Agora Financial’s Rude Awakening

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Ouzilly, France

• Fannie and Freddie seized by the government,
• $5.3 trillion of mortgages now under “conservatorship,”
• The “poor man’s attic” of the Federal Reserve and plenty more…   

Joel Bowman, reporting from Dubai in the Persian Gulf…

Congratulations! If you are an American taxpayer (like us), you now own a share of the risk held by two firms that own or guarantee around half the mortgages in the country.

And this at a time when home prices are plummeting, inventories are swelling, foreclosures have reached an all time record and unemployment skipped along to a five-year high of 6.1 percent, further weighing on demand for new digs.

But before we break out the champagne, let’s take look at what went down…

Yesterday Treasury Secretary Henry Paulson announced Fannie Mae and Freddie Mac, the two mortgage behemoths which own or guarantee around half of all home loans in America - some $5 trillion worth – will be placed under “conservatorship.” To do so, the Treasury will acquire $1 billion of preferred stock in each of the companies and has earmarked another $200 billion to keep them solvent.
 
In other words, it will exchange its rapidly diminishing supply of economic arsenal for the junk on Freddie and Fannie’s books…yes, the very same junk nobody in the marketplace wanted to touch with a ten-foot pole.

The news came after Fannie (NYSE:FNM) and Freddie (NYSE:FRE) fell over 20% each in after hours trading on Friday. A year ago the two stocks stood at around $60 a pop. Since then, however, they have gone up in smoke. In fact, if you hung around late Friday, you could’ve picked up a share in either of the nation’s largest financial companies for about the price of a pack of cigarettes. Almost nobody bothered, of course…until Hank showed up with your retirement fund account.

So, how much are we all in for?

Former Federal Reserve Bank of St. Louis President William Poole, who described the burden on taxpayers as “an unacceptable situation,” projected the Treasury may need to cover as much as $300 billion of losses.

But wait…there’s more! This from today’s Wall Street Journal:

“In addition to its initial acquisition of preferred shares, the government receives warrants giving it the right to a stake of 79.9% of each company for a nominal sum. The Treasury’s preferred shares, which carry an annual dividend yield of 10%, will be senior to those earlier issued, meaning the government will have the first right to receive dividends.”

Common stock, meanwhile, will likely be reduced to zip. The Office of Thrift Supervision, a government agency that supervises savings and loans, estimates there are 17 banks that have a concentration in common or preferred shares of the twins above 10% of their Tier 1 capital. Good luck guys!

Meanwhile, we noticed Daniel Mudd and Richard Syron, the respective CEOs of Fannie and Freddie were given the boot. But don’t get the Kleenex out just yet. Including pension and other “deferred compensation,” the two will receive about $15 million each for their troubles

And so ends the great “kinda public, kinda private” experiment of Fannie Mae and Freddie Mac: with the death of mortgage lending in the U.S. as we know it and the taxpayer on the hook for the bill.

In the column that follows, Bill Bonner examines the “poor man’s attic” of the Federal Reserve and reveals where all our money has gone. Enjoy…

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Making a Bad Situation Badder
By Bill Bonner

This week, according to the Bloomberg report:

“Prime Minister Gordon Brown suspended a tax on buying some homes for the first time since 1991 and brought forward 1 billion pounds ($1.8 billion) of spending in an effort to revive the U.K. economy.”

Brought forward? From where? In effect, the government will take money from renters and solvent homeowners to help a few people stay in houses they can’t really afford. Meanwhile, in the United States, private lenders have grown wary, but the feds’ money still flows like free beer. Fannie Mae and Freddie Mac face combined losses of up to $100 billion – much of which will have to be swallowed by the taxpayer. Next in line at the bar are the automakers, asking for $25 billion – at negative interest rates, of course.

“The response to this sad situation is unfortunately simple,” wrote Marc Touati, in the new French version of MoneyWeek magazine. “The United States is doing everything it can to promote growth and employment, knowing that as soon as the economy improves its economic policies can be less accommodating.”

Mr. Touati is an admirer of America’s financial activism. Looking back over the past 10 years, he sees two episodes when U.S. financial authorities acted aggressively and apparently, successively. In 1995, for example, economists thought the United States was headed into a prolonged slump while Europe was poised for a period of dynamic growth. Instead, it was America that surprised to the upside. Again, in 2002, same situation. The U.S. seemed to be in for a tough time, while Europe had the wind at its back. But again, America sailed ahead, while the Old World couldn’t seem to catch a breeze.

Now, in 2008, here we go again, he seems to say: “Once again, the consensus is wrong. Thus, the American economy has avoided the much-announced serious, prolonged recession, while the euro zone is threatened…”

Fortunately for you, dear reader, we do not have the space to describe in detail where Mr. Touati goes wrong; we can only summarize: each time the U.S. consumer threatened to stop spending more than he could afford, the feds gave him more credit on easier terms. The U.S. economy “grew,” but it grew worse off.

George Magnus, writing in the Financial Times on Tuesday, also looks with favor on U.S. monetary and fiscal policies: “[T]he Fed has been obliged to do unusual things to avert a systemic financial meltdown. I see nothing [in its] operations that is irreversible and cannot be undone as the sense or crisis evaporates.”

Mr. Magnus ought to take a look at the Fed’s books. Hardly more than 12 months ago, the American central bank’s vaults were so full of U.S. Treasury debt that anything else in there wasn’t worth talking about. But at the end of last year, the bank began buying up the flotsam and jetsam from sinking Wall Street ships. Now, the Fed’s assets look like a poor man’s attic – including $106 billion of junk in a category known as “other.” What exactly is in these credits, we don’t know. But we know they weren’t there a year ago and they are only there now because other financial institutions were desperate to get rid of them. The Fed, serving as chump of last resort, was the only player dumb enough, or rich enough, to take them on.

If Mr. Magnus is right – if the crisis “evaporates” – perhaps these soggy credits will be crisp and saleable again. And perhaps the British government will make a profit on Northern Rock. Then again, maybe the markets are wrong about oil too. Perhaps it will sell for $10 a barrel again next year…just like it did in ‘98. And maybe the Russians will reconsider; maybe they’ll hoist the old hammer and sickle and go back to standing in lines to buy a can of peas.

We don’t know. We have tried to look into the future. Maybe if we could do it, we too would be tempted to improve it before it happened. But we’ve never gotten the hang of it. Instead, we turn to the past…

“Unusual events merit unusual solutions, especially when systemic risk is present,” concludes Mr. Magnus. On this point, he is surely mistaken. There is nothing unusual about these events, nor about the solutions. Every bubble in history was followed by a bust. And the feds always use a crisis like a whale uses a beach. Emperor Diocletian, like Richard Nixon and Robert Mugabe, washed up on wage/price controls. Troubled by inflation, their economies got worse when they tried to stop it with price controls. Philippe d’Orleans, Regent for the young Louis 15th, turned to Beau Wilson’s killer to save the monarchy from the Sun King’s debts. John Law, with his funny, paper money, soon beached the entire country, and himself too. And now, the world turns its weary eyes to Ben Bernanke. The price Mr. Bernanke seeks to the control is the most important of all – the price of credit. He holds it down in order to try to keep other prices moving up – and to keep the consumer spending!

Mr. Magnus says the “erosion of the consumer’s purchasing power from shrinking access to credit and dwindling housing wealth has only just begun. This is true in the U.S. and the U.K…” Elsewhere in the FT comes word that another $96 billion in risky home loan chickens are coming home to roost in the next two years, citing a Fitch report that estimates an average increase of 63% – or $1,053 extra per month. This comes as late payments and defaults are already as high as 24% for these make-believe mortgages. Too bad, but no thanks are given to the feds for sending the birds off in the first place.

[Joel's Note: Bill Bonner is the founder and editor of The Daily Reckoning . He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis .

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here: Mobs, Messiahs and Markets  

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[Rude Endnote: Markets across Europe and Asia markets rallied hard after news Freddie and Fannie were absorbed into the government’s control. Most major indexes leapt three and four percent in early trading with the Nikkei up 412 points, the Hang Seng up over 860 points and London’s FTSE up 200 points.

Ahh, the old, “I’m from the government and I’m here to help” line again. Is anyone else here getting nervous?

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com