 Casey Files:
The Biggest Bailout of
All Time
Doug Casey
Casey Research
'Intensely Curious, Focused on Facts'
The
Casey Report
Sep 10, 2008
The failure and subsequent
government bailout of Fannie Mae and Freddie Mac has been no
surprise to the Casey Research team. But where do we go from
here - will the bold action of the federal government save the
housing market and revive the economy?
The editors of The Casey
Report weigh in with their thoughts...
A Casey Research Prediction Come True
On Sunday, September 7, Treasury
Secretary Hank Paulson, flanked by James Lockhart, the new conservator
from the Federal Housing Finance Agency, announced a plan to
take over the operation of Fannie Mae and Freddie Mac and to
guarantee their debt. They cited what we all knew, that they
did not have enough capital to continue operating. Their business
is to borrow to lend for housing mortgages, and to guarantee
half the country's housing mortgages, about $5.4 trillion. The
equity and preferred is all but wiped out as all dividends are
suspended and management and the board are fired.
This is the biggest bailout
ever. If 10% of the $5 trillion of guarantees must be made good
by the government, the payments would be $500 billion. That is
the size of the annual U.S. defense budget. The outstanding debt
of the U.S. held by the public is the size of the guaranteed
mortgages. It is huge.
We from Casey Research have
seen this coming for more than a year:
"For one thing, at the
point that falling prices leave homeowners with mortgages exceeding
the value of their homes, default rates will soar. This, in turn,
will put lenders that hold large amounts of mortgage debt at
risk, and possibly jeopardize the solvency of Fannie Mae and
Freddie Mac, since they guarantee much of this debt. If these
mortgage giants faced collapse - and they are already in well-documented
trouble - a government bailout involving hundreds of billions
of dollars would be a likely next step.
"...The impending calamity
- mass housing foreclosures, failing banks, Fannie Mae and
Freddie Mac in ashes, millions of personal bankruptcies -
is so dire... most people can't even conceive of it. And indeed
it may not hit us this year, or next, but the market always corrects
itself, and this time will be no exception, sooner or later.
"We have said before,
and we repeat again: Rig for stormy weather."
-International Speculator
- the predecessor of The
Casey Report - March 2007
Unusual Aspects
The Treasury will add funding
to Fannie and Freddie when their assets are less than their liabilities.
The Treasury gets warrants to own 79.9% of the equity. Fannie
and Freddie are allowed to expand mortgage lending through the
end of 2009 but are required to wind down their $850 billion
of debt at 10% per year until they are essentially out of business
at only $250 billion debt.
The effect on the Credit Default
Swap (CDS) market could be big: there are about $1.47 trillion
of CDS on Fannie/Freddie-backed mortgages. The creation of the
conservatorship is probably a credit event, triggering the payment
of the insurance on the debt. But as we know, the insurers are
already weak, and forcing them to pay could eliminate them as
ongoing business, thus creating a cascading loss of the value
of insurance on other debt they guarantee.
The "New Secure Loan Agreement"
that is designed to bail out the debtors of Fannie and Freddie
will also be used to bail out the Federal Home Loan Banks. $274
billion additional housing market funding was passed through
the FHLB last year, and it is safe to assume there are problems
there too.
Who Will Rescue the Taxpayers from
Fannie and Freddie?
The U.S. Government has decided
to spend an enormous amount of money to prevent the two mortgage
giants from defaulting. What will be the real effects?
The rescue won't resuscitate
the housing market.
As much as prices have declined, they still haven't come down
enough to make houses affordable. (They only seemed affordable
for a while because of the artificially low interest rates the
Federal Reserve engineered during the housing boom through its
inflationary policies.) Don't expect the rescued Fannie and Freddie
to revive the housing market; the government's rescue package
requires them to shrink their operations.
The rescue won't end the
credit crisis that is pulling the economy into recession. Fannie and Freddie are perhaps the
biggest, but certainly not the only, institutions that overcommitted
to risky mortgages. Banks, insurance companies, and pension funds
are holding billions in the same kind of dangerous stuff. And
they still must get through another two years of interest "resets"
on subprime mortgages created during the housing boom. As those
resets occur, there will be more defaults on mortgages that borrowers
can no longer afford - or no longer want because the loan balance
exceeds the value of the house.
The rescue helps keep bad
decision makers in place.
Managers of banks and other financial institutions that invested
heavily in Fannie and Freddie paper get let off the hook. They
get another chance to make more bad decisions about how to deploy
trillions of dollars of capital. And the politicians who passed
the laws that encouraged Fannie Mae and Freddie Mac to take all
those wild risks? They're up for reelection.
Implications for the Future
The complete collapse of what
was 80% of the funding of new mortgages this spring is now here.
The whole structure of creating mortgage-backed securities and
passing them on is gone. There will be no creating new phony
tranches of sliced and diced SIV debt, and no CDO and no CDS
and no AAA-rated toxic waste. We don't know what happens to $62
trillion of notional CDS derivatives, but somebody is holding
a disaster. This financial crisis is far from over.
By itself, the government might
be able to manage some of these problems, but the problems are
not isolated: the Federal Deposit Insurance Corporation (FDIC)
guarantees deposits at banks of $4.3 trillion but has only a
$50 billion reserve to handle bank failures.
Interest rates are close to
50-year lows, from the Fed cutting the short-term rate, and from
flight to Treasuries, which are safer than other debt. But the
longer-term implication of the bailout is that more deficits
will weaken the dollar and therefore higher interest rates will
be required in the long term, especially for non-government-guaranteed
debt, to cover inflation and increased risk.
There will be many more financial
institutions in trouble: perhaps 150 banks will fail, including
probably one or two big banks, like Lehman, Citi, or Merrill.
FDIC is next, in our opinion, once a big commercial bank goes
under.
The dollar is up in the short
term on what we expect is a short covering rally, but that is
not consistent with long-term implications, so we don't expect
it to stay up.
Homeowners gain, as Fannie
and Freddie are allowed to continue to expand in 2009. But after
that, they will be looking for a newly reconstituted system beyond
what is in the conservatorships that are being asked to unwind.
The long term is unclear.
The U.S. Treasury is now in
the mortgage business. The financial future of the world is crumbling,
and this is the biggest step in that change.
The Casey Report is the latest monthly newsletter from
Casey Research. With its focus on big market trends and outstanding
investment opportunities, it shows subscribers how to keep their
money -- and multiply it - in times of economic crisis. Try The
Casey Report risk-free, with a 3-month money-back guarantee,
click
here.
###
 Editor's ALERT: This week - on Friday,
Sep 12 2008 - you can have the opportunity to sit in on a round-table
discussion of the economy, the market, and the best ways to profit
from this crisis - FREE and online.
The Crisis and Opportunity
Summit is the first-of-its-kind event by Casey Research...
giving investors exceptional information and analysis for over
a quarter century.
Simply click
here now to sign up for this free event.
Casey Archives
321gold Ltd
|
