Fannie and Freddie are Finito

Bill Bonner
Provided as a courtesy of Agora Publishing & The Daily Reckoning UK
Jul 15, 2008

Meanwhile, we have our own troubles to reckon with. And again... there's no backing up.

Now getting hot is the war between inflation and deflation. Both sides launched major attacks at the end of last week.

Fannie, Freddie - Finito

Yes, the dark twins of mortgage finance dominated the news over the weekend. Every financial page covered the story. One story reported that the government was mounting a rescue operation. Another said the Fed had opened its discount window to them. Another had the U.S. Treasury Secretary denying that they needed any extraordinary assistance. Still another explained how they got into such a mess.

Of course, here at The Daily Reckoning we know how they got themselves into such a jamb. They lent money to people who couldn't pay it back. And they weren't the only ones.

"Crisis Deepens as Big Bank Fails," adds the Wall Street Journal. The big bank is IndyMac. It is the largest bank failure since Continental Illinois bit the dust in '84. Much of the depositors' money is protected by FDIC insurance. But there's still $1 billion uninsured. And, of course, FDIC can't bail out everyone; it only has so much money.

"Analysts say more banks could fail," reports the International Herald Tribune.

FDIC can bail out a few of these banks...but not all of them. And there is no way it can bail out Fannie and Freddie. Together, the twins have more than $5 trillion in liabilities. That's more than a third of US GDP. And former Fed governor William Poole says they're broke already.

Investors are still holding on - barely. Fannie's shares fell to $10.25 on Friday. Freddie was down to $7.75 - for a total loss of 87% from the peak. (We previously reported that the share had traded as high as $60. Actually, the high was closer to $100. Sometimes we get the facts wrong, here at The Daily Reckoning. But it's the interpretation of the erroneous facts that matters; of course, we get that wrong too, sometimes.)

Fannie and Freddie are "too big to fail," no doubt about it. But who has the money to stop them from failing? Where are those Sovereign Wealth Funds when you really need them? We doubt whether they are stupid enough to do it, but what a coup it would be! We mean, if the Sovereign Wealth Funds recapitalized America's largest mortgage lenders. So far, they've contented themselves with a few minor purchases of America's iconic buildings, infrastructure and industries. But if they bought control of Fannie and Freddie, they would hold the mortgage on America's housing too. And they could get rid of trillions of their unwanted dollars. (Foreign central banks already hold large pieces of Fannie and Freddie's debt.)

But for the moment, the bailout looks like it will come from homegrown sources. Ben Bernanke called on Freddie's CEO over the weekend. It is believed that the Fed chairman let it be known that its discount window would be opened a bit wider today - wide enough to lend directly to Fannie and Freddie. This will give them access to money at a preferential rate - about half the rate of consumer price inflation. You'd think you could make a fortune - if you could borrow so cheaply. In "normal" times, it would be a cinch. But in wartime, it's hard to make money - even when lenders give you credit at no cost. No matter where you put the cash, it's always in danger of getting blown up.

Bill Bonner
email: DR@dailyreckoning.com
website: The Daily Reckoning

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