http://www.marketoracle.co.uk/Article5598.html


Oil and Food Prices Falling, Real Estate Stabilizing, Stocks Soaring, Crisis Over?

Are feds stockpiling survival food? Are feds stockpiling survival food?
'These circumstances certainly raise red flags'
Posted: July 24, 2008
12:00 am Eastern

© 2008 WorldNetDaily A Wall Street Journal columnist has advised people to "start stockpiling food" and an ABC News Report says "there are worrying signs appearing in the United States where some … locals are beginning to hoard supplies." Now there's concern that the U.S. government may be competing with consumers for stocks of storable food.

http://www.marketoracle.co.uk/Article5590.html
The Greatest Transfer of Wealth in History is About to Unfold

Evidence of the US Banking System Teetering on the Brink of Collapse
http://www.marketoracle.co.uk/Article5594.html

Housing Bill Passes House iht.com — The House approved far-reaching government assistance for the housing market, including broad authority for the Treasury Department to protect the nation's two largest mortgage finance companies and an aggressive plan to help troubled borrowers avoid foreclosure by refinancing their mortgages. The White House said President Bush would sign the measure despite his opposition to $4 billion in grants included in the bill for local governments to buy and refurbish foreclosed properties.

Fannie/Freddie Rescue Unlimited businessweek.com — The House passed a bill that authorizes the Treasury Dept. to extend Fannie Mae and Freddy Mac a lifeline without any of the conditions that the companies' critics had demanded. The House agreed to let the Treasury Department extend unlimited amounts of credit to Fannie and Freddie, and buy shares in the companies to bolster their capital bases. Treasury Secretary Henry Paulson — who argued that the unlimited line of credit and authorization to buy shares would discourage short sellers from mounting attacks on the companies — likened it to a bazooka that scares off enemies even if it's never used.

Jobless Claims Surge ap.google.com — The number of newly laid off people filing claims for unemployment benefits bolted past 400,000 as companies trimmed their work forces to cope with a slowing economy. The Labor Department reported that the number of new applications filed for these benefits rose by a seasonally adjusted 34,000 to 406,000 for the week ending July 19. The last time claims were higher was after the devastation of the 2005 Gulf Coast hurricanes. Then, they spiked to 425,000. The new snapshot of layoffs was worse than economists were forecasting. They were expecting claims to rise to 375,000. A year ago, new claims were much lower — at 308,000. The rise in claims underscores the deterioration in employment conditions.

Prices Rising As Economy Slows washingtonpost.com — The economy has continued slowing across most of the nation as prices keep rising sharply, according to a report by the Federal Reserve, indicating that the squeeze that has made times tough for Americans throughout 2008 shows no sign of letting up. The Fed's "beige book," a compilation of anecdotal information from businesses around the country, gives a portrait of an economy that continues to experience deep stresses from many sides: a soft labor market, banks that are reluctant to lend, higher fuel prices, and consumers hesitating to buy big-ticket items such as autos.

Consumers Fall Further Behind usatoday.com — Americans' household finances are bad and getting worse, and that spells trouble for the economy for the rest of the decade, according to a study by Moody's economy.com. Consumers are behind schedule in payments or have walked away from nearly $800 billion in household debt of all kinds — like mortgages, credit cards, and car loans. As prices decline, fewer homeowners can borrow against their home equity. More borrowers also owe more than their homes are worth. More than 8 million homeowners are underwater now, and Moody's forecasts that number will rise to about 12 million in 2009.

Congress Stalled on Gas Prices iht.com — Republicans and Democrats agree that high gasoline prices are the driving domestic political issue of the moment, spurring new campaign advertisements and maneuvering almost every day. But that is about all they can agree on when it comes to the national panic at the pump. Making it increasingly clear that the congressional debate is more a matter of political positioning than policy creation, the Senate failed to come to terms on the ground rules for considering an energy bill, delaying a proposal to curb speculation in oil futures and stymieing a broader review of energy initiatives. The stalemate is drawing sharp contrasts for the November election.

PIMCO's Gross Project $1 Trillion in Mortgage Losses - Calculated Risk

Joblessness Over The Years
Unemployment by Education
The Male, Female Divide
Getting Richer, Paying More
Manufacturing Productivity
Foreign Investement Boom
Immigration and Assimilation
Geography of Mortgage Crisis
Soaring Rates of Fraud

It's Always Darkest Before the Dawn...of a Economic Depression - 24th July 08

Panic Building on Wall Street - 24th July 08

Evidence of the US Banking System Teetering on the Brink of Collapse - 24th July 08

Beware the Stocks Bear Market Dividend Trap - 24th July 08 The Greatest Transfer of Wealth in History is About to Unfold - 23rd July 08 Banking Crisis Alert -How Safe is Your Bank - 23rd July 08

US Treasury Bonds at Risk Under Weight of Debt Moutain - 23rd July 08

I think The Market Oracle is really just a shill for Silver.

Snuff, you can find better material than from these guys.

Visualizing Dow 6,000
Last Wednesday, at an improvised press conference, George Bush gave what may have been the most comical performance of his eight year presidency. Looking like the skipper on the flight-deck of the Hindenburg, Bush tried his best to reassure the public that "all's well" with the economy and that everyone's deposits were perfectly safe in the rapidly disintegrating US banking system. Leaning lazily on the presidential podium, Bush shrugged his shoulders and said,

"My hope is that people take a deep breath and realize that their deposits are protected by our government. We're not seeing the growth we'd like to see, but the financial system is basically sound."

Right. "Breath deep" and chill out; no need to panic. One shouldn't let the long lines of anxious depositors who are presently trying to extract what's left of their life savings from the now-defunct Indymac Bank upset one's basic equanimity. The banking system is perfectly safe, you heard it from President Trickledown himself.

At the same time Bush was offering his soothing words on all the major TV news networks, Fed chairman Ben Bernanke was on the other side of Washington giving a decidedly grimmer assessment of the economy:

"The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated."

Keep in mind, that these two events were perfectly coordinated to take place at exactly the same time; 10:20 AM Wednesday. Quite a coincidence, eh? Just another masterful public relations coup engineered by the Bush PR team, the last functioning agency in the entire bureaucracy. To no one's surprise, the collusive media managed to divert attention from the impending financial firestorm long enough to lull the American people into believing that nothing is really wrong; the economy is just hunky-dory.

Fed-chief Bernanke again:

"The economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities....The deteriorating performance of subprime mortgages in the United States triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risks of any type....Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain."

As Bernanke delivered one hammer-blow after another, our engaging Commander in Chief was busy swapping funny stories and rough-housing with his pals in the Washington press corps. The media confab turned out to be a typical Bush frat-party with plenty of back-slapping and hee-haws to go around.

"You had a question, Stretch?" (Ha, ha)

And that was that. Bernanke's candid and (frankly) scary assessment of the economy was dwarfed by Bush's diversionary palavering and bravado; another stunning victory for the White House spinmeisters. Even so, the Fed chairman's testimony should be dug up and examined by anyone who is interested in knowing how bad things really are so they can prepare themselves for the hard times ahead. (Find it here: Bernanke's Semiannual Monetary Policy Report to Congress)

Bernanke again:

"In the housing sector, activity continues to weaken...Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas....The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas......Surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of the year."

The economic sky is quickly darkening and Bernanke made no effort to hide his concern. His testimony was as close to the truth as one gets in Washington where honesty is usually eradicated like a malignant tumor. In any event, it is worth wading through Bernanke's speech word by word even if it only reinforces one's belief that the economy is about to take a sleigh-ride through a deflationary blast-furnace which will ultimately result in the demise of Breton Woods, the disorderly replacement of the dollar as the world's reserve currency, and an end to the United States short-lived dominance as the world's lone superpower. The American Century has about run out of steam just eight years into the new mellenium. Bernanke's presentation confirms what the econo-bloggers have been saying for the past three years; the end is nigh, get your house in order.

Personal consumption is down, the labor market is softening, and food and fuel prices are soaring. Housing values are plummeting, wages have stagnated, and American households are more overextended, underpaid and stressed out than anytime in history. It's all bad. No wonder consumer confidence is at its nadir.


"THE SUMMER OF 1931"?

The next shoe to drop is the stock market. Its not that complicated either; when wholesale prices on supplies and raw materials go up, but businesses can't pass along those costs because consumers are already maxed-out, then corporate profits plummet and the stock market crashes down with the force of an avalanche.


Journalist Ambrose Evans-Pritchard summed it up like this:

"It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution. The International Monetary Fund has abdicated into schizophrenia....My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger." (Ambrose Evans- Pritchard, "The Global Economy is at the point of maximum danger", UK Telegraph)

"Maximum danger", indeed. Stock market mayhem is just around the corner. Visualize the Dow at 6,000 and then hang on for dear life. The indexes will tumble and Wall Street will be reduced to Dresden-type rubble, nothing left but toxic fumes and twisted iron. By the end of 2009, the last few bulls will be driven out of the exchanges and onto the streets where they'll be slaughtered one by one. It won't be pretty.

According to Bloomberg News: "Investors worldwide are betting more than $1 trillion on a collapse in stock prices".

But no matter how bad it gets, the media will still bang-out its "Sunny Jim" market-forecasts while reiterating every mangled phrase and muddled thought from our alcohol-addled Dear Leader. The lines from the shelters, pawn shops and soup kitchens may stretch from the Golden Gate to the Statue of Liberty, but the perennially upbeat predictions of a "bottom in housing" or an "economic turnaround" will continue to blast from every media bullhorn in the nation. America's financial media is an never-ending source of baseless optimism and hogwash.

It's funny; while Bush was hosting his faux-press conference, live-footage was appearing on other media of fully-armed LA policemen being dispatched to the various Indymac locations. Their task was to remind the gathering of elderly "blue-hair" women and middle-aged white guys in Tommy Bahama T-shirts that any public display of outrage would be swiftly met with Rodney King-style justice. Hmmm. So now withdrawing one's savings from the bank is not only riskier; it's tantamount to committing a felony. My, how America has changed.

Just imagine the frustration of spending $5 a gallon for gas to drive to the local Indymac branch to get whatever is left of your savings only to get roughed-up by the local constabulary. Nice touch, eh?

Going to the bank? Don't forget the protective head-gear!

The truth is the banking system is built on a foundation of pure quicksand and its only a matter of time before the Bush's truncheon-wielding Robocops start tasering old ladies and gassing portly white guys for massing in front of the boarded up doors of their local bank. Move along, now.

Market Ticker's Denniger made this insightful observation about about the present condition of the banking system. He said, "Why does Paulson keep telling us that the banking system is sound every time he gets within 200' of a microphone? Maybe it is because the banking system is on the verge of all-out collapse, and he knows you could blow it over with a feather!" (The Market-Ticker)

It is worth noting that the demise of Indymac is expected to cost the FDIC around $8 billion of its meager $53 billion of reserves. 4 or 5 bank failures of equal size and the FDIC will be underwater, which is a serious problem since even conservative estimates expect bank failures to run into the hundreds. The Fed will be forced to monetize the debt, further weakening the dollar.

But Indymac is small potatoes compared to the liabilities of the two mortgage behemoths, Fannie Mae and Freddie Mac. Years of sketchy accounting, risky investments, abusive lending, and political cronyism have eroded the two Government Sponsored Enterprises (GSEs) balance sheets and pushed them to the brink of insolvency. If they fail, it will be disastrous for the US taxpayer who will be expected to guarantee $5.2 trillion of US residential mortgages, hundreds of billions of which was lent to borrowers who will likely default on their loans in the next few years. As the housing bubble continues to fizzle; Fannie and Freddie will face losses of $500 billion or more, forcing disgruntled foreign investors to ditch their bonds and make for the exits. When that happens, long-term interest rates will skyrocket and the ailing dollar will collapse in a heap. The Bush administration can't allow that to happen, which means that Henry Paulson will push for emergency funding from the congress (which he is doing now) so he can rebuild investor confidence and stop the hemorrhaging of foreign capital. Whether Fannie and Freddie are saved or not, it is bound to be a drain on the dollar which can only get weaker as deficits soar and confidence wanes. There's really very little chance the dollar will survive as the "international currency".

Economist Nouriel Roubini summed it up like this:

"The existence of GSEs...is a major part of the overall U.S. subsidization of housing capital that will eventually lead to the bankruptcy of the U.S. economy. For the last 70 years investment in housing –- the most unproductive form of accumulation of capital -– has been heavily subsidized in 100 different ways in the U.S.: tax benefits, tax-deductibility of interest on mortgages, use of the FHA, massive role of Fannie and Freddie, role of the Federal Home Loan Bank system, and a host of other legislative and regulatory measures.

The reality is that the U.S. has invested too much – especially in the last eight years – in building its stock of wasteful housing capital (whose effect on the productivity of labor is zero) and has not invested enough in the accumulation of productive physical capital (equipment, machinery, etc.) that leads to an increase in the productivity of labor and increases long run economic growth. This financial crisis is a crisis of accumulation of too much debt ---by the household sector, the government and the country –- to finance the accumulation of the most useless and unproductive form of capital, housing, that provides only housing services to consumers and has zippo effect on the productivity of labor." (Seeking Alpha, "Just How Terrible is Housing as an Asset Class? Roubini Weighs In")

Fannie and Freddie made a big mistake by shifting into mortgage-backed securities (MBS) in the 1990s. From 1997 to 2007, Fannie's portfolio of dodgy MBS jumped from $18.5 billion to $127.8 billion by the end of 2007. The numbers at Freddie were even higher. Now they're caught in the same downgrading-spiral as the investment banks, with billions of dollars of assets steadily losing value every month. It's death by a thousand cuts. The losses have left the two GSEs cash-starved and searching frantically for new sources of capital to build their cushion. Regrettably, foreign sovereign wealth funds feel like they were burned in the Citigroup bailout and are no longer in the market for destitute US investment banks.

Here's "The Economist" shedding a little more light of Fannie and Freddie's creative bookkeeping:

"The companies have also been unwilling to accept the pain of market prices in acknowledging delinquent loans. When borrowers fail to keep up payments on mortgages in the pool that supports asset-backed loans, Fannie and Freddie must buy back the loan. But that requires an immediate write-off at a time when the market prices of asset-backed loans are depressed. Instead, the twins sometimes pay the interest into the pool to keep the loans afloat. In Mr Rosner's view, this merely pushes the losses into the future." (The Economist, "The End of Illusions")

Nice, eh? Wouldn't it be great if guys didn't have to explain to their wives why they pissed away their paycheck at the race track? Apparently, it's okay for Fannie and Freddie; just keep paying the interest on bad loans and no one's the wiser. What a racket. This is the type of sleazy Enron-type accounting that goes unchallenged in Washington where everyone fudges the numbers to hide their losses from their shareholders or taxpayers, as the case may be. That's why the namby-pamby regulators at the SEC need to be replaced with a few knuckle-dragging Abu Ghraib interrogators. There's nothing going on at Fannie and Freddie that a set of leg-irons and a few lively dunks on a waterboard wouldn't fix.

THE ROAD TO PERDITION: Paulson's Scatterbrain Capitalism

Something has gone terribly wrong with the economy, but no one wants to say what it is. This is more than just a typical downturn in the demand-cycle or a temporary "rough patch". In fact, it's not a recession at all; it is a meltdown of the financial system. And it's obvious. The "deep pocketed" Federal Reserve is currently providing hundreds of billions of dollars through its auction facilities to the most craven speculators on the planet, the investment banks. These very same banks have no ability to pay that money back. Show me their revenues; show me their assets; show me their capital cushion which is calculated mainly in terms of "Level 3 assets" and which allow the banks to assign their own value to the bad paper that's overflowing from their vaults. Have you ever heard of anything more ridiculous? One blogger called Level 3 assets "mark to fantasy". He's right, too. It's all smoke and mirrors. So why are we letting crooks decide what their assets are worth?

True, a few of the investment banks just reported "better than expected" earnings, but no one on Wall Street is fooled by that baloney. The SEC changed the rules on shorting bank stocks just days before their earnings reports were due; another gift from Uncle Sam to hide the dirty laundry. Also, some of the banks have started extending their "write downs" from 120 days to 160 days, buying themselves a little more time to deceive their shareholders about the size of their losses. It's all one big swindle following another. The whole business stinks to high heaven and the Bush administration is right there in bed with them, snuggling up close and holding their hands.

If the public grasped the significance of the Bear Stearns fiasco, they'd understand how grave the situation really is. The technical details are irrelevant; don't bother with them. What IS important is that the Fed acknowledged that the investment speculators had so polluted the financial system with their toxic, unregulated garbage,(Credit default swaps) that if the transaction with JP Morgan flopped, the entire system would have imploded. Think about that. In other words, the legitimate, "Real Economy" is now inextricably lashed to a massive $500 trillion dollar unregulated shadow banking system that operates without rules, supervision or sufficient capital. Over the counter derivatives trading is a cancer that has spread to every part of the system and is devouring it from the inside. It's only a matter of time before the patient succumbs. That's what the Bear bailout really means; the rest is bunkum.

The banking system is broke, busted, penniless; and yet the Fed and the G-7 allow this comedy to persist like nothing is wrong. When will the American people wake up?

And, will someone please explain how free markets can exist when speculators are subsidized by the state, or when the risk is removed from risky investing? That's what it means when the Fed opens its auction facilities to the investment banks and brokerage houses. It makes no sense at all. Government "safety nets" are anathema to free market capitalism. "You pays yer money and you takes yer chances". That's finance capitalism; deal with it.

What we are seeing is a hybridized version of capitalism; "Paulson's Scatterbrain Capitalism"; a hodge-podge of taxpayer bailouts, government intervention and free market mumbo jumbo. It's a toxic mix on off-balance sheets operations, over-the-counter "unregulated" derivatives, dark pool trading, opaque hedge funds, dodgy Enron-style accounting, and complex, hard-to-pronounce debt-instruments wrapped up into one, cheesy, unsustainable shell game, managed by Harvard-educated flim flam men and backed by a 100% government guarantee. That's the system we're supporting with our tax dollars and that's the system that is dragging us headlong to ruin.

It ain't capitalism, my friend. It's a crooked system run by corporate carpetbaggers and banking scalawags who've shot the Golden Goose in hopes of keeping the larder at the cottage on the New Jersey coast chock-full of Dom Perignon and halibut fillets. They created this nightmare and they've doomed us all.

As long as we prop up the existing system, the economy will continue to flounder, unemployment will continue to rise, foreclosures will continue to soar, banks will continue to be shuddered, and the wobbly old greenback will continue its inexorable march towards Pesoville. It's time to clean house and we can start by firing Paulson.

Mike Whitney lives in Washington state and can be reached at fergiewhitney@msn.com

http://www.counterpunch.org/whitney07232008.html[email="fergiewhitney@msn.com"]
[/email]

I don't know who they are shilling for. I just try to canvass what I can. I like the financial news coverage in the Asian Times myself. And that led me to the Prudent Bear and the Prudent Squirrel, the latter though has an expensive
newsletter fee.

Should Government Be In Bailout Business? - Roger Lowenstein, NY Times

Paulson's Deal Scraps Free-Market Push - Brinsley & Christie, Bloomberg

Deluded Pols Think They Run Markets - Randall Forsyth, Barron's

Government Puts Gun to Capitalism's Head
- Caroline Baum, Bloomberg

CREDIT BUBBLE BULLETIN
In short, crisis reaches
bedrock level
The jump in benchmark yields on Fannie Mae mortgage-backed securities last week and the tightening of US rules on shorting large financial stocks are not unrelated. With the mortgage crisis reaching the bedrock of the mortgage credit system, any meaningful tightening in conventional mortgage credit would exacerbate already escalating problems. (Jul 21, '08)
Doug Noland looks at the previous week's events each Monday.

Debt capitalism self-destructs
By Henry C K Liu

In a period of less than a year, what had been described by US authorities as a temporary financial problem related to the bursting the housing bubble has turned into a fully fledged crisis at the very core of free-market capitalism.

A handful of analysts have been warning for years that the wholesale deregulation of financial markets and the wrong-headed privatization of the public sector during the past two decades would threaten the viability of free-market capitalism. Yet ideological neoliberal fixation remain firmly imbedded in US ruling circles, fertilized by irresistible campaign contributions from
profiteers on Wall Street, methodically purging regulatory agencies of all who tried to maintain a sense of financial reality.

This ideology of "market knows best" has allowed the nation to slip into an unsustainable joyride on massive debt giddily assumed by all market participants, ranging from supposedly conservative banks, investment banks and other non-bank financial institutions, to industrial corporations, government sponsored enterprises (GSEs) and individuals.

The once-dynamic US economy has turned itself into a system in which it is difficult to find any institution, company or individual not over their head in speculative debt. Undercapitalized capitalism, also known as debt capitalism, has been the engine of growth for the US debt bubble in the last two decades. This debt capitalism cancer is caused by a failure of central banking.

In the face of a broad systemic collapse of debt capitalism, where capital has become dangerously inadequate and new capital hazardously and prohibitively scarce, having been crowded out by massive debt collateralized by overblown assets of declining value and with a credit crisis that clearly requires systemic restructuring and comprehensive intensive care, those in the US responsible for the financial well-being of the nation seem to have been reacting tactically from crisis to crisis with a script of adamant denial of obvious facts, symptoms and trends, with no signs of any coherent grand strategy or plan to save the cancerous system from structural self-destruction.

This band-aid short-term approach to artificially pop up share prices in the collapsing equity market and to maintain insolvent financial institutions with technical life-support will lead only to long-term disaster for the whole economy.

Yet this approach is preferred by those in authority, trapped in self deception about unregulated market capitalism being still fundamentally sound. They try to calm markets by asserting that the current turmoil is merely a minor liquidity bottleneck that can be handled by the central bank releasing more liquidity against the full face value of collaterals of declining worth.

The message is that somehow, if easy money in the form of debt is made endlessly available, the economy will recover from this credit crunch, notwithstanding that excessive debt has been the cause of the problem; or bad loans can be made good by Congress giving the US Treasury authority to buy up bad loans with unlimited amounts of taxpayer money.

Yet these incremental measures taken so far by the Treasury and the Federal Reserve make the two government units with direct responsibility on the nation's long-term financial health look like panicky rogue traders trading for the national account in desperate hope to score a win in the next quarter by upping the ante, to contain allegedly isolated crisis hot points. The aggregate effect adds up to a broad stealth nationalization of the insolvent financial sector. Their prescription for stabilizing a debt-destabilized market is more public debt to support corporation socialism.

For years, anyone warning that the government sponsored enterprises (GSEs), namely Fannie Mae and Freddie Mac, should be held to normal capitalization requirements was ridiculed as a fear monger by the powerful lobbying machines these GSEs employed. Capital is considered as superfluous in the new game of debt capitalism held up by complex circular hedging. As a result, the GSEs have become the monstrous tail that wags the dog of housing finance.

The current talk about the need to curb speculation in the commodities and financial markets to stabilize prices is off target, especially for believers of market capitalism. All market transactions are speculative in nature. Speculation can stabilize prices as well as to destabilize them, but only in the short term. Long-term price levels (inflation or deflation), as Milton Friedman aptly observed, are always monetary phenomena. The current turmoil in the financial system, the subprime mortgage implosion, the credit crisis from the seizure in the asset-backed commercial papers market, the undercapitalization of commercial and investment bank, the rating agency dysfunction, the insolvency of monocline (bond) insurers, the massive financial losses by the GSEs and a host of other financial problems percolating under the media radar, are the outcome, and not the cause, of this market turbulence. (See Perils of the debt-propelled economy, Asia Times Online, September 14, 2002.)

Fanny Mae and Freddy Mac, GSEs that have provided mortgage funds for the housing market since 1938, were created as part of the New Deal to help low-income families. They were privatized in 1968 on terms that would alter their social mandate and would inevitably lead them into financial trouble on a big scale. Finally but suddenly, these GSEs find themselves in danger of defaulting on their massive debts, upwards of US$5 trillion, in the course of a single week.

Deeply rooted in US political culture is the view that credit is a financial public utility, much like air and water, and should be equally accessible to all, not just to the rich. Economic democracy has been the core strength of US political democracy. Government loan guarantees for students and home mortgages for low- and moderate-income groups and loans to small business are based on this principle. Yet from time to time, this principle of economic democracy is overshadowed by free-market extremism to push the nation's economy into extended depressions.

The US National Housing Act was enacted on June 27, 1934, as one of several economic recovery measures of the New Deal to get the nation out of the Great Depression. It provided for the establishment of a Federal Housing Administration (FHA). Title II of the Act provided for the insurance of home-mortgage loans made by private lenders, taking the disaggregated risk in lending to low-income borrowers off private lenders and managing the risk on a national scale with a government agency to take advantage of the law of large numbers, a theorem in probability that describes the long-term stability of a random variable. Title III of the Act provided for the chartering of national mortgage associations by the FHA administrator. These associations were to be independent corporations regulated by the administrator, and their chief purpose was to buy and sell the mortgages insured by the FHA under Title II.

Only one association was ever formed under this authority. On February 10, 1938, this association, the National Mortgage Association of Washington, became a subsidiary of the Reconstruction Finance Corp, a government corporation. Its name was changed that same year to Federal National Mortgage Association (Fannie Mae). By amendments made in 1948, Title III of the US National Housing Act became a statutory charter for Fannie Mae.

Balloon payment barrier
Before the Great Depression, affording a home was difficult for most people in the US. At that time, a prospective homeowner had to make a down payment of 40% and pay the mortgage off in three to five years. Until the last payment, borrowers paid only interest on the loan. The entire principal was paid in one lump sum as the final "balloon" payment. Lenders could demand full payment of the outstanding loan at any time of the lender's choosing, often at time least advantageous to borrowers. This allowed lenders to use foreclosures as a means to take over desirable properties.

During the 1920s boom time in real estate, a rudimentary secondary mortgage market had come into being. The stock-market crash of 1929 ended the real-estate boom and forced many private guarantee companies into insolvency as home prices collapsed. As economic conditions worsened, more and more borrowers defaulted on mortgages because they couldn't come up with the money for the final balloon payment or to roll over their mortgage because of low market value of their homes.

To help lift the country out of the Great Depression, Congress created the FHA through the National Housing Act of 1934. The FHA's insurance program protected mortgage lenders from the risk of default on long-term, fixed-rate mortgages. Because this type of mortgage was unpopular with private lenders and investors, Congress in 1938 created Fannie Mae to refinance FHA-insured mortgages.

As soldiers came home from World War II, Congress passed the Serviceman's Readjustment Act of 1944, which gave the Department of Veterans Affairs (VA) authority to guarantee veterans' loans with no down payment or insurance premium requirements. Many financial institutions considered this arrangement a more attractive investment than war bonds.

By revision of Title III in 1954, Fannie Mae was converted into a mixed-ownership corporation, its preferred stock to be held by the government and its common stock to be privately held. It was at this time that Section 312 was first enacted, giving Title III the short title of Federal National Mortgage Association Charter Act.

By amendments made in 1968, the Federal National Mortgage Association was partitioned into two separate entities, one to be known as the Government National Mortgage Association (Ginnie Mae), the other to retain the name Federal National Mortgage Association (Fannie Mae). Ginnie Mae remained in the government, and Fannie Mae became privately owned by retiring the government-held stock. Ginnie Mae has operated as a wholly owned government association since the 1968 amendments. Fannie Mae, as a private company operating with private capital on a self-sustaining basis, expanded to buy mortgages beyond traditional government loan limits, reaching out to a broader income cross-section.

By the early '70s, inflation and interest rates rose drastically. Many investors drifted away from mortgages. Ginnie Mae eased economic tension by issuing its first mortgage-backed security (MBS) guarantee in 1970. Investors found these guaranteed MBSs highly attractive. Also in 1970, under the Emergency Home Finance Act, Congress chartered the Federal Home Loan Mortgage Corp (Freddie Mac) to buy conventional mortgages from federally insured financial institutions. The legislation also authorized Fannie Mae to purchase conventional mortgages. Freddie Mac introduced its own MBS program in 1971.

Fannie and Freddie charters give these GSEs exemptions from state and local taxes, allow them relatively meager capital requirements, and provide them with an ability to borrow money at lowest possible rates to lend at near market rates. Over the years, this advantage has served not to lower home prices and mortgage payments to help low-income buyers but to enrich debt securitizers and brokers.

Aging credit line
Each agency now has a $2.25 billion credit line with the Treasury, set nearly 40 years ago by Congress at a time when Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion. Today the two companies also hold or guarantee loans with face value of more than $5 trillion, about half the nation's mortgages. Market analysts estimate that the market value of this liability may be less than 50% unless the housing market recovers. In other words, the GSEs face a $3.5 trillion exposure to default if they cannot raise new funds in the credit market.

In the early 1980s, the US economy spiraled into deep recession. Interest rates were high while house prices while falling, remaining beyond the reach of many low- and moderate-income buyers because income growth stayed stagnant. The US economy faced a dual problem of income deficiency and money devaluation. In this poor housing market environment, Ginnie Mae, Fannie Mae and Freddie Mac all created programs to handle adjustable-rate mortgages. The Ginnie Mae guaranty is backed by the full faith and credit of the United States. Today, Ginnie Mae guaranteed securities are one of the most widely held and traded MBSs in the world. Ginnie Mae has guaranteed more than $1.7 trillion in MBSs. Historically, 95% of all FHA and VA mortgages have been securitized through Ginnie Mae. Ginnie Mae is a guarantor, a surety. Ginnie Mae does not issue, sell, or buy MBSs, or purchase mortgage loans. Ginnie Mae is not in financial distress.

Fannie Mae is another story. Many of the innovative mortgage options introduced during the early 1980s to revive the weak housing market in a recession were exploited to fuel a housing bubble with excessive liquidity provided by the Federal Reserve, helping low- and middle-income buyer to buy homes their stagnant income could not afford. Fannie continues to operate under a congressional charter that directs it to channel its efforts into increasing the availability and affordability of home ownership for low-, moderate- and middle-income Americans. Yet Fannie Mae receives no government funding or backing, and it is one of the nation's largest taxpayers as well as one of the most consistently profitable corporations until now.

The company has evolved to become a shareholder-owned, privately managed corporation supporting the secondary market for conventional loans. Its congressional mandate of keeping homes affordable has since been largely forgotten in favor of an unprecedented boom in the housing market. Yet it continues to operate under a congressional charter that provides it with low-cost funds with only perfunctory oversight from the US Department of Housing and Urban Development and the US Treasury.

Fannie Mae has two primary lines of business: Portfolio investment, in which the company buys mortgages and mortgage-backed securities (MBSs) as investments, funding those purchases with debt, and credit guaranty, which involves guaranteeing for a fee the credit performance of single-family and multi-family loans.

Overseas debt holders
During the housing bubble which it essentially helped create with the Fed easy money, Fannie was highly profitable, with high returns for happy shareholders and lucrative compensation for its executives. Above all, it provided a continuous stream of income and profit for Wall Street and central banks around the world while US homeowners were led down a treachery path of eventual foreclosure. According to data from the Council on Foreign Relations, foreign central banks own $925 billion of debt in the two GSEs. China tops the list with $420 billion in Freddie and Fannie debt; Russia and Japan come in second with a combined $407 billion in GSE debt. Others countries that hold the debt include Singapore, Taiwan, and several cash-rich countries in the Persian Gulf.

Fannie's portfolio investment business includes mortgage loans purchased throughout the US from approved mortgage lending institutions. It also purchases MBSs, structured mortgage products and other assets in the open market. The corporation derives income from the difference between the yield on these investments and the low subsidized costs to fund the purchase of these investments, usually from issuing debt in the domestic and international markets. Fannie Mae has $3.46 trillion in MBSs outstanding today, held by a dispersed network of investors, including foreign central banks, topped by China's.

The GSEs now only pay lip service to accomplishing its mission to provide products and services that increase the availability and the affordability of housing for low-, moderate- and middle-income buyers by operating in the secondary rather than the primary mortgage market.

Fannie Mae purchases mortgage loans from mortgage lenders such as mortgage companies, savings institutions, credit unions and commercial banks, thereby replenishing those institutions' supply of mortgage funds. It either packages these loans into MBSs, which it guarantees for full and timely payment of principal and interest, or purchases these loans for cash and retains the mortgages in its own portfolio. Yet Fannie's role in recent years has been to supply the housing bubble with excess liquidity released by a wayward central bank, by buying at a profit economically unsound mortgages that depended on a continuing spiral of rising home prices way beyond reasonable projection of home buyer income growth. It has turned the US from a nation of homeowners into a nation of foreclosed homes.

Fannie Mae is now one of the world's largest issuers of debt securities, the leader in the $14 trillion US home-mortgage market. Fannie Mae's debt obligations are treated as US agency securities in the marketplace, which is just below US Treasuries and above AAA corporate debt. This agency status is due in part to the creation and existence of the corporation pursuant to a federal law, the public mission that it allegedly serves, and the corporation's continuing ties to the US government through a weak oversight link. It benefits from an appearance, though not the essence, of being backed by sovereign credit that borders on outright fraud and protected by the doctrine of too big to fail.

Fannie Mae debt obligations receive favorable treatment from a regulatory perspective. Fannie Mae securities are "exempted securities" under laws administered by the US Securities and Exchange Commission to the same extent as US government obligations. Also, Fannie Mae debt qualifies for more liberal treatment than corporate debt under US federal statutes and regulations and, to a limited extent, foreign overseas statutes and regulations. Fund managers who buy GSE debt are protected from fiduciary challenges.

Some of these statutes and regulations make it possible for deposit-taking institutions to invest in Fannie Mae debt more liberally than in corporate debt and other mortgage-backed and asset-backed securities. Others enable certain institutions to invest in Fannie Mae debt on par with obligations of the United States and in unlimited amounts. Fannie Mae uses a variety of funding vehicles to provide investors with debt securities that meet their investment, trading, hedging, and financing objectives, not all of which serves the public interest. Fannie Mae is able to issue different debt structures at various points on the yield curve because of its large and consistent funding needs. As the Treasury retired 30-year bonds, these GSE agencies stepped in to fill the void in long term finance.

Ideology triumphant
The privatization of Fannie Mae and Freddie Mac was an ideological move. It was financially unnecessary as sovereign credit could have funded the entire low-, moderate- and middle-income housing-mortgage needs with no profit siphoned off to private investors and brokers. These agency debt instruments played a crucial role in developing and sustaining the credit bubble in the US that is now coming home to roost.

In fact, the funding risk of both agencies was questioned, among many others, by the voice of free-market capitalism, the Wall Street Journal, on February 20, 2002 in an editorial about Fannie Mae's and Freddie Mac's safety, soundness and financial management, characterizing both agencies as risky, fast-growing companies that "look like poorly run hedge funds" … "unduly exposed to credit risk with large derivative positions", and that they "use all manner of derivatives" and "are exposed to unquantified counterparty risk on these positions". Such concerns would have been avoided if both agencies had been funded directly with government credit, and the cost of housing to low-, moderate- and middle-income Americans would have been lower. As it happens, the government is now faced with the prospect of having to bail out these GSEs with public funds.

The term "undercapitalization" for financial institutions is merely a sanitized euphemism for insolvency. The real source of the present market turbulence is more than just the waywardness of runaway GSEs sidetracked from their public purpose. It is another symptom of the failure of central banking. The world is now witnessing the slow but steady collapse of the central banking regime that came into being in the US in 1913, which has since failed to fulfill its mandate of managing the monetary system to maintain price stability and full employment. Dysfunctional monetary policies adopted by all central banks, led by the US Federal Reserve, have allowed the market to take capital out of free market capitalism to turn it into a gigantic Ponzi scheme.

In the 1990s, the original congressional intent for the GSEs was distorted from making homeownership affordable to low- and moderate-income families to a new role of supporting a housing bubble that enables families to buy homes at prices with mortgages their incomes cannot service. The profit from housing price appreciation went mostly to mortgage originators and banks that bought and sold MBSs to investors who also profited from buying debt with debt collateralized with the debt they bought. Capital suddenly became only a notional value in the market of debt derivatives. Homebuyers bought mortgages with no downpayment, banks and mortgage brokers sold the debt to securitizers who sold it to institutional investors who borrowed using the securities as collateral. The GSEs also became very profitable, leaving homeowners to default on their mortgages as the market turned on them. The whole transaction cycle did not require any capital.

Fannie Mae and Freddie Mac, ranked Aaa by the world's leading credit-rating companies, are now being treated by derivatives traders as if they were rated five levels lower because the issuers are pitifully undercapitalized for the size of the debt they issue. Credit-default swaps tied to $1.45 trillion of debt sold by these two biggest allegedly US-backed mortgage finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default has doubled in the past two months.

Debt guarantee disregarded
Traders are disregarding the government's implied guarantee of GSE debt as credit losses grow and concern rises about the GSEs not having enough capital to weather the biggest housing slump since the Great Depression. Fannie Mae has lost 80% of market capitalization value in the first half of 2008 on the New York Stock Exchange; and Freddie Mac lost 70%. The two GSEs reported combined operating losses of more than $11 billion, and have raised more than $20 billion new capital since December 2007. After Lehman Brothers Holdings Inc released a report on June 7, 2008, saying a new accounting rule may require the GSEs to raise another $75 billion in new capital, Freddie Mac shares dropped another 18% and Fannie Mae fell 16%.

Still, the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator of these GSEs, declared them as adequately capitalized in regulatory terms. The companies' existing congressional charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, against a total liability of over $5 trillion. The works out as an equity injection of less than half-a-cent on each dollar of liability.

Credit-default swaps tied to the senior debt of Fannie Mae and Freddie Mac have climbed 35 basis points to 70 basis points since May 1, 2008. A basis point is 0.01 percentage point. The cost to protect the companies' subordinated debt from default


rose at a faster rate. That debt is rated Aa2 by Moody's. Credit-default swaps on Fannie Mae's subordinated notes jumped 103 basis points to 190 basis points since May 1, while contracts on Freddie Mac's subordinated notes rose 102 basis points to 190 basis points.

The median credit-default swap on debt rated Aaa by Moody's was 26 basis points as of July 8. It was 76 basis points for debt rated A2, and 180 basis points for debt rated Baa3, the lowest investment-grade ranking. The costs likely reflect counterparty risk, or the risk that the bank or securities firm on the other end of the contract fails. For most companies, the counterparty risk embedded in credit-default swap costs would not be as pronounced because the risk of a default on the underlying debt would be greater than that of the bank backing the protection. In the case of Fannie Mae, Freddie Mac and other companies with Aaa ratings, the default risk for lower-rated banks is greater.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite. A basis point on a contract protecting $10 million of debt for five years is equivalent to $1,000 a year.

On January 11, 2006, in Asia Times Online I wrote in Of debt, deflation and rotten apples:

In the US, where loan securitization is widespread, banks are tempted to push risky loans by passing on the long-term risk to non-bank investors through debt securitization. Credit-default swaps, a relatively novel form of derivative contract, allow investors to hedge against securitized mortgage pools. This type of contract, known as asset-back securities, has been limited to the corporate bond market, conventional home mortgages, and auto and credit-card loans. Last June [2005], a new standard contract began trading by hedge funds that bets on home-equity securities backed by adjustable-rate loans to sub-prime borrowers, not as a hedge strategy but as a profit center. When bearish trades are profitable, their bets can easily become self-fulfilling prophesies by kick-starting a downward vicious cycle.

The US charter and the GSEs' role in guaranteeing about 46% of the $12 trillion US mortgages outstanding led to expectations that the government would stand behind the agencies' debt. Standard & Poor's assigned the debt top ratings, citing the agencies' "explicit and implicit support" from the government.

Moral hazard effect
The bailout of Bear Stearns Cos arranged by the Federal Reserve in March signaled to the market that the government would not allow the GSEs to fail or default on their debts. It is clear evidence of the moral hazard effect on the financial market from bailing out one institution. With all the exposure that all banks and non-bank institutions and central banks have to Fannie and Freddie debt default, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail. It was also clear evidence of the "too big to fail" doctrine.

The risk surrounding Fannie Mae was reflected in the GSE's latest sale of $3 billion of two-year benchmark notes at higher yields over benchmark rates than in previous offerings. The 3.25% notes, which mature August 12, 2010, priced to yield 3.27%, or 74 basis points more than comparable US Treasuries. The company in June 2008 sold $4 billion of 3% notes maturing July 12, 2010, that priced to yield 3.036%, or 65 basis points more than Treasuries.

The government has been leaning on the GSEs to help revive the home mortgage market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger, so-called jumbo mortgages, to spur demand for home loans as private lenders fled the market. The decision to use Fannie Mae and Freddie Mac as part of a $300 billion housing stimulus plan strengthened perceptions of the government's support of the GSEs. Their share of new conforming mortgages, or loans of $417,000 or less, almost doubled to 81% in the first quarter of 2008, according to the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator. It appears that the fire engines caught on fire on its way to the scene of the fire.

Merrill Lynch analyst Kenneth Bruce said in a report that the "highly levered financial institutions" would have pretax credit-related losses of $45 billion, suggesting that Fannie and Freddie are going to have to raise more capital, but the market does not think they are going to be able to raise capital when they need to at a cost they can live with. The New York Times reported on the night of July 13, 2008 (Sunday) that discussions among senior US government officials had heated up with respect to the US taking over Freddie Mac and Fannie Mae before markets opened in Asia. The structure being contemplated is a "conservatorship", which is permitted under a 1992 law and is one that would essentially wipe out the two GSEs' respective equity while allowing their loans to be managed.

Conservatorship is another fancy term of nationalization. The scheme allows the government to pretend the GSEs' liabilities are not its own even after it assumes them. A finding from the Office of Federal Housing Enterprise Oversight, the enterprises' regulator, that the GSEs are "critically undercapitalized" would be needed for conservatorship application. Up to now, the OFHEO has sent out the opposite message to the public. It will have to announce a 180-degree "correction" to shift quickly from "adequately capitalized" to "critically undercapitalized" for the government's proposal to work.

But unlike 1933 in the days of the New Deal when deficit financing was an operative option to revive the economy because the government was relatively free of debt, the US in 2008 is already deeply in debt, having operated with deficit financing in a boom time for more than two decades. Estimates suggest that for each 10% decline in Freddie/Fannie assets value, a loss of $150 billion would result, equivalent to the cost of the Iraq War to date. And Fannie has lost 80% of market capitalization and Freddie has lost 70% to date.

Soaring government obligations
By assuming the GSEs' combined $5 trillion in liabilities, the US government's total obligations would soar from $9.5 trillion to $14.5 trillion. This will raise the per capita national debt from $31,250 to $47,650. The added debt is one and a half times the Bush Administration proposed 2008 fiscal budget of $3.1 trillion. While the agencies own housing-related assets that roughly match their liabilities, the still-collapsing housing market makes their value uncertain. This will unavoidably force the dollar to fall and dollar interest rates to rise. Meanwhile, the turmoil is impeding or even paralyzing the GSEs in their crucial life-support role for the housing market.

An analyst's early July report from Lehman Brothers, an investment bank itself on the brink of collapse, provoked the market panic over the GSEs. Lehman, a major player in the mortgage-backed securities market, lost as much as 20% in intraday trading on talk that PIMCO, the world's largest bond trader, no longer was conducting business with the Wall Street firm. Then William Poole, a respected former chief of the St Louis Federal Reserve, now a private investment advisor since July 1, 2008, observed that Fannie and Freddie were technically insolvent in the first quarter this year on a mark-to-market basis. Such information was not news - in a 2006 speech, Emil Henry, then a Treasury assistant secretary, likened a failure of one of the GSE companies to a "single gunshot setting off an avalanche" - and had no bearing on the GSEs' solvency in regulatory terms. Yet the new unsettling attention on two market leaders of overwhelming scale in an uncertain climate threw financial markets into a downward spin.

Fannie and Freddie were the original inventors of mortgage-backed security, a key cause of the housing bubble and its subsequent deflation. These GSEs received credit and recognition for ingenuity in unbundling risk and reselling mortgage-backed securities to buyers of varying risk appetite in the global market. It was the secret behind the US housing boom and the enabling idea behind the structured finance market. Alan Greenspan, former Federal Reserve chairman, praised it ceaselessly as an ingenious breakthrough that did much to widen home ownership. But the development weakened the mortgage originators' oversight of loan quality.

Greenspan accepted the risk as part of the natural phenomenon of "bad loans are made in good times". The backing of the GSEs enabled securitization of "ninja" mortgages (no income, no job or assets), loans that no one would buy if they were not guaranteed by the government. Thus the fault did not lie with mortgage originators, for they would not be able to issue shaky mortgages unless there was a market for them. GSEs' abuse of their alleged government guarantee had rendered market discipline inoperative, allowing the system to go on a wide joyride that was bound to crash of a cliff. Because of their complexity and broad distribution, when securitized debts default, restructuring is almost impossible. There is no effective fire break once the fire begins and quickly engulfs the whole market.

The sooner the need for a systemic restructure is acknowledged and acted upon, the better it would be for the long-term health of the economy, or the future of regulated market capitalism itself. However, hybrid solutions of quick fixes to paper over seismic financial faults are being proposed to enable the evasion of responsibility and for political advantage in an election year.

Treasury Secretary Henry Paulson said on Friday, July 6 this year that the government would support the GSEs "in their current form as they carry out their important mission". On Sunday, the Treasury issued a statement indicating that

its main focus was still on supporting Fannie and Freddie in their current form. Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction. GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.

Regulatory reform while necessary cannot be backdated. There are $5 trillion of outstanding debt instruments written under


problematic regulatory oversight that need to be dealt with. Expressions of support for the "current form" that has proved wanting by a wide margin, a new line of credit to support bad loans and a proposed unlimited injection of capital by government that would surely face congressional opposition is a prescription to muddle through a major structural rupture.

Government support
The ability of the GSEs to raise new capital and credit from private sources is totally dependent on government support. Thus the plan to support these GSEs in distress will be much more costly if it must be done through private profit incentives. The outcome is likely to be a new contraction in the supply, and increase in the cost, of mortgage finance - further lessening the chances of an early recovery in the housing market and the wider economy. Private profit incentive overwhelming public interest got the GSEs in trouble. How can more private profit incentives be expected to get them out of trouble?

The Fed has announced that it will allow Fannie Mae and Freddy Mac to borrow from its discount widow, normal open only to commercial banks and since March 2008 open also to investment banks as part of the bail out of Bear Stearns. Under a three-part proposal by the Treasury, the Fed will also be given a consultative role in setting capital requirements and other regulatory standards for Fannie and Freddie, as part of an evolution to be the top regulator and overseer of the nation's financial system.

Former Fed chairman Paul Volcker expressed concern that by expanding its role of lender of last resort to institutions beside commercial banks that previously were not allowed to hold positions in equities, the Fed may have opened itself up to moral hazard dangers if large institutions believe their adventurous behavior will be bailed out by the Fed.

With the Fed, whose perspective tends to align with those of its member banks, taking over many of the regulatory powers of the Security Exchange Commission, whose mandate was originally to protect the interest of small investors, the public interest may face further diminished protection.

Yet the financial market has irreversibly changed with the emergence of structured finance in which loan securitization has taken loans that once had to stay in the balance sheets of issuing banks but are now securitized and sold by brokers to institutional investors worldwide. Default of a major broker default, such as Fannie and Freddie, will be as damaging as failure of a major money-center bank and cause catastrophic collapse of the credit market.

In 1968, then president Lyndon Johnson, as part of his Great Society program, turned Fannie into a shareholder-owned company as part of a national housing policy to make finance capitalism finance the nationalization of housing. It was the beginning of corporate market socialism in the name of populist economic democracy. The public could only benefit if corporate and financial institutional interests could profit first. And the public must pay if market capitalism fails systemically, absolving the losses of wayward corporations and financial institutions.

In 1970, the savings and loan industry, envying the huge profit made by commercial and investment banks from Fannie Mae, called for and received congressional approval for a GSE of their own and Congress created Freddie Mac. Like the Urban Renewal program of the 1950s, the GSEs served a coalition of interest that included liberals who wanted to help low-income households, real state developers that wanted guaranteed demand, home builders that wanted a guaranteed market, local politicians who wanted tax revenue from redevelopment, banks that wanted lucrative risk-free loan proceeds and congressmen who wanted campaign contributions from mortgage lenders.

Too good to be true
Low-income voters were first dazzled by the new homes they were able to acquire with no money down and with monthly payments financed with home equity loans as house prices rose. They acted like Pinocchio in a Pleasure Island - that would soon turn them into jackasses to be sold to work in salt mines. The financial institutions were comforting their pangs of conscience over taking loans off their balance sheets as soon as they made them by excusing themselves with the idea that they were making low-cost mortgage available to millions of homebuyers. Neoliberal economists were celebrating the US miracle of mass capitalism that does not need capital.

The program of passing unsustainable loans to faceless investors benefited also land speculators, home builders, real estate agents, investment bankers, structured financiers and household furnishers. Since the main thrust of the GSE program was to help low- and moderate-income homebuyers, opposition was considered undemocratic.

Yet everyone knows that the GSEs face an interest-rate risk in their long-term mortgages if interest rates should rise over the loan period. To protect itself from interest rate risks, the GSEs use derivatives to hedge against interest-rate risk.

The OFHEO was created by the House Banking Committee chaired by Texas populist Henry Gonzalez in 1992 with minimal power to regulate the two giant GSEs on the ground that GSEs were institutions intended to support the national policy of a nation of homeowners by making housing loans affordable and should be exempt from regulation regulating commercial institutions.

The problem of this good policy intention was that during the era of neoliberal ascendancy, the light regulatory environment was used to negate a more fundamental economic law: the need to increase worker income to match mortgage payments, subsidized or not.

The GSEs have been financially successful because they combine private sector appetite for profit with access to government-backed credit at below market rates. It was a way to nationalize housing through the free market capitalism. The problem was that financial manipulation cannot replace the need for adequate income growth. The mismatch of income with asset price is the definition of a financial bubble. People were buying homes with cheap credit at prices that their income could not afford. The more home prices rose due to cheap credit, the more homeowners fell into the debt trap.

Yet in all the current talk about finding ways to deal with the crisis, not one single voice is heard from official circles about the need to increase worker income. Instead, false hopes on one-time stimulant tax rebates are hailed as the magic bullet.

Suddenly this summer, Fannie and Freddie's relatively anemic capital supply is a serious concern for the market. In one week in July, Fannie's stock plummeted to $10.25, down 74% in 2008. Freddie's shares also dived, closing at $7.75, a loss of 77% this year.

Even as investors stampede out of these battered stocks, the sycophants of free market capitalism in Washington, led by Treasury Secretary Paulson and Federal Reserve chairman Ben Bernanke, rushed to reassure the market, pointing out that the mortgage giants' regulators had confirmed that the companies were "adequately capitalized", trying to give the impression that regulators had the problem firmly in hand and that no new capital was needed by the GSEs.

But these two leaders had lost much credibility since in August 2007 when they voiced a similar mantra that problems in the mortgage market were "contained" to subprime loans and would not spread beyond. SEC chairman Christopher Cox tried to calm investors by telling them that Bear Stearns passed financial muster only days before it required a Fed-engineered bail out by JP Morgan Chase with Fed loans.

More than capital adequacy is at risk. The credibility of the team with responsibility for the nation's monetary system and its financial market is heading for a meltdown. Unfortunately, credibility is much easier to lose than to regain. (See America's Untested Management Team Asia Times Online, June 17, 2006.)

Recurring anxiety
Anxiety about Fannie and Freddie's liabilities of more than $5 trillion getting too big for the funding authority of the Federal Reserve of a measly $2.5 billion credit line has been a recurring concern in many quarters in recent years. Even after both GSEs were found to be infested with accounting irregularities (Freddie Mac in 2003 and Fannie Mae in 2004), Congress failed to act, except to make the regulator require the GSEs to hold 30% more capital than the minimum previously required, in effect capping their ability to purchase mortgages when the housing bubble was approach its peak.

Still, Fannie and Freddie were allowed to pose as high-growth companies whose shares were safe enough for widows and orphans. GSE market share fell to 45% at the peak of the housing bubble. After the bubble burst, it rose to 68% in the first quarter of 2008.

After empty official assurances failed to convince the market because it was plain for all to see that the two GSEs' direct and guaranteed liabilities were almost 65 times their regulatory capital at the end of the first quarter of 2008, the near-term priority was to restore the rapidly fading confidence of buyers of Fannie's and Freddie's debt, many of whom are foreigners. By increasing the GSEs' credit line and pushing for authority to inject fresh equity if necessary, the Treasury's proposed plan appears to be aimed at allaying fears of widespread counterparty default and market failure. Freddie seemed to have no serious problem offloading $3 billion of new paper on Monday, July 14, although arm-twisting was rumored to have been needed to persuade banks to buy it.

The bigger problem for Washington is that merely stabilizing Fannie and Freddie is not enough. With US banks seriously distressed by the credit crisis, the GSEs, which hold or guarantee 22% of the $24.3 trillion outstanding debts borrowed by US households and the non-financial sector, are a major source of credit. Yet the market is clearly uncomfortable with the inability of the GSEs to maintain its over-bloated balance sheet. The options are either to shrink the balance sheet drastically, thus exacerbating the credit crisis, or to seek a massive injection of new capital, both requiring government action at an unprecedented scale.

Despite these ad hoc measures, which may or may not receive congressional approval, the whole world knows that credit capacity is shrinking drastically in the market. There are rumors that the US is pressing foreign central banks to acquire more GSE debt, but the market is inundated with fear of new crises before the housing market recovers. And the housing market is lying in a coma in intensive care with an oxygen tank of new credit running near empty.

As the housing market collapses, both GSE companies are reporting steep losses. But the subprime mortgage meltdown has also made the GSEs more important than ever in holding up the housing finance sector. Since the credit markets seized up, Fannie and Freddie have regained their central role in mortgage finance after losing significant market share to investment banks during the housing boom. They have issued the vast majority of mortgage securities sold in the last six months because investors have lost confidence in deals put together by big investment banks.

In February 2008, prodded by the Treasury, federal regulators announced they were easing some restrictions on lending by Fannie and Freddie. Then on March 19 the federal government announced that it was easing those restrictions in an effort to calm the turmoil afflicting the mortgage markets. Officials said the change could allow the two GSEs to invest $200 billion more in mortgages.

Alarmed by the sharply eroding market confidence in the nation's two GSEs, the largest mortgage finance companies, the Bush administration announced plans on Sunday, July 13 to ask Congress to approve a sweeping rescue package that would give officials the power to inject unlimited funds into the beleaguered companies through investments and loans.

In a separate announcement, the Federal Reserve said that at the request of the Treasury it would make one of its temporary short-term lending programs at the discount window available to the two GSEs, "to promote the availability of home mortgage credit during a period of stress in financial markets." The program for the GSEs would end when Congress approves the Treasury's proposed plan.

Treasury Secretary Paulson announced dramatically Sunday on the steps of the Treasury building: "The president has asked me to work with Congress to act on this plan immediately. Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction."

Paulson paradox
While officials in successive administrations, both Republican and Democrat, have for many years repeatedly denied that the trillions of dollars of debt Fannie and Freddie issued is guaranteed by the government, the Paulson package, if adopted, would bring the Treasury closer than ever to exposing taxpayers to potentially huge new liabilities. The two GSEs are expected to face significant new losses this year as the wave of housing foreclosures continues and rises. Paulson seemed to suggest that there is no choice but for the government to intervene. The proposed plan, requiring the Treasury to be giving authority by Congress to command unlimited funds to stabilize the GSEs, is predicated on the hope that the very availability of unlimited funds would make it unnecessary to use them. The investment and lending elements of the proposed plan are to last two years.

Over the weekend, Treasury officials sought assurances from Wall Street firms that the $3 billion auction on Monday by Freddie Mac of short-term debt would go off without a hitch. While $3 billion is a relatively small sum for an institution of Freddie's size, officials said they did not want to risk even a small misstep that could set off a new round of problems. Despite repeated assurances by top officials that the companies had adequate cash to weather the current financial storm, Fannie and Freddie had suffered a withering blow of confidence the week before. As a result, Freddie was faced with an uncertain debt offering on Monday. Should Fannie and Freddie fail, $5.3 trillion in mortgage debt would go unpaid. As it happened, the offering went smoothly but everyone knew it was not a normal market.

Freddie Mac continued to try to raise capital from private investors even after a government rescue plan it and its sister company Fannie Mae was announced the weekend before, indicating concern that the government plan may be delayed in Congress. On Friday, July 18, Freddie Mac cleared one of the last obstacles to raising new capital through a planned $5.5 billion stock offering when it received approval to register with US securities regulators. However, Freddie Mac's ability to attract much-needed capital from new and existing shareholders has been potentially lessened by the possibility of a future government stake that might place restrictions on the business. There is also little clarity with regard to where in the capital structure the government might invest, and how dilutive such a move would be to existing shareholders.

The government's rescue plan, which would allow the Treasury unlimited powers until the end of 2009 to increase its credit line to Fannie Mae and Freddie Mac and invest in their equity, met some strong vocal resistance in Congressional hearings during the week before July 18.

While many expect Congress to have no option except to approve the Paulson plan, a few skeptics were voicing their opposition in public hearings. Senator Jim Bunning, a Republican from Kentucky, described Paulson as "asking for a blank check ... for this unprecedented intervention in our free markets." He also vowed to try his best to stop a proposal that would give the Federal Reserve sweeping new powers aimed at protecting the nation's shaky financial system. Bunning said the Federal Reserve "can't be trusted with the power it already has". He says the Fed's policies in recent years have contributed to economic woes, including surging inflation, a declining dollar and the housing bust.

"When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed's purchase of Bear Stearns' assets was amateur socialism compared to this," thundered the Republican Senator against his own party's Treasury secretary. In US political discourse, socialism is a dirty word, albeit what Paulson proposes is not anywhere near what socialism is commonly understood to be in the rest of the world, but a scheme to use public funds to save debt capitalism by frustrating the right to fail in market capitalism.

Predatory lending
Ron Paul, Republican congressman from Texas, told Bernanke that the Federal Reserve is a "predatory lender". But he did not mention that by law, predatory lenders forfeit any right of collection.

Lender liability is embodied in common and statutory law covering a broad spectrum of claims surrounding predatory lending. It is a key concept in environmental-cleanup litigation. If a lender knowingly lends to a borrower who is obviously unable to make reasonable beneficial gain from the use of the funds, or causes the borrower to assume responsibilities that are obviously beyond the borrower's capacity, the lender not only risks losing the loan without recourse but is also liable for the financial damage to the borrower caused by such loans. For example, if a bank lends to a trust client who is a minor, or someone who had no business experience, to start a risky business that resulted in the loss not only of the loan but of the client trust account, the bank may well be required by the court to make whole the client.

In the United States, although predatory lending is not defined by federal law, and various states define abusive lending differently, it usually involves practices that strip equity away from a homeowner, or equity from a company, or condemn the debtor into perpetual indenture. Predatory or abusive lending practices can include making a loan to a borrower without regard to the borrower's ability to repay, repeatedly refinancing a loan within a short period of time and charging high points and fees with each refinance, charging excessive rates and fees to a borrower who qualifies for lower rates and/or fees offered by the lender, or imposing new unjustifiably harsh terms for rolling over existing debt. Predation breaks the links between an economy's aggregate resource endowment and aggregate consumption and between the interpersonal distribution of endowments and the interpersonal distribution of consumption.

The choice by some to be predators decreases aggregate consumption, both because the predators' resources are wasted and because producers sacrifice production by allocating resources to guarding against predators. Much of welfare economics is based on the concept of pareto optimum, which asserts that resources are optimally distributed when an individual cannot move into a better position without putting someone else into a worse position. In an unjust global society, the pareto optimum will perpetuate injustice.

Now, there is a close parallel in most Third World debts and International Monetary Fund (IMF) rescue packages to the above predation examples, where sophisticated international bankers knowingly lend to dubious schemes in developing economies merely to get their fees and high interest, knowing that "countries don't go bankrupt", as Walter Wriston, former chairman of Citibank, once famously proclaimed.

The argument for Third World debt forgiveness contains large measures of lender liability and predatory lending. Debt securitization allows predatory bankers to pass the risk to global credit markets, socializing the potential damage after skimming off the privatized profits. The housing bubble has been created largely by predatory lending without any lender liability. The argument for forgiving Third World debt is applicable to low- and moderate-income home mortgage borrowers in the US as well. Let's hear some proactive commitments from the presumptive candidates of both political parties instead of empty populist campaign rhetoric.

Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.

(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

No bottom for flailing financials
The sell-off of US financial stocks may tempt investors to seek out bargains. That raises the questions of whether the government will be able to underwrite the entire financial industry and what impact its interventions will have on inflation. - John Browne (Jul 24, '08)

THE MOGAMBO GURU
Riding it out to rock bottom
Against a staggering load of liabilities and liabilities masquerading as assets equivalent to a third of the annual United States GDP, Fannie Mae and Freddie Mac have only US$80 billion in capital. The companies may "ride out the storm", but their investors will probably lose everything. (Jul 18, '08)

CHAN AKYA
A stone for Chris Cox
Investors in the United States might wish they, like Pakistanis, could stone their stock exchange. New rules designed to reduce market volatility will have the exact opposite effect by locking in unsophisticated investors into a permanent downward spiral. (Jul

The next big wave is breaking
The bailout of US mortgage guarantors Fannie Mae and Freddie Mac will not halt the financial tsunami that is sweeping corporate America and later the world, as the mad experiment of asset-backed securitization unravels in wave after wave of destruction. - F William Engdahl (Jul 16, '08)

Forget those retirement plans
US consumer prices have gained sevenfold since 1967, and wages have climbed by exactly the same amount. In other words, per hour earnings have not increased a single penny. No wonder you can't afford to buy a new car - let alone retire!! (Jul 14, '08)

To hell in a currency basket
Raise interest rates, lower them, or leave them the same - the US Federal Reserve and chairman Ben Bernanke can do nothing to avoid the deepening financial crisis they have created for the rest of us. And banks elsewhere that believe fancy currency pegs are helpful escape tools - they are wrong.

SPENGLER
How to stop the Great
Crash of '08
The United States can still break out of its economic death spiral. Tax changes and higher interest rates are a start. And let overseas funds buy American banks. While investors are waiting for that to happen - it won't - they would do best to sit back and watch the horrors unfold. (Jun 30, '08)

Commentary
12:40 PM, 25 Jul 2008 Robert Gottliebsen
NAB will shock Wall Street

T

he National Australia Bank's decision to write off 90 per cent of its US conduit loans will have dramatic repercussions around the world. Wall Street will be deeply shocked when they understand the repercussions of what NAB has done. It is clear global banks have nowhere near provided for their exposures to US housing loans which in the words of John Stewart are experiencing a “meltdown”.

We are now way beyond sub-prime. NAB says that it is suffering a 55 per cent loss on American housing loans – an event that has never happened in the history of a developed country in recent memory. This is an unprecedented event and means that the cost of bailing out the US financial system is now far beyond the highest estimates. A US recession is now locked in, but more alarmingly, 55 per cent loan losses point to the possibility of a depression.

It means the cost of bailing out housing exposures to the two mortgage insurers will be so great that it will leave no room to bail out anything else and there are several US banks that are now in big trouble. NAB says that the dislocation in the residential market is separate from the corporate market, but the flow on is inevitable.

While global banks have been writing down their balance sheet assets, few have tackled their conduit exposures which are off balance sheet but to which they are ultimately liable.

This morning at around 6am I wrote that we had been experiencing a 'dead cat bounce'. I had no idea that NAB would trigger the downturn and confirm what I had written. And of course Wall Street will receive a deep shock when it wakes up.

How did NAB get caught in $1.2 billion mess? They had a number of big clients who wanted to invest in these US housing loans. They were sucked in by the 'triple A rating' given to the securities by the rating agencies. They did not take into account that the monoline insurers who guaranteed some of the loans had no substance. To become a player NAB took out $1.2 billion in these triple A securities and 90 per cent of it has been lost.

Many Australian institutions are very angry. NAB is paying out far too much in dividends and should be conserving capital. The American bank it purchased, Great Western, was a good idea but it is now clear it overpaid for it. Fortunately it only has a small exposure to the bad loans. But what’s happening to the NAB is not the main game.

The global banks have been marking to market the assets they held on their balance sheet, but the vast amounts held in so called 'conduit trust accounts' have not been written down because they were not marketable. NAB wrote them down when they saw the bad mortgages.

US banks have written down $450 billion in bad housing loans. The revelation from NAB means that they will now certainly need to take provisions to $1,000 billion. But write-downs of $1,300 billion and perhaps even more are on the cards.

Where will the equity come from to cover these bad loans? The world has never attempted a rescue effort of this size and it will make liquidity in the globe very tight. That’s why corporates will be hit. All Australian companies that need equity should raise it now.

http://www.businessspectator.com.au/bs.nsf...ent&src=sph

Can Hank Paulson Defuse This Crisis?
J. Scott Applewhite/Associated Press

As the Bush administration’s third Treasury secretary, Henry M. Paulson Jr. has faced a brutal series of crises on Wall Street and in Washington that have sparked fiercely partisan debates.

By STEVEN R. WEISMAN and JENNY ANDERSON
Published: July 27, 2008

IF Henry M. Paulson Jr. hadn’t left Wall Street for Washington to become Treasury secretary in 2006, he would still be making tens of millions of dollars a year as the chairman of Goldman Sachs. He would be comfortably zipping around the globe on a corporate jet. He would be presiding over the only big Wall Street firm that hasn’t lost billions on bad debt.

http://www.nytimes.com/2008/07/27/business...omy/27hank.html

Too Big to Fail?
By PETER S. GOODMAN
Published: July 20, 2008

IN the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government’s job description. Economic policy makers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.


RESCUE Christopher Cox, the S.E.C. chairman, left, and Ben Bernanke, the Fed chairman, center, hear Treasury Secretary Henry Paulson tell senators he wants authority to help save Fannie Mae and Freddie Mac.

Through this uniquely American lens, saving businesses from collapse was the sort of thing that happened on other shores, where sentimental commitments to social welfare trumped sharp-edged competition. Weak-kneed European and Asian leaders were too frightened to endure the animal instincts of a real market, the story went. So they intervened time and again, using government largess to lift inefficient firms to safety, sparing jobs and limiting pain but keeping their economies from reaching full potential.

There have been recent interventions in America, of course — the taxpayer-backed bailout of Chrysler in 1979, and the savings and loan rescue of 1989. But the first happened under Jimmy Carter, a year before Americans embraced Ronald Reagan and his passion for unfettered markets. And the second was under George H. W. Bush, who did not share that passion.

So it made for a strange spectacle last weekend as the current Bush administration, which does cast itself in the Reagan mold, hastily prepared a bailout package to offer the government-sponsored mortgage companies, Fannie Mae and Freddie Mac. The reasoning behind this rescue effort — like the reasoning behind the government-induced takeover of Bear Stearns by J. P. Morgan Chase just a month before — sounded no different from that offered in defense of many a bailout in Japan and Europe:

The mortgage giants were too big to be allowed to fail.

Big indeed. Together, Fannie and Freddie own or guarantee nearly half of the nation’s $12 trillion worth of home mortgages. If they collapse, so may the whole system of finance for American housing, threatening a most unfortunate string of events: First, an already plummeting real estate market might crater. Then the banks that have sunk capital into American homes would slip deeper into trouble. And the virus might spread globally.

The central banks of China and Japan are on the hook for hundreds of billions of dollars worth of Fannie’s and Freddie’s bonds — debts they took on assuming that the two companies enjoyed the backing of the American government, argues Brad Setser, an economist at the Council on Foreign Relations.

Commercial banks from South Korea to Sweden hold investments linked to American mortgages. Their losses would mount if American homeowners suddenly couldn’t borrow. The global financial system could find itself short of capital and paralyzed by fear, hobbling economic growth in many lands.

Nobody with a meaningful office in Washington was in the mood for any of that, so the rescue nets were readied. The treasury secretary, Henry Paulson Jr., announced that the government was willing to use taxpayer funds to buy shares in Fannie and Freddie. The chairman of the Federal Reserve, Ben Bernanke, said the central bank would lend them money.

The details were up in the air as the week ended, but some sort of bailout offer was on the table — one that could ultimately cost hundreds of billions of dollars. Whatever the dent to national bravado, or to the free-enterprise ideology, the phrase “too big to fail” suddenly carried an American accent.

“Some institutions really are too big to fail, and that’s the way it is,” said Douglas W. Elmendorf, a former Treasury and Federal Reserve Board economist who is now at the Brookings Institution in Washington. “There are no good options.”

Still, there are ironies. Since World War II, the United States has been the center of global finance, and it has used that position to virtually dictate the conditions under which many other nations — particularly developing countries — can get access to capital. Letting weak companies fail has been high on the list.

Mr. Paulson, who announced the bailout, made his name as chief executive of Goldman Sachs, the Wall Street investment giant, where he pried open new markets to foreign investment. As treasury secretary, he has served as chief proselytizer for American-style capitalism, counseling the tough love of laissez-faire. In particular, he has leaned on China to let the value of its currency float freely, and has criticized its banks for shoveling money to companies favored by the Communist Party in order to limit joblessness and social instability.

All through Japan’s lost decade of the 1990s and afterward, American officials chided Tokyo for its unwillingness to let the forces of creative destruction take down the country’s bloated banks and the zombie companies they nurtured. The best way out of stagnation, Americans counseled, was to let weak companies die, freeing up capital for a new crop of leaner entrants.

But as Japan’s leaders engaged in bailouts and bookkeeping fictions to keep banks and companies breathing, they offered those words of justification now heard here: The companies were too big to fail.

In 2002, the government engineered the rescue of Daiei, a huge, debt-laden grocery chain. In 2003, it injected some $17 billion into Resona Bank to keep it upright. Each time, Japan’s leaders said failure was not an option. It would pull too many others into a downward spiral.

Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.

For one thing, this argument goes, taxpayers — who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel — will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money — a step that encourages further inflation.
Skip to next paragraph
Multimedia
Fannie Mae and Freddie Mac: Titans