I had occasionally come across these names on certain web sites, particularly that of James Kunstler, my favourite grumpy old man, after me, that is. Now every one knows that Freddie Mac and Fannie Mae are two humungous mortgage operators in the USA, supposedly privately owned, but backed by some sort of indeterminate government guarantee arising from the history of these organisations. They manage about half, or a bit more, depending on the source, of the approximately US$12 trillion mortgage market, so conservatively about US$6 trillion, but apparently no-one is very sure. They will be even less sure now. As I understand it briefly the first of these two financial behemoths was Fannie Mae, the financial child of Franklin Delano Roosevelt's New Deal. (Fannie Mae is the nickname of the Federal National Mortgage Association), later Freddie Mac (Federal Home Mortgage Corporation) was created as a competitive rival to the privatised Fannie Mae (in 1968 - due to financial pressures created by the Vietnam War - an interesting, reverse corollary perhaps to the Iraq war.) My information comes from a nice background written in 2003 by Rob Alford, a student at the Washington University and intern of the History News Network, on who's site this page can be found.
As Rob Alford's article was written in 2003, and contains this information:
..... their combined debt is equal to 46 percent of the current national debt. It is this combination of rapid growth and over leveraging that has lead to the current concerns of Congress, the Justice Department and the SEC with regards to the financial practices of these GSEs.Give Rob Alford a coconut. Talk about prescience. I wonder what Rob's doing now? I tried Googling his name, top of the list is Rob Alford's Mt. McKenzie Log Chalet business, perhaps he got fed up of the Washington scene and emigrated to the Canadian wilderness, perhaps anticipating our present, rather wild bear market.
Fannie Mae and Freddie Mac are the only two Fortune 500 companies that are not required to inform the public about any financial difficulties that they may be having. In the event that there was some sort of financial collapse within either of these companies, U.S. taxpayers could be held responsible for hundreds of billions of dollars in outstanding debts. A recent investigation by the Justice Department and the SEC into the accounting practices at Freddie Mac revealed accounting errors in the amount of 4.5 to 4.7 billion dollars and resulted in the termination of three of the company's top executives. Ongoing investigations by Congress, particular the House Finance Services subcommittee that oversees the activity of GSEs, will determine the future role of Fannie Mae and Freddie Mac and the secondary mortgage market that they dominate.
But certainly it would appear no-one in the higher echelons of business or government have deigned to read the wise words of Rob. Fannie Mae and Freddy Mac have been allowed, indeed encouraged, to continue their merry financial ways, and as long as they have been able to offload all that dubious debt into collaterals and derivatives, every one else was happy too. It fuelled the boom of the last few years, just as their failure will fuel the collapse of the next few.
A rather longer and slightly more recent article about these two companies can be found in this three year old article by Dr Utt on the "Heritage" web site, in which Dr Utt says it is time to reform Freddie Mae and Fanny Mac. Dr. Utt goes on to explain how shonky accounting practices led to the dismissal of three top executives. According to Dr Utt the problem was (is) that "Both Fannie Mae and Freddie Mac have proven exceptionally adept at lobbying Congress to preserve and enhance their privileges. His article is a real eye-opener for anyone reading about this two organisations for the first time, croneyism, purchase of priveleges, mind-boggling financial gains for directors, tens of millions of dollars invested in lobbying and all the other devices used by rapacious rich people in positions of power. Dr. Utt said much the same as Rob Alford two years earlier:
The failure of Congress to address these broader issues stems from a flawed reform process that focused on Fannie Mae's Enron-like behavior instead of the statutory privileges that have allowed it to amass enormous market power. Together, these two GSEs control half of the residential mortgage market, deterring competition and forcing the housing and housing finance markets to rely on two financially unstable co-monopolists. With such market power concentrated in the hands of only two companies, the stability of U.S. financial markets could be undermined by financial prob?lems in just one of them. Of course, if a bailout ever becomes necessary, the taxpayers could end up paying the bill.Looks as if we're there. James Kunstler said this in November 2005, after Hurricaine Katrina:
What will happen in the financial sector when the no-money-down-interest-only mortgage racket ceases to generate ever more hallucinated tradable debt? What will happen to Fannie Mae and Freddie Mac, the two federal governments sponsored entities at the center of that racket, and to their sponsor, whose treasury certificates are held by nervous foreign investors? And finally what happens to a dollar hammered by high energy costs and repatriated treasury certificates?So today we read on the Wall Street Journal's Market Watch web site this quote from the organisation, Citizens Against Public Waste:
"The reports of alleged irregularities in the way the GSEs' reported their cash reserves evokes the specter of the 2003 accounting scandals that rocked both Fannie Mae and Freddie Mac," said CAGW President Tom Schatz. "Despite claims by executives in both companies that they had put their accounting houses in order, the culture of manipulation and obstructionist behavior appears to have persisted. Ultimately, though, this collapse must be laid at the feet of policymakers and legislators in Washington, D.C., particularly members of the Senate Banking Committee and the House Financial Services Committee."
"Despite years of warnings about the systemic risk that these giants' activities posed to our entire economy, members of Congress thought that whistling past the fiscal graveyard constituted a rational policy with regard to the shadowy operations at Fannie Mae and Freddie Mac. It is an outrage. Heads have rolled in the halls of Fannie Mae and Freddie Mac, but they should also be rolling in the halls of Congress. Even now, some members of Congress are dismissing out of hand appropriate calls to action by Secretary Paulson and others for the structural reform of these entities. The result is that taxpayers are now being taken to the cleaners. It is long past time to repeal the GSEs' congressionally-conferred special benefits and privatize them both," concluded Schatz.
(Citizens Against Government Waste is a nonpartisan, nonprofit organization dedicated to eliminating waste, fraud, abuse, and mismanagement in government.)
The day after this re-nationalisation, share markets soared as speculators heaved a sigh of relief, and for the moment think that that problem's been sorted. But I think far from being sorted this is the beginning of the end, or possibly the end of the beginning. What we now have is a sort of economic cosmic collision where a massive and dangerous blackhole of debt is in the process of swallowing up the galactic remnants of what was once the American economy. And once in that blackhole, there's no coming out, all meanings of time and place and information no longer exist, although according to the famous theoretical cosmologist, Stephen Hawking, a certain amount of radiation can be detected from a blackhole, now called Hawking radiation, so we may see the merest glimmer in the form of the results of the inevitable enquiry, but I wouldn't count on it.
I wrote a letter to Nine-to-Noon after hearing the programme's American correspondent, Richard Adams give this interview with Kathryn Ryan. Click Here. As Richard points out it isn't only the two GSEs that are introuble, but many smaller banks, and at least one very large bank, Lehman's, is also in dire straits. Lehman's had been counting, literally, on a rescue package from a consortium of Korean banks, led by the Korean Development Bank (KDB). There had been a lot of quibbling about what Lehman's was worth (is it worth anything?). Now the Korean financial regulator is issuing warnings urging the consortium to think very carefully before committing. (Telegraph article) My letter reads:
Dear Kathryn and Team
What an amazing world we live in. Here are the USA's two largest mortgage suppliers, responsible for loans of around US$6 trillion dollars, now bankrupt. They have been supposedly shored up by an even more bankrupt Federal government, a re-nationalisation which is usually the preserve of communist governments - the true measure of the desperation of the Federal authorities. The failure of Fannie Mae and Freddie Mac represents the largest chunk so far to fall off the tottering edifice that is the financial institutions in the US; every businessman, politician and private citizen in the world should be quaking in their boots with dismay. But the wallpaper looks nice and the share market booms, and reality, never a strong point in financial circles in recent times, is laid aside for a few more precious weeks. Until the next time.
Yours faithfully,
I was going to leave this weblog here, but today we read that Lehman's shares have almost halved in value, as a result of the bank's likely inability to raise the $6billion needed to save itself (and don't these billions of dollars trip off the tongue so easily?) and Wall St has fallen 280 points as a result. I remember the Vietnam war, and the reason for this war, the so-called domino effect, the US claim being that if Vietnam were to fall to the communists, then so would Cambodia, then Thailand, then Singapore etc. We are now seeing the financial equivalent in the US, and whereas I was never that sure about the domino theory as applied to Vietnam, we're seeing a rather more more robust example of this theory in operation now.
