Personal Finance Blog by Debit versus Credit

The Bailout of Fannie and Freddie: Redux

October 2, 2008 | Filed in: Miscellaneous | 5 comments

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You may remember the post I published a month ago which was about the government bailout of Fannie Mae and Freddie Mac and what it might mean to us as the American people.  I haven’t made it a habit to revisit old posts often because a large amount of my content is focused more on timeless financial advice.  However while I was reading back through some of my old content today this post caught my eye and I thought it might be fun to revisit it, especially on a day where our government may pass an extraordinarily large bailout package to prop up the U.S. financial system.

Expect To Pay More In Taxes

The first point that I made was in reference to the sheer size of Fannie Mae and Freddie Mac and how taxpayers are likely to be ultimately responsible for any losses taken on by our government with the privatization of these two mortgage giants!  Here’s what I said in early September:

Fannie Mae and Freddie Mac are HUGE companies. They alone service over half of the mortgages in the U.S. They have trillions of dollars worth of liabilities as well. In fact according to the former president of the Federal Reserve Bank of St. Louis, William Poole, they have up to $6 trillion dollars in liabilities (as reported by the Wall Street Journal Online). He believes that it would not be unreasonable to assume that they may end up taking a loss on as much as 5% of their loan portfolio which would provide taxpayers a burden of some $300 billion dollars.

Unfortunately it’s much too soon to make any educated assumptions about how well I did (or rather Mr. Poole did) on this prediction.  I’m going to stand by Mr. Poole and agree with him that Fannie and Freddie are likely to end up taking a loss of at least 5% on their current loan portfolio.  The problems in the housing market haven’t hit rock bottom yet and this will lead to an increased number of foreclosures and, therefore, bad loans.

Mortgage Rates May Finally Drop

The second point I made was in reference to mortgage rates at the time and the likelihood that they were going to drop.  Here’s what I said last month:

The rising level of defaults on mortgages over the past year or two has forced Fannie and Freddie to get more defensive and stop buying up so many mortgages. This has led to an increased risk for mortgage originators, as they might not be able to sell off their risky loans. It has also decreased the amount of cash flowing through the mortgage market and as such has had a strong effect on mortgage rates. Because of the increased risk and the limited capital mortgage lenders have been forced to raise mortgage rates and keep them high. Now that the U.S. has virtually guaranteed the success and liquidity of Fannie and Freddie mortgage originators are likely to have a less difficult time securing cash and selling off their loans. This should lead to a drop in mortgage rates over the next six months or so.

Six months may have been too conservative an estimate.  Mortgage rates actually dropped almost overnight, by about half a percent.  They’re still hovering around six percent (which is what they dropped to after the Fannie and Freddie takeover) and are likely to stay there for a while longer.

Start Investing Now If You Haven’t Already

We’re really starting to get to the meat of this stuff now.  It’s interesting how right after this bailout investors were sure that things were finally starting to get better.  Check out what I had to say then, paying special attention to the bold text:

The markets rebounded on Monday with the Dow Jones Industrial Average ending up almost 300 points (or 2.59%). Investors are excited about the future now that they don’t have to worry about Fannie and Freddie. If the Treasury Department and Paulson are right (and I personally doubt they are) then this bailout should fix everything. After all the housing market is the primary cause of the “recession” that we are currently facing. By shoring up the two largest mortgage companies and providing much-needed capital to the mortgage industry they’re hoping to end this downturn once and for all. Things aren’t quite that black and white however but we’ll come back to that in the next section. In the meantime for the purposes of investing they (the feds) may be right about one thing. By taking over Fannie and Freddie they should increase investor confidence and lower mortgage rates. This should have the effect of a declining bear market if not the return to a bull market.

The heading to this point was the same as the heading above… a recommendation to begin investing.  Considering that it’s nearly impossible to time the markets right, I’m fairly confident that if someone had taken $1,000 dollars and put it into an index fund it would be a great time to start investing.  Sure we’ve had some ups and downs over the past month but overall the markets have been trading mostly sideways since then.  Truthfully in my opinion no time is better than the present to begin investing.  If you haven’t done so yet, then why not start now?

I want to concentrate on the bold point in the quoted paragraph above.  As you can see I predicted that the bailout of Fannie and Freddie would NOT fix the markets like Paulson and the Treasury were predicting.  In fact they were far from right on this point, as if any of us need to be reminded that the government is most likely going to be investing around $700 billion dollars in the financial system over the next several weeks.  I said it here first folks, the Fannie and Freddie takeover would not fix our problems - ready for another one?  Neither will this $700 billion bailout.  It’ll help, there’s no denying that - at least not in the short term.  However it’s not going to fix things overnight, or even over the course of several months.  We still have an underlying problem that is directly related to an OVERSUPPLY of housing in the U.S.  There just aren’t enough potential homeowners to fill all of the houses.

The Financial System Is Nowhere Near A Full Recovery

It’s important to remember that this financial turmoil that our economy is facing was not created overnight and it won’t be fixed overnight either, no matter how hard Bernanke, Paulson and Washington try.

It is true that the primary cause of the economic turmoil that the U.S. is currently facing is due to the uncertainty in the mortgage markets. It’s also true that the decreased cash flowing into these markets due to Fannie and Freddie’s cutbacks was having a negative affect on the entire market. However one would have to be naive to assume that by taking over Fannie and Freddie and providing capital to the mortgage markets that this mess will clean up quickly. The fact is that homeowners are not walking away from their houses because their mortgage lender was unable to sell their mortgage to Fannie - they are walking away because they are upside down on their houses they are unable to afford the payments. Losses will continue to come. The process may be slowed down and stopped sooner than it might have without this bailout (due to the increased affordability of purchasing a home) but unfortunately home values have not reached their lows, as most would-be homeowners are not ready to jump into the market even with today’s home prices!

The fact is that homes are STILL unaffordable in many markets across the U.S. Homeowners are losing money and are bailing ship which is slowly decreasing home prices but we still have quite a ways to go before the buyers start to line up. Bailout out Fannie and Freddie may help some, but as I stated already, the financial system is nowhere near a full recovery.

The point is that we’ve got to be patient and focus on the future and not so much the present.  Things will get better - they always do - but in the meantime it’d be smart of us to take advantage the great investing opportunities that this bear market is providing.  But be smart and don’t rush into anything without some good research.  Good luck out there!

Tags: Bailout Nation, Economy, Fannie Mae, Freddie Mac, Investing Tips, Rants

5 Reasons We Don’t Need No Stinking Bailout

September 24, 2008 | Filed in: Miscellaneous | 7 comments

A wise man once said, “with great power comes great responsibility.”  Whether you are into Spider Man or not it’s hard to ignore such a profound statement, especially when the U.S. is facing times of great turmoil and our nations’ leaders are asking for unprecedented levels of power in order to shore up the financial system.

You may not realize it but the fate of our economy is essentially in a small number of hands right now, the most significant being Henry Paulson and Ben Bernanke.  These two men are pushing to pass a bill in Congress that will give the Department of the Treasury the power to form an entity that will be responsible for buying troubled assets from banks and other financial institutions.  By doing so they hope to free these financial institutions from their troubles and allow the banking system to continue to pump money into the struggling economy.  With a price tag of around $700 billion dollars this would be the mother of all government bailouts.

The question is, do we really need such an enormous bailout?  I’m of the opinion that we don’t and I’ll list for you here 5 reasons why we don’t.

1.  The big banks are hurting, but how realistic is it that they ALL fail?

Bank of America, Wells Fargo, Chase.  What do these banks all have in common?  They are some of the largest financial institutions in the United States.  They also all seem to have the cash to survive this credit crunch that we’re in.  If this bailout doesn’t pass we’re likely to lose some more banks.  Maybe not to bankruptcy, but there will be consolidation for sure.  Washington Mutual is in a shaky condition and may not be around in its current form a few years from now.  However to assume that without this bailout all banks are going to fail is completely preposterous.  That’s highly unlikely to happen, at least at this point.

2.  Most regional and local banks and credit unions are still in good condition.

The authorities seem to forget that the BofA’s and the WaMu’s of the world are not the only banks here in the U.S.  There is a huge system of credit unions and regional/local banks that have a huge marketshare of the available money here.  These banks and credit unions are often in much better conditions than their larger and national counterparts.  Sure a lot of the bank failures this year have been with these smaller banks, but it’s important to remember that the ones who took the most risks have failed and been absorbed already.  More is likely on the way, but overall these financial institutions have largely avoided the risky mortgage mess.

3.  Under the right (or wrong) circumstances such a large bailout could devastate the American Dollar.

The dollar has recovered a lot over the past few months.  The price of oil and other commodities is lower now than it was just a few months ago.  However this bailout will put a huge strain on the dollar because the government doesn’t have the cash just sitting around in a vault.  They’ll have to print money and they’ll have to sell debt.  This will put a lot of pressure on the dollar and unless other competing foreign economies collapse (the Euro zone, etc) the dollar will be heading lower.  This means we’ll be facing higher prices and increased inflation, as if it wasn’t bad enough already.

4.  It reeks of socialism.

A bailout of this magnitude reeks of socialism.  We’ll essentially be privatizing the mortgage asset industry and putting it completely under government control.  Now last time I checked we lived in nation that’s against socialism and for democracy and a market economy.  This bailout is exactly what we’ve fought so hard against since the founding of our great nation.

5.  The economy will eventually correct itself, without such drastic intervention.

I believe in the power of a free market.  I think that we’re facing a recession and things might be difficult for the next year or so.  However the economy always corrects itself and things always get better.  It’s a completely natural phenomena to have good years and bad years.  Why don’t we let things sort themselves out as they should?  If Mr. Greenspan would have done that earlier in the century we likely would not be facing this problem today.  Let the economy correct itself so we don’t risk making things worse somewhere down the line.

Henry Paulson and Ben Bernanke are asking for great power.  I am concerned about the level of responsibility being placed upon them.  I don’t think that they are acting in the best long-term interest of our country by promoting this bailout.  Therefore I don’t trust them to have such great power and great responsibility.  My advice is to let things work out naturally, just like they always have a tendancy to do.  What are your thoughts on the matter?  Are you for or against the bailout?

Tags: Bailout Nation, Ben Bernanke, Department of the Treasury, Economy, Free Market, Government Intervention, Henry Paulson, Rants, Socialism

When Will The Bailouts End?

September 18, 2008 | Filed in: Miscellaneous | 3 comments

Maybe it’s just me, but these bailouts seem to be happening more and more frequently these days. Six months ago it was Bear Stearns. Just two weeks ago we bailed out Fannie Mae and Freddie Mac. Now, as you’ve undoubtedly heard, the U.S. government has taken it upon itself to bail out American International Group, otherwise known as AIG. What was their reasoning this time around? What does this mean to us as taxpayers? Will the bailouts ever end? These are all questions that you have probably found yourself asking. I’d like to attempt to answer them for you.

Why Did We Bailout An Insurance Company?

To be fair AIG is involved in more than just insurance.  That is, however, their primary business.  Unfortunately they have had large levels of exposure to the credit crisis through an insurance-like product that protects the purchasers of the product from bond defaults.  Essentially they insured investments.  As so many of these investments are going south so is the cash of AIG as they are forced to pay out to their customers.  The problem lies therefore with their current level of capital.  They were unable to raise enough in time and their credit ratings were dropped.  This may have forced them to declare bankruptcy because they did not have enough cash coming in.  The fed stopped this though by offering an $85 billion dollar loan and agreed to taking an 80% stake in the company.  Essentially they just bought AIG.

Will This Affect Our Taxes?

More than likely this will not have an impact on our taxes.  But it may.  There’s something that a lot of American’s don’t know about the Fed and our government.  They have been running a budget deficit for a LONG time.  That much is common knowledge.  But think about it.  Where did they get the $85 billion to loan to AIG?  It wasn’t sitting in a vault somewhere twiddling its thumbs.  That much is for sure.  No.  When the government needs money they print it.  Just out of thin air.  They fire up the money machine and call it cash.  Of course if I tried to do this I’d be arrested for counterfeiting.  They ought to be arrested for causing high inflation.

So rest assured this money did not come from our taxes.  It may not either.  If AIG can pull through this ok the Fed hopes to sell their portion of the company back to the general public, at a gain.  But that doesn’t help the damage that’s already been done.  The fact is that the Fed and the treasury have thrown billions upon billions of dollars into the economy.  Dollars that didn’t exist before.  Is it any wonder why gas costs so much?  It shouldn’t be.

When Will The Bailouts End?

I’ll be perfectly honest with you.  I was surprised when the Fed let Lehman file bankruptcy.  I was pleasantly surprised in fact.  Don’t get me wrong.  I feel terrible that such a large business with so many employees was allowed to fail.  But it has to happen.  We are supposed to have a free market system.  There will be ups and there will be downs.  Right now we’re facing some serious crisis’ on wall street and in the financial system as a whole.  Things will eventually get better, but in the meantime there will be pain and there will be losses.

Right now WaMu looks like it may be the next target for failure.  They’re currently shopping themselves around for a buyer.  Their problem is also a lack of capital.  Cash truly is king.  Like I’ve been telling all of you, make sure you have an emergency fund for when a crisis comes into your personal life.

On that note I don’t think we’ve seen the last of the bailouts.  The Fed and the Treasury department have been too forgiving and too quick to pull the trigger.  These companies more or less deserved what was coming to them.  I hope that these bailouts will not create an attitude of “we can’t fail” in companies.  I hope that our country will be stronger after this crisis.  Unfortunately it’s looking to be quite the opposite.

What are your thoughts?

Tags: AIG, Bailout Nation, Bear Stearns, Debt, Economy, Fannie Mae, Federal Reserve, Freddie Mac, Rants

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