Vol. 20, No. 4,928 - The American Reporter - March 5, 2014




by Joyce Marcel
American Reporter Correspondent
Dummerston, Vt.
July 24, 2008
Momentum
10 REASONS WHY JIM DOUGLAS MUST GO

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DUMMERSTON, Vt. -- I have written often over the past few years about the house of cards that is the American economy, but the events of the past week should frighten everybody.

First, there was the collapse of IndyMac, a California bank deeply involved in subprime lending. The Federal Deposit Insurance Corp. calls it the second biggest bank failure in its history.

The scene of people lining up hoping to get what's left of their money is unnerving, especially when you consider that the FDIC has said that as many as 150 more banks may go under in the next year or so.

Then there are trials and tribulations of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corp.), the two federally-chartered companies that either hold or guarantee half of the home mortgages in the United States - more than $5.3 trillion.

Fannie Mae was created in 1938 to expand the flow of mortgage funds across America at a time when millions of Americans risked losing their homes. In 1968, it was re-chartered by Congress to become a shareholder-owned company with private capital.

Fannie Mae and Freddie Mac are what's known as secondary lenders. They buy mortgages from banks and other lenders and package them into bonds, which they sell to pension funds and other investment firms. The banks use this money to make further loans to new homeowners.

Because the loans backed by Freddie and Fannie are considered low-risk, federal regulators have allowed them to carry smaller reserves of capital. The standard ratio in banking is $10 of loans for every dollar of capital. For Fannie and Freddie, the ratio is closer to $30 for every dollar.

When times were good, Fannie and Freddie weren't needed. Even though warnings were sounded that they did not have enough reserves, the federal government believed that house prices would keep going up and that it was worth the financial risk to promote homeownership.

Fannie and Freddie can't be blamed for the subprime mortgage debacle, because by law they could only give mortgages to qualified buyers. Unfortunately, the housing bubble was so inflated that even the well-qualified mortgage holders who bought at the top of the market are now facing foreclosure.

Here's where things get tricky. If Fannie and Freddie run into trouble, investors expect the federal government (i.e., taxpayers) to bail them out - a textbook example of modern capitalism, where the profits are privatized and the losses are socialized.

The savings and loan crisis of the 1980s was a classic case of this theory, as these institutions offered high interest rates to attract investors, then reinvested that money into riskier ventures. When the bets went bad, it cost taxpayers more than $100 billion to clean up the mess. That's because those deposits were federally insured, and the FDIC was obligated by law to come up with the money.

The same guarantee of federal backing is why Fannie and Freddie became so popular with investors. Even though they sell stock, they have an extra layer of security that other stocks just don't have.

So we taxpayers may be on the hook for hundreds of billions of dollars because of bad bets made on the housing market. But to let Fannie and Freddie fail would mean huge problems for the U.S. economy.

That's why the Treasury Department and the Federal Reserve announced an emergency rescue plan on Sunday to temporarily increase a long-standing Treasury line of credit that could go to either company.

The Treasury Department also said it would, if necessary, buy stock in the companies to make sure they have enough money to operate, while the Fed announced it would allow Fannie and Freddie to get loans directly from the Fed. That's something previously done only for commercial banks, but now a privilege extended to investment banks and other institutions in the wake of the Bear Stearns collapse in March.

The hope is that if Freddie and Fannie can be shored up, it will restore confidence in the financial sector. But the problem that Fannie and Freddie got sucked into remains - namely that there are trillions of dollars of mortgages that won't ever be repaid. Those bad mortgages have been sliced, diced and julienned into top-rated securities that may be next to worthless.

Now that the housing bubble has burst, nobody knows for sure what any investment is really worth. That's how deeply the subprime scam has infected the economy. That's why the ride may get even rockier in the months ahead.

Randolph T. Holhut has been a journalist in New England for more than 25 years. He edited "The George Seldes Reader" (Barricade Books). He can be reached at randyholhut@yahoo.com.

Copyright 2014 Joe Shea The American Reporter. All Rights Reserved.

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