Thursday, March 20, 2008



As I predicted (See, inter alia, my 1/17/08 post, “NOT THE CANDY COMPANY, NOT THE PAUL NEWMAN/PATRICIA NEAL MOVIE …”), federal regulators, at the prodding of the Bush Administration, are moving to get Fannie Mae and Freddie Mac to buy more mortgages and mortgage backed securities (“MBS”) in an effort to “stabilize” the housing market. Regulators are reducing the capital these two government sponsored enterprises (“GSEs”) must hold from 3.25% of their mortgage holdings to 3.00% of their mortgage holdings. If Fannie and Freddie take full advantage of the “opportunity” presented them by OFHEO, their primary regulator (Remember, these are private businesses with shareholders to consider, so expansion of their balance sheets is not a foregone conclusion.), they could increase their combined mortgage holdings by about $200 billion which, even in Washington, is not small change.

Fannie and Freddie lost a combined $9 billion in the second half of 2007, largely because a growing proportion of the mortgage loans they guarantee defaulted. Those losses are expected to continue through the second half. This does not seem to be the time to be adding leverage in order to buy more mortgage loans that may go sour. We, of course, are being assured that the mortgage loans that Freddie and Fannie will buy with this new leverage will be subject to stringent underwriting guidelines and thus will be of the highest quality with little chance of default, no sir. The people delivering these assurances are the same people who were telling you that the mortgage problem was an isolated one, limited to sub-prime mortgages, that would never spread to Alt-A mortgages, and that the mere suggestion, being made by lost in the ‘80s rubes like the Insightful Pontificator, that this problem could spread to prime mortgages and beyond was absolutely risible. After all, as astute observers like Jim Cramer were telling us, the “guys on the Street” assured these financial wiremen that the problem was a trifling one, easily handled by the type of financial wizardry that got us into this mess in the first place.

It looks to me like this latest move to prod Fannie and Freddie to buy more mortgages amounts to attempting to solve problems caused by using leverage to buy dyspeptic assets by using more leverage to buy more dyspeptic assets. Sounds like a great plan to me, but what do I know? I thought that this mortgage “problem” would turn out to be a real mess, and I had the temerity to suggest that, consequently, the stock market was not going to soar upward as 2007 turned into 2008, undergirded by “strong fundamentals.”

Further, since Fannie and Freddie are GSEs and as such have the implicit guarantee of the U.S. government, who will be left holding the bag? So now not only have you bailed out creditors and counterparties to Bear Stearns, addle-brained practitioners of the recondite arts of financial alchemy, and “homeowners” who borrowed beyond their means partially in an effort to look down their noses at those of you who still practice financial prudence; now you’ll be bailing out all of the above, only to a greater degree, and the financial wizards at Fannie and Freddie. All this, of course, in the interest of making the world more comfortable for the ardent champions of free market capitalism and self-reliance who inhabit Wall Street and Republican administrations.

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