Moral Hazard Be Damned! Fed Takes Over Fannie & Freddie

September 9, 2008

I can’t let the Federal take-over of Fannie Mae and Freddie Mac pass without comment.  The federal government has now crossed a new threshold of fiscal irresponsibility, making a quantum leap from its old paradigm of pretending that one day we’ll balance the budget and pay down the national debt, to a new paradigm of doling out mortgage money with reckless abandon, not caring if and when it ever gets it back because it’s the taxpayers who will be on the hook.  Our national debt has jumped overnight from $10 trillion to $15 trillion. 

Last night, Treasury Undersecretary Ryan was interviewed on PBS’ Newshour with Jim Lehrer.  He was asked whether the federal government would operate these companies now with the well-being of the taxpayers in mind, or whether it would loosen lending standards even further in order to carry out its mandate of stoking the economy with mortgage money.  He squirmed a little and tried to take the tack that, now that the government has restored investor confidence, Fannie and Freddie will have no problem pouring money back into the mortgage market.  When asked whether the government has created a “moral hazard” problem (giving investors the perception that the government will always bail them out), he replied that, since stockholders took a big hit and since the CEO’s were fired, the moral hazard issue was adequately addressed. 

But bondholders were bailed out.  Why?  I think it’s obvious.  Bonds are the mechanism the government uses to fund its deficit spending.  It doesn’t dare risk investors getting even an inkling that their bond investments may ultimately be defaulted upon by the federal government.  Wiping out the bond investors of Fannie and Freddie would have done exactly that.  It would have sent the message that the U.S. government can’t be relied upon to pay its debts.  That would result in a rapid melt-down of the whole global economy. 

The root cause of all of this is quite clear.  The trade deficit has drained so much money from the economy that there is nothing left.  The only way to keep the economy running is to print boat loads of money and pass it out to everyone in the form of “loans,” which the government knows full well will never be repaid.  Not to worry!  We’ll just print more to replace it!  Sure, this will continue to drive down the dollar and stoke inflation.  But we have an answer for that, too!  We’ll print even more money!

Well, it isn’t going to work.  The reason Fannie and Freddie failed so quickly, only weeks after Congress was reassured by Bernanke that they had plenty of money, was because their source of “capital,” our foreign creditors, have gotten wise to our financial problems and were no longer willing to pour money down a rat hole.  This will only accelerate the issuing of bonds by the Fed, and it won’t be long before they grow leery of those as well.  The sell-off of America will now accelerate dramatically, but will take an ominous turn as our foreign creditors shun our bonds and start demanding hard assets – anything and everything, including federal land.  With all of this will come more foreign control. 

It’s so sad to see what’s become of this country.  I thought that things were bad in 1979, following the Vietnam War, Watergate and the Iran hostage crisis.  For those too young to remember, that was a really bad time for Americans.  It was probably the worst we’d felt since the Great Depression.  Well, today’s climate is even worse and I’m beginning to think that my prediction of only a recession was too optimistic.  I think there’s a good chance that a full-blown depression is on the way.  Only a world war and a lot of government spending pulled us out of the last one.  This time, it’s the trade deficit and government spending that will start it.  This time, there may be no escape.

Don’t Peek Under America’s Economic Rugs

July 12, 2008

We’re now learning how America has kept the floor of its grand Economic Ballroom so spotlessly clean. It’s been sweeping the dirt under pretty rugs. This week, someone lifted a corner and peeked under the rug known as GSE’s (government-sponsored enterprises), otherwise known as Fannie Mae and Freddie Mac, and found a disgusting mess. The mortgage crisis has eroded their balance sheets to the point where their continued viability – the very under-pinning of the mortgage industry – the heart and soul of the American economy – is at risk of collapse.

There’s no easy way out of this mess. There are only two bad choices that will have the same result:

1. Let them fail. Without the GSEs as a source of mortgage funds for the banks, mortgage interest rates will skyrocket, making it much more difficult to buy a home and driving home values down further, forcing more people into foreclosure. Essentially, it would accelerate the downward spiral in the housing industry.

2. Give them a government bail-out. Whether it’s handled by the federal government or by the Federal Reserve, the result will be the same. The value of U.S. government-issued bonds will move closer to “junk” status in the eyes of investors (especially foreign investors), driving interest rates sky high. The net effect will be the same as option 1 above – an acceleration of our downward spiral.

What’s the real root cause of all of this? It’s our trade deficit, pure and simple. Our cumulative trade deficit since 1976 now stands at $9 trillion, a good chunk of which was swept under the GSE rug. (The collective debt backed by Freddie Mac and Fannie Mae is $5.1 trillion.) The trade deficit has eliminated many millions of jobs, driving down incomes. To compensate, the GSEs have held interest rates artificially low to enable people to still afford homes. They’ve pumped trillions of dollars into the economy, packaging the debt and selling it to foreign buyers. Everything was rosy until the mountain of debt began to collapse under its own weight.

There is no light at the end of this tunnel. With the trade deficit continuing to drain $2 billion a day from the economy, the dike holding back the effects of a sea of debt is crumbling faster than the Federal Reserve can stick fingers into the holes. It’s impossible to overstate the economic danger the U.S. is facing, and most Americans are oblivious. They walk along at the foot of that dike and enjoy the pretty stream flowing by, not realizing that they’re about to be inundated.

Is This Recession Just a Normal “Business Cycle” Recession?

February 7, 2008

I don’t see it that way.  This is actually the 2nd recession that is a direct result of the effects of a rising population density and/or attempting to engage in free trade with nations much more densely populated than ourselves. 

The first occurred in ‘91-’92.  At that time, the downsizing of companies in response to foreign competition was fierce.  Every day, more companies announced tens of thousands of job reductions.  It was pretty tough to avoid a recession in that environment. 

That recession was ended by a confluence of three factors:  (1) A wave of optimism that accompanied the election of Bill Clinton, who vowed to turn the economy around, (2) a high-tech explosion that introduced cell phones and the internet to the American economy in a big way, and (3) lower interest rates, although this last factor was dwarfed by the first two. 

The brief recession in 2001 was due to the bursting of the “dot-com” bubble and collapse of the NASDAQ stock market, followed by the effects of 9/11.

But the recession we now find ourselves in is the 2nd caused by the effects of population density which, over the years since the ‘91-’92 recession, have continued to grow.  But, during the period following the 2001 recession, these effects were masked by three things:  (1) unprecedented deficit spending by the government, (2) money fleeing the stock market and seeking shelter in real estate, driving the housing boom and, once again, (3) unprecedented cuts in the Fed’s interest rates, also helping to fuel the housing boom. 

But the housing boom couldn’t be sustained once the flight of money from the stock market subsided.  Lending standards were reduced in a vain attempt to keep it going, selling homes to people who couldn’t afford them because their wages hadn’t kept pace with inflation.  Now the debt binge is over.  Our foreign benefactors aren’t happy about losing their money and are demanding safer investments.  So the easy money that kept us going the last few years has dried up.  And, by this time, all those “high tech” jobs created during the ’90s, which at that time were ballyhooed as our economic salvation, had long since been exported, just like all of our other manufacturing jobs.  Now we’re left to face reality – an economy with a manufacturing sector, one of the key pillars of any economy, that has been almost completely gutted.  Even jobs in the services sector, another one-time supposed savior, have been fleeing the country. 

How will we pull ourselves out of this recession?  Well, although it was our debt binge that papered over our economic problems for the last few years, the government believes we need to make it easier for Americans to keep borrowing and spending.  They are printing money to lavish on the banks to artificially shore up their reserves.  They want Fannie Mae and Freddie Mac to be able to make bigger loans.  All of this will ultimately make these entities more insolvent.  It will probably work for a while and this recession will end, but our problems will continue to grow.

This isn’t just the normal business cycle at work.  The government is running out of rugs under which to sweep our problems.  Until they come up with some way to restore balance to our trade picture (and tariffs are the only way), the underlying problem will continue to grow, regardless of what else they do.  Count on it.