Guarantees for America’s guarantors By Clive Crook
The Bear on Jul 15 2008 at 8:26 am | Filed under: Economy, Need to Know
US taxpayers are about to find out what their long-standing and (strictly speaking) non-existent guarantee of Fannie Mae and Freddie Mac will cost them. One way to think of it is this: take the US national debt of roughly $9,000bn and add $5,000bn. Not bad for an obligation still officially denied.
In the end, that astounding prospect might be the outcome. Partial or outright nationalisation of the housing lenders – colossal pseudo-private entities that own and underwrite US housing loans – would add some or all of their $5,000bn (€3,144bn, £2,513bn) in liabilities to the government’s balance sheet. While it is true that the agencies (unlike the government) own housing-related assets that roughly match those liabilities, the still-collapsing housing market makes this a lot less reassuring than one could wish.
Covering the agencies’ losses on their loans and guarantees is going to require an actual outlay, which will fall on taxpayers. You could plausibly call the rest – namely, bringing these “government-sponsored enterprises” explicitly inside the public sector – just a bookkeeping entry. But what an entry! It would surely shake financial markets, raise the government’s cost of funding and put heavy downward pressure on the dollar. Meanwhile, the turmoil impedes or paralyses the GSEs in their crucial life-support role for the housing market.
A small irony deserves to be noted. Fannie’s and Freddie’s shares have been falling for months, but it was an analyst’s report from Lehman Brothers – a struggling securities firm judged by many to be next in line for the fate of Bear Stearns – that provoked new alarm last week. Then on Wednesday Bill Poole, a respected former chief of the St Louis Federal Reserve, said that Fannie and Freddie were insolvent in the first quarter on a mark-to-market basis. This should have come as no surprise and has no bearing on their solvency in what the US Treasury calls “the regulatory sense”. Strangely, being reminded of something they already know often throws financial markets into a spin.
Here is a greater irony: Fannie and Freddie were the inventors of the mortgage-backed security, a principal cause of the housing bubble and its subsequent deflation.
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