that would almost certainly involve refinancing through Fannie Mae and Freddie Mac for homeowners who qualify for whatever program Congress might eventually pass, once they all quite fighting about it, which will happen, well, who knows when it will happen?

The point is, by the time Congress agrees on a package, it seems clear that neither of these lenders will be in any position to help anyone in any way, least of all themselves. Instantly, the too-little-too-late Congressional measures will become worthless measures, that is, no measures at all. It is what we have come to expect from this Congress (their approval rating is hovering around 17% right now, even lower than the President’s), but it isn’t nearly good enough.

We need bold action on this, and we needed it months ago.

It strikes me that the financial crisis that started with the sub-prime lending mess has gotten rapidly worse for one major reason, and it’s always the same reason, over and over again: Denial. Every month, for months now, we’ve been hearing that the housing mess is finally bottoming out, and then the next thing you know, it’s worse. And not just a little worse either; a lot worse.

When the Federal Reserve took the extraordinary step of brokering a deal so that Chase could buy out Bear Stearns at a fire sale price, the Fed was acknowledging in a backhanded way that this particular US financial crisis is an extraordinary crisis, not just an economic lull. The Fed correctly recognized that the Bear Stearns failure had the potential to freeze up credit markets completely, and that a string of domino-effect bank failures could happen very quickly without the dramatic intervention it made.

And yet, it didn’t take long for Wall Street to lull itself back to sleep and start looking for signs that the worst was already over.

It’s not even close to over. Ordinary people have known this for over a year now, but Washington does not seem to know this. The Fed is out of ammunition and will likely have to start raising interest rates very soon. Not only that, the money it has been loaning financial institutions to get them through this rough patch can’t keep flowing at the rate it is currently flowing, and the Fed knows this. At some point, the Federal Reserve will have to allow some banks to fail: At last count, the FDIC was looking at about 70 of them, mostly large regional commercial banks.

The next big wave of defaults will be on home equity lines of credit and unsecured credit like credit cards; in fact, it’s already starting, with many banks freezing both kinds of lines and cutting way back on availability. Some people who had home equity lines maxed out at 100K or 200K are now being sent letters that their new appraisal gives them a credit line of 30K or 40K, the line is frozen, and by the way, the line is past due too. These aren’t necessarily customers with bad credit, but they are customers who are now facing mounds of debt and no way to get any other loans. So the crisis continues to spread and infect other areas of commercial and personal finance that no one thought about when it all started to go sour.

It seems incredible that with these extraordinary negative developments happening on a daily basis, pundits can still be kicking around the precise meaning of ‘recession’ and ‘Bear market’. It’s as if a hemorrhaging patient arrived in an emergency room, and instead of taking emergency measures to save the patient, the doctors started to debate the exact moment and which the bleeding moved from ordinary heavy bleeding to hemorrhaging, and why. And while the doctors debate this, the patient bleeds out and dies.

I don’t envy Benjamin Bernanke. I don’t want his job. But it would be refreshing to hear at least one know-it-all admit that, well, we’re screwed. I mean, it comes down to that, doesn’t it? The truth is always a good place to start, I think.

If we’d have started with the truth two years ago, we wouldn’t be here.

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