Freddie, Fannie, and the Federal Reserve Note
New Deal monstrosities Freddie Mac and Fannie Mae have long insured mortgages with the implicit backing of the US Treasury. These government sponsored enterprises (GSEs) bought mortgages on the secondary mortgage market from originators and banks. This took financial risk out of the equation for originators, banks, and put it on the shoulder of gov't if gov't decided to honor its implicit guarantee. The implicit backing turned explicit when they were bailed out with taxpayer money.
Without fear of risk there is little to constrain greed.
To make sure F&F are not mistaken for private firms, the President of the USA picks five of their eighteen directors, as one example, not to mention their tax breaks and congressional charter. F&F have also been notorious for accounting fraud to boost executive earnings.
Foreign investors, like sovereign wealth funds and China’s state-owned banks, accounted for nearly $1 trillion of the $1.5 trillion of debt that F&F held as of August 2008. Foreign nations have begun to "diversify away from the dollar" in our hitherto core institutions, as have oil producing nations, and that puts even more negative pressure on our economy.
This is dollar hegemony at work. It’s one of the reasons why we strive to keep the dollar the reserve currency of the world, that is having foreign nations hold dollar denominated assets to provide liquidity (or cash) to our own markets, while our own dollar devaluation allows us to tax their holdings denominated in USD through monetary inflation. We tie them to our markets and therefore our fate but in so doing also tie our fate to their actions. As the dollar becomes weaker through monetary inflation they lose money/value and seek other foreign currency/assets.
Updated: 2008-09-12 07:32
China, which holds a fifth of its currency reserves in Fannie Mae and Freddie Mac debt, may cut the portion held in US dollars, according to China International Capital Corp (CICC), one of the nation’s biggest investment banks.
The US government this week seized control of the two mortgage-finance companies, which account for almost half of the home-loan market in the world’s biggest economy, to prevent defaults from crippling them. China holds up to $400 billion in the two firms’ debt, CICC Chief Economist Ha Jiming said in a report Thursday.
"The crisis has made Chinese officials realize it’s a bad idea to put all their eggs in one basket," wrote Hong Kong-based Ha. "This will likely lead to greater diversification of foreign exchange reserve investments."
Bank of China flees Fannie-Freddie
Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.
From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period.
It's nice to Win when you Win and to Win when you Lose
Mortgage-backed securities (MBS) needed to be auctioned off with investors recouping whatever price they could get, eating the loss on their investment, just as any NORMAL investor (read: one not guaranteed by the US gov) would. The Fed and the Treasury essentially bailed out the MBS investors, not so much F&F itself (it would have been better to dismantle them), like China at US taxpayer expense. No free-market risk here for these investors, you (the taxpayer) covered their losses. Did you get a thank you card?
Home prices need to collapse even further, which would lower capitalization in the market and throw more people and firms into default BUT would return housing to an affordable and sane level to spur buying - while lo and behold bringing housing to market levels. The government decided to prop up home prices and recapitalize banks with taxpayer cash instead.
For those of you who support the bank bailout, the government could have taken the same amount of money and paid down a portion of the homeowner's mortgage (absolving them from the mortgage in part or in entirety) and accomplished the same deleveraging of risk with the same amount of money spent.
(more to come later)