35 Comments for this entry

1. John M. says:

   July 18, 2008 at 3:29 AM

   twist -

   The pretense of guaranteeing about $5 trillion of mortgage backed debt using two quasi-private companies with (now) essentially no market cap is a bit farcical. When are we going to learn that Nixon’s 1972 so-called privatization of over a third of America’s sovereign debt was simply a very, very large Enron-style off-balance-sheet exploit?
2. John M. says:

   July 18, 2008 at 4:00 AM

   Ready for some serious spin?

   “Paulson’s View”, by David Ignatius, Washington Post, July 18, 2008.
   

   And he says he was troubled about Fannie Mae and Freddie Mac, the mortgage giants that had grown fat on an implicit (but never tested) government guarantee to back up their debt. “It didn’t take a genius to know that there was a problem,” he says. “The elephant was too big for the tent, frankly. They were too big, and they posed a systemic risk.”

   But it’s one thing to sense that a crisis is looming and quite another to mobilize the federal government to do something about it. And these chronic financial problems were in Washington’s “too hard” file.

   “Shocked,” says Igor, who must be easily shocked on a Friday.
3. twist says:

   July 18, 2008 at 5:20 AM

   John-

   Paulson is up there with Bush, who a couple of days ago was saying that he saw economic problems early, and worked to head it off with his economic stimulus package.

   Problems have been brewing for years, but he didn’t mention any problems until just a few months ago- when he was still saying the economy is strong.

   There seems to be a pattern of Deny until it’s undeniable- then say that you saw it it all along.
4. twist says:

   July 18, 2008 at 5:31 AM

    

   John-

   Have you seen this one yet this morning?

   Mortgage giant Freddie Mac is considering raising capital by selling as much as $10 billion in new shares to investors, The Wall Street Journal reported, citing people familiar with the matter.

   The report comes after the U.S. Treasury and Federal Reserve announced a plan on Sunday to shore up the balance sheets and borrowing capabilities of Freddie Mac and sister company Fannie Mae.

    Such a share sale, which has not yet been determined, could forestall a full government rescue, the WSJ said.

   I wonder if the powers-that-be are worrying the Paulson’s plan won’t fly, and are looking for a plan "B"?

    

    
5. John M. says:

   July 18, 2008 at 11:57 AM

   twist (#4) -

   There has been a blizzard of stories about how for the foreseeable future the GSEs need neither the discount window, nor more capital, nor Government support, nor broader borrowing limits from the Treasury. In truth they are desperately urgent to seize on all these tools and more, but their lying power is completely shot and they have to lie low until Congress (hopefully) authorizes all these things that F&F don’t need.

   Sooner rather than later they will spring the value-trap on guys buying into this wild rally and those investors will discover that their money was more in the nature of a charitable contribution than an investment.

   All that’s a sideshow, though, with the money flowing into the Treasury to help pay for GSE nationalization (coming soon) being a pittance. The main event is in the debt markets, and it should hit in the next three days, as soon as the Asian cenbanks realize that Roubini’s proposal for a five percent adjustment on agency debt is gonna happen.

   Haircuts on F&F obligations will be the obligatory tribute assessments to pay for the wars. There’s no way around it.

   Remember Ambrose recently contradicted the Spanish Minister of Finance by saying that today is not that country’s worst crisis in history, it was at the height their empire in the 16th Century when there were the three worst ones, including Phillip nuking the Italian banking system by defaulting on the loans for his failed invasion of England. The pattern of sovereign default is a law of human nature and it won’t be a bit different this time around.

   Meanwhile, the MSM is busy building up their dossier of embarrassing efforts to soothe the sheep. Today’s stack will look much like the howlers from 1929-31, the dawn of WD I, that we have been laughing over.

   “Crisis? What Crisis?”, by Justin Fox, Time, July 17, 2008.
   

   It’s getting to be a familiar ritual. Markets panic. A bunch of G-men in dark suits interrupt their routines for an emergency meeting or a conference call to piece together a rescue plan. They announce the plan. Panic subsides. Then, a week to a couple of months later, it starts all over again.

   I count six such episodes since August 2007. In the early days, the Federal Reserve Board did all the work and usually made its big announcement on a Friday. Since then, Treasury Secretary Hank Paulson has moved to the fore, and he picked a Sunday afternoon to float his proposal for bolstering beleaguered mortgage giants Fannie Mae and Freddie Mac. The basic pattern, though, remains the same: Financial tizzy. Dramatic government action. Period of reduced tizzy. Repeat.
   …

   Finally, there’s the matter of effectiveness. Washington’s response has so far shielded the economy from the worst of the catastrophe in financial markets. But it hasn’t fixed the problem that started the crisis: the fact that a few million Americans got home loans they can never pay back. The resulting foreclosures have been driving housing prices down and forcing lenders to retrench. The result is less credit for heavily indebted American consumers. In the second quarter of 2008, this credit crunch was counteracted by $78 billion in stimulus checks–yet another of those government interventions. That boost is petering out. The likeliest next step, while not the Great Depression, is a recession that even Gramm will have to concede is more than just mental. Which could lead to a few more emergency meetings of the men in dark suits.

   Of course it’s once Asia comes to terms with just how many homeowners are actually going to default that the F&F bill sales will seize up. I give it three days, but it might be ten. No more. What started with Coventree will have completed in somewhat less than a year. This is the end of capitalism as we have known it, and the beginning of the end of the Anglophone adventure which kicked off with Sir Francis Drake.

   But it was one heck of a ride
6. agnostic says:

   July 18, 2008 at 12:44 PM

   John -

   This is a legitimate, non-rhetorical question, and I don’t want the 2nd-grade answer:

   Why are the GSE spreads widening?
7. John M. says:

   July 18, 2008 at 1:02 PM

   agnostic -

   CR has a specific explanation (follow the link for more information):

   “Agency Mortgage-Bond Spreads Increase”, Calculated Risk, July 18, 2008.
   

   This is still below the spread in March of 238 bps. The increase today is apparently due to comments made in a Freddie SEC filing.

   We now return to our usual Apocalyptic Gloom & Doom …
8. agnostic says:

   July 18, 2008 at 3:31 PM

   Yeah, I read that earlier today, but if F&F are more or less explicitly backed by the Fed, why would the paper trade at a premium to treasuries? Sure, I know, perceived risk, blah, blah, but IF the explicit backing is there…
9. John M. says:

   July 18, 2008 at 4:07 PM

   It’s not explicit, it’s semi-explicit. Paulson threw out the implicit guarantee that had been in place for 36 years but failed to specify anything about the new state of affairs, which is assumed to be explicit, but is at this point totally undefined. That is certainly enough uncertainty to explain the spread relative to treasuries.

   Anyone with a pencil and the back of an envelope will immediately see that amortizing this monster would entail certain inconveniences, e.g. enslaving most Americans for the next fifty years or so. Economically speaking, the GSE bill sales / redemptions constitute cheque kiting on a balance of $5 trillion dollars, so this penultimate working piece of the debt rollover market (treasuries is the last) is pretty important.

   A real statement of full-faith-and-credit applying to the GSEs’ debt would simply end the concept of agencies and create an approximately (but God knows exactly) $12 trillion treasuries market chock full of post-bubble mortgages. S&P is hardly going to put America on negative watch, but if that happened, they wouldn’t have to.

   Clearly Roubini’s suggestion of clarifying the situation by specifying the “modest” haircut the Treasury has in mind for agency bond holders is suicidal, but the alternative appears to be revocation of the 14th Amendment. Paulson’s in Zugzwang.

   While he’s dithering, fear will creep inexorably into the agencies market. I expect it will freeze around Monday. Therefore it is not unlikely that Paulson will take his best shot at managing this unmanageable situation Sunday evening before the Asian markets open again. I have no idea what he will say, and I hazard a guess that at this time he doesn’t either.
10. agnostic says:

    July 18, 2008 at 5:48 PM

    If it’s semi-explicit, it is not explicit. Sure, Hank is out there saying “we don’t know what type of bridge we’re going to throw up until we get to the river,” well, they’re on the bank (pun intended).

    And, honestly, I can’t stomach these “experts” who are saying that F&F are absolutely essential in having an orderly, smooth housing market. Ridiculous. If a lender can only cover their risk with a 9% or 10% coupon, so be it. The rate is either subsidized or it isn’t, I don’t think there can or should be a middle ground – if the only thing propping up housing values is cheap plentiful government-backed capital, then the values are not propped up.
11. twist says:

    July 18, 2008 at 9:58 PM

    John, Agnostic-

    I must say, “semi-explicit” reminds me of “kind of pregnant”- it’s seems you must be one thing or the other.

    I understand what you are saying though, John. It sounded like Paulson was being more explicit, without actually saying so.
12. John M. says:

    July 19, 2008 at 6:26 AM

    Hi guys -

    I just found this one from near the outer limits of the gold-bug community. His guess for the ultimate damage is four times what Roubini is asserting, but the following paragraph does a good job of summarizing Paulson’s dilemma.

    “Stocks Bounce as Fannie and Freddie Looking for Fresh Capital”, by Anthony Cherniawski, Market Oracle, July 18, 2008.
    

    Lawmakers want nothing to do with a bailout, since estimated losses in Fannie and Freddie may exceed $1 trillion. The federal debt ceiling was set at $9.85 trillion last spring and as of April, it had already exceeded $9.5 trillion. Taking on Fannie and Freddie will undoubtedly force the debt ceiling higher and that won’t fly in an election year. The last time congress raised the debt ceiling, we found the only news release about it in the China People’s Daily. Do you think someone doesn’t want us to know about it?
13. John M. says:

    July 19, 2008 at 7:35 AM

    twist -

    You can have no idea how much I enjoyed reading your recent sidebar find (link below).

    In fact the final years of my career in technical support for naval C3I and related areas like ASW research were devoted (rather embarrassingly) to trying to raise (i.e. numerically lower) DEFCON on the emerging national security threat coming out of agency debt. Doomers might imagine the blank looks this received around 2004/05

    I just had a blast of nostalgia recalling all the confusion occasioned trying to remember “1 is bad, 5 is good” as we were maintaining the displays for the levels on the operators’ screens.

    “Fannie & Freddie: DEFCON 1 or just a sad day for taxpayers?”, Stockhouse, July 19, 2008.
    

    A bailout “would send a message to the entire world that the Federal Reserve and the U.S. government will print any amount of money or do anything to protect the interest of bankers, the dollar be damned.” Swanson continues, “Such a bailout would put the government directly in the mortgage business. It’s akin to communism. Or communism for the rich and well connected.”
14. twist says:

    July 19, 2008 at 8:40 AM

    John-

    I had a feeling you might enjoy that one. : )

    Did you follow the link to the Swanson article? It’s actually more expansive than the one on the sidebar. Swanson doesn’t mince any words.
15. John M. says:

    July 19, 2008 at 9:13 AM

    twist -

    No, I hadn’t followed that link inside the story at #13. I have now and, as you say, it’s pretty strong stuff.

    “Fannie and Freddie bring credit crisis to DEFCON 1: A bailout would tell the world that U.S. government will do anything to protect the interest of bankers”, by Mike Swanson, Stockhouse, July 14, 2008.
    

    “This really blows away the notion of an implicit guarantee,” independent banking consultant Bert Ely said of the Treasury’s plan to ask Congress to allow it to make equity investments in Fannie Mae and Freddie Mac. “It suggests a greater concern about how these companies are doing. It says the problems are deeper. It gets to the solvency of the companies, not just the liquidity.”

    There is no news that would be worse than the collapse of these two institutions and such an event, if it happens, will have ramifications for the economy and stock market for years to come. Fannie and Freddie buy mortgages and then package them into bonds, which they guarantee. They then sell the bonds to investors, including mutual funds, hedge funds, pensions, annuities – just about any institutional investor you can think of. Odds are that if you own a mutual fund or annuity that you indirectly own a security backed by one of these two institutions. The two of them combined own half of America’s twelve trillion in outstanding mortgages and their failure would be the implosion of the entire financial system.
16. John M. says:

    July 19, 2008 at 11:55 AM

    The fun bit of this article is near the end. I wonder if America’s trading partners knew they were being cast as first responders holding a net designed to catch a grand piano being tossed out of the eleventh floor of a burning building.

    The author is a former Fed type now working at the AEI.

    “Securitization and the Mortgage Mess”, by Vincent Reinhart, Wall Street Journal, July 18, 2008.
    

    Securitization also provides some important benefits that have helped to contain the current crisis. Mortgage-backed securities are typically better diversified than the original set of loans that a depository originates. Furthermore, securitized mortgage products are distributed far more widely, including overseas, than whole mortgages. In effect, our trading partners have shouldered some of the burden of the U.S. housing crisis.

    So the $250 billion question over this weekend includes the question of how much of this “support” will be imposed through the means of a haircut to holders of agency debt. Igor has a comment … “cheated.”
17. John M. says:

    July 19, 2008 at 12:16 PM

    Thursday’s GSE cover at The Economist seems to have opened the MSM floodgates. Newsweek in particular has several stories. In the following one, they’re trying to frame the story within the Hoover vs FDR paradigm.

    “Seeing Shades of the 1930s: The government’s efforts to keep Fannie and Freddie afloat have a lot in common with the New Deal”, by Daniel Gross, Newsweek,
    Published Jul 19, 2008; From the magazine issue dated Jul 28, 2008.
    

    The jam session started in March, when Paulson and Bernanke worked out a deal for JP Morgan Chase to take over ailing Bear Stearns. Paulson helped dictate the price, and Bernanke agreed to let JP Morgan present $30 billion in assets belonging to Bear at the so-called discount window—usually available only to banks in the system—in exchange for cash. In the ensuing weeks, as Wall Street firms were leery about lending money to one another, the Fed opened up the discount window to 19 investment banks —which, like Bear, aren’t regulated by the Fed—thus putting more taxpayer funds at risk. As of last week, $13 billion in such loans were still outstanding.

    Those sums pale in comparison to the potential exposure proposed last week, when Paulson and Bernanke gamely asked Congress to have the taxpayer explicitly back the $5.2 trillion in combined debt of Fannie Mae and Freddie Mac. “It’s an unprecedented request for an open-ended amount,” said Rep. Spencer Bachus, a House Finance Committee member and one of a group of skeptical GOP congressmen who met with Paulson after the hearing last Tuesday. Lawmakers said they want a quo for all the taxpayers’ quid they’re putting in.
18. agnostic says:

    July 19, 2008 at 12:34 PM

    If there is going to be explicit backing (man, I hope there isn’t), the quo needs to be that the shareholders’ equity needs to be wiped out (i.e. nationalization). The shareholders can’t have it both ways.
19. jryskmpr says:

    July 20, 2008 at 9:53 AM

    Well, the comments above are really excited. However, the important point to remember is that it doesn’t matter either way. Can you say, “It’s over”? The idea that it was sufficient to “back up” finance, was fine in the 1930′s, when public opinion would support 23% unemployment. But that won’t work this time.
20. John M. says:

    July 20, 2008 at 10:34 AM

    Hi John (#19) -

    When you start coming across as moderate and respectful then we know we’re in serious trouble

    To answer your rhetorical question, I did indeed say “It’s over” in the course of this 7/7 comment. That could just be my defeatist habits, though. I sense a building consensus among all the Washington and New York political and business factions to rally around Secretary Paulson’s efforts to build an ontology that will take us through the current crisis. He is speaking on major news outlets this weekend, leading up to a major speech this Tuesday July 22nd. His effort is currently Google News top business cluster and I’ll mine a few links and quotes below as the afternoon wears on.

    Doomers will be interested in the analysis of our friend (and former chief Fannie lobbyist) Bill Maloni. A reporter at The Independent has recently sourced him for a story on the situation.

    The key battlefield in this crisis is agency debt yields over treasuries and the success of Fannie’s and Freddie’s periodic bill sales. The sales have been healthy as recently as last Thursday and have been getting strong support, especially from Asian central banks.

    The bill sales, together with F&F’s debt redemptions, constitute the rollover of America’s AAA-rated mortgage paper. The paper deriving from lesser quality assets, starting with subprime RMBS 11 months ago, has completely seized up. That is the SIVs, ABCP, auction-rate securities, etc. Only treasuries themselves are better quality than agency debt, and if the rollover process for agencies seizes up the crisis would basically go out of control. So Paulson’s communication efforts from now until Tuesday must serve to maintain the faith of the buyers at the F&F bill sales above all.

    I don’t think it’s possible, given Roubini’s recent analysis, but with all the significant forces wishing Paulson well he’s sure going to give it the old college try.
21. John M. says:

    July 20, 2008 at 10:47 AM

    Ely & Roubini are starting to sound a bit like a Good Cop / Bad Cop act on this issue.

    “Opinions Split About Financial Sector, But More Large Bank Failures Feared”, RTTNews, July 20, 2008.
    

    Banking analyst Bert Ely calls IndyMac’s failure an “aberration,” saying it is more evidence of regulators being “asleep at the switch” than symptomatic of widespread industry distress.

    However, NYU professor Nouriel Roubini predicts that around 10 of the 30 regional banks around the country with sizes comparable to IndyMac will fail before the market fully recovers from the current financial crisis. He also predicts trouble for some large, national financial institutions, naming beleaguered Wall Street giant Lehman Brothers (LEH: News, Chart, Quote ) as one of the possible victims.
22. John M. says:

    July 20, 2008 at 10:55 AM

    This one gets my vote for the weekend’s least astonishing headline.

    “Paulson `Very Optimistic’ on Freddie, Fannie Rescue”, by John Brinsley, Bloomberg, July 20, 2008.
    

    “We’re very close to getting reform,” he said in a separate interview on CNN’s “Late Edition” program. “These are very important organizations — they have a very important role to play — and we need to make sure that they have access to adequate capital to get through this period.”

    The economy is in a “challenging time” and probably will have “slow growth” for “months” as higher oil prices prolong the slowdown, Paulson said on CBS. The banking system is “sound” and regulators are being “vigilant,” though some banks are starting to struggle, he said.

    Speech on U.S. Economy

    The Treasury secretary is scheduled to spend the next two days in New York for meetings with executives from financial services companies and to give a speech July 22 on the condition of the U.S. economy and capital markets.

    Regulators are aiming to resuscitate investor confidence in the firms [Fannie & Freddie] after their shares this month fell to the lowest in more than 17 years on concern they may have insufficient capital to survive the collapse of the housing market.
23. John M. says:

    July 20, 2008 at 11:02 AM

    Bottom calling in the US housing market has now become a matter of economic life and death.

    “US economy needs months to recover – Paulson”, Reuters, July 20, 2008.
    

    A key to recovery was for the housing market to stabilize quickly, he said. To that end, it was essential that Congress approve the plan aimed at shoring up confidence in Fannie Mae and Freddie Mac.
24. John M. says:

    July 20, 2008 at 11:12 AM

    Sorry guys, but it’s a bit late to be worrying about Moral Hazard …

    “We can’t say no, but we can regulate them”, Newsday, July 20, 2008.
25. John M. says:

    July 20, 2008 at 11:24 AM

    “Paulson says recovery to take months, not years: Treasury chief confident Congress will approve Fannie, Freddie aid plan”, by Michael Kitchen, MarketWatch, July 20, 2008.
    

    “This is a tough time,” Paulson said in an interview on CBS’s Face the Nation. “We’re going to be in a period of slow growth for a while.”

    But he added that recovery would involve a matter of months rather than years.

    Paulson also voiced confidence on government’s ability to deal with the recent string of bank failures.

    “Our regulators are on top of it. This is a very manageable situation,” he said.

    “Paulson braces public for months of tough times”, Associated Press, July 20, 2008.
    

    Treasury Secretary Henry Paulson sought to reassure an anxious public Sunday that the banking system is sound, while also bracing people for more troubled times ahead.

    “I think it’s going to be months that we’re working our way through this period — clearly months,” he said.

    Months? “Coverup,” says Igor.
26. twist says:

    July 20, 2008 at 12:14 PM

    John-

    If he were so supremely confident, why isn’t he taking a Sunday off? Futures have been way up on FRE and FNM all weekend.

    There is the possibility though,that with BAC reporting tomorrow and WB and WM later this week, perhaps analysts didn’t limbo low enough in their estimates and maybe investors will get spooked again this week.

    I think he protests too much.
27. John M. says:

    July 20, 2008 at 1:32 PM

    twist -

    I think he’s simply freaked out at the number of things that could go catastrophically wrong in the next week or so if either the debt investors or the stockholders get spooked. Yesterday one of Roubini’s buddies explained why the Administration needed to tear up parts of their ideological play books in the present emergency. They simply need buyers of FNM and FRE too much.

    “Moral Hazard Misconception”, by Ricardo Caballero, RGE Monitor, July 19, 2008.
    

    By punishing equity holders, the Treasury chose to hurt those that it had invited to stabilize the situation just a few hours earlier. In doing so, it may have damaged its ability to leverage its policies with private capital support, a key aspect of policy success in dealing with a coordination failure problem.
28. wylacot says:

    July 20, 2008 at 2:48 PM

    I’m seeing strong parallels between Mussolini’s corporatist Italy (A/K/A “fascism”), in which the state holds a controlling interest in the major national corporations, and today’s national financial circumstances. A “too-big-to-fail” anything is de facto ownership, regardless of who purportedly owns the shares in the organization.

    Is corporatism a bad thing provided the corporations are well-managed and unemployment figures and inflation remain low? Can a corporatist state continue to sell bonds forever and not expect some kind of consequence?

    I’m starting to think that home mortgage meltdowns are the mild rash that appears before the smallpox sets in.
29. John M. says:

    July 20, 2008 at 5:10 PM

    wylacot -

    As it happens, over the last ten years I’ve often entertained the thought that Italy actually won the Second World War

    America’s hard left has for generations held the viewpoint that economic, political and military crises were all being engineered to bring on totalitarianism.
    

    “In [Noam Chomsky's] reckoning, the “statist reactionaries” currently running the Executive branch are engineering a “fiscal train wreck” designed to “starve the beast”; the beast, of course, is the social welfare system … .”

    Today’s Naomi Klein interview focuses on the idea that the present state of fear will be used to crush environmental issues and reward corporate clients like the oil industry.

    The web paper (probably the world’s best independent news source) that stands at the left edge of acceptable discourse is looking at the present situation with a bit of confusion (see below).

    In my own conspiracy-theory moments I tend to concur with the ZNet gang that these crises are indeed deliberate and manufactured. However, I like to see the blogging community’s leaderless information dissemination activities (thanks Google!) as a factor that blind-sided the fascists with the unmanageable speed with which the drama unfolded for all the players.

    The period from 7/7 until about 7/22 (when the establishment will have crafted a message, Paulson’s speech, with which to be “on message” about) was one of those rare cusp moments when the high state of confusion allows genuinely diverse opinions and occasional glimpses of raw truth to peek out from behind the curtain.

    7/7 blew the prevailing ontology about America’s economic state into a cocked hat, and it will be another couple of days before the new one is in place. It is good to be aware during these times when the concrete is still wet, as this is when an incautious panicking functionary might actually fall back on telling the truth.

    “Efforts to regulate ‘Wild West’ markets are long overdue: Moves by the Fed and the Treasury to prop up mortgage giants are a welcome sign”, by David R. Francis, Christian Science Monitor, July 21, 2008.
    

    “To me,” says E.J. Dionne, Jr., a fellow at the Brookings Institute in Washington and a Washington Post columnist, “the crisis calls conservative ideology into question.”
    …

    The oddity of today is that a Republican administration is pushing an expansion of government regulation. Dionne hopes that whatever emerges in Washington will protect citizens better from Wall Street fraud and foolishness.
30. John M. says:

    July 20, 2008 at 5:21 PM

    Over the last couple of weeks we’ve seen quite a few analysts asserting we’ve seen various bits of this movie before …

    “Short Sales: SEC Turns Back the Clock to 1931″, by Charles Jones, SeekingAlpha, July 20, 2008.
    

    Emergency orders don’t happen every day, so you might think we are in uncharted waters. But when stocks go down sharply, it’s actually a fairly common response by regulators to try to throw sand in the gears and slow down the shorts. Perhaps the SEC was looking to the 1930s for guidance.

    Back in September 1931, the world economy was spiraling downward into the depths of the Great Depression. U.S. stocks had fallen about 70% (!) from their 1929 peak, and short sellers were blamed. Many people called for an outright ban on shorting. When Great Britain abandoned the gold standard on Sunday, September 21, 1931, the NYSE capitulated and issued an emergency order prohibiting all short selling. The gold standard news should’ve led to a sharp decline, but stocks advanced, mostly because specialists and other market-makers had no ability to provide liquidity on one side of the market. It became clear that the rise in prices was completely artificial, and after two days the NYSE repealed the ban.
31. John M. says:

    July 20, 2008 at 5:32 PM

    Looks like Cap’n Panick himself was reading that last one (#30) -

    “The global economy is at the point of maximum danger”, Ambrose Evans-Pritchard, Telegraph, July 20, 2008.
    

    It feels like the summer of 1931. The world’s two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution.

    UPDATE: it gets hairier as one reads lower. This nugget should freeze the blood of even battle-hardened Doomers.
    

    China, Russia, petro-powers and other foreign states own $985bn of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700bn over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a “financing crisis” within months. Foreigners have a veto over US policy.
32. John M. says:

    July 20, 2008 at 6:10 PM

    This story from the heart of the MSM (and presently Google News’ top Business story — UPDATE: now top story) neatly frames one side of Paulson’s GSE dilemma:

    “Trouble at Fannie and Freddie Stirs Concern Abroad”, by Heather Timmons, New York Times, July 21, 2008.
    

    [Fannie & Freddie] often compared their product to United States Treasuries when they talked to international investors, and adjusted the way that bonds matured and were priced so they looked and acted more like Treasury bonds.

    In an interview with a London financial trade paper in 1999, Jerome T. Lienhard, Freddie Mac’s senior vice president of investment funding, said, “Investors that make the transition from U.S. Treasuries to our securities will be pleased with the performance.” Freddie Mac’s program is “designed to mirror that already used by the United States government,” he said.
    …

    Questions about Fannie and Freddie have prompted individual institutions and governments in Asia and Europe to specify their exposure in recent days, but so far international concern has been limited. …
    …

    Hannover Re, Germany’s second-largest reinsurer after Munich Re, said it held 125 million euros, or $199 million, in securities issued by Freddie Mac and Fannie Mae. “We are not worried about the exposure,” said Stefan Schulz, a spokesman for the company, “because we expect the U.S. government to step in if there is any problem.”
33. agnostic says:

    July 21, 2008 at 12:24 PM

    John – I want to refer/commend everybody to Thomas Donlan’s column in Barron’s, specifically, the quote from Jim Rogers, speaking on a potential GSE bailout “What is This? It ruins the Federal Reserve’s balance sheet, it makes the dollar more vulnerable, and it increases inflation, and it drives down the dollar.”
34. agnostic says:

    July 21, 2008 at 12:27 PM

    Also, hilariously, Donlan coins the term “Feddie” as the collective taken-over F&F. I’m going to have to start using it.
35. John M. says:

    July 21, 2008 at 1:10 PM

    agnostic (#33) -

    Here’s coverage (and a video interview with Rogers).

    “Jim Rogers attacks Fannie Mae and Freddie Mac bail-out”, by James Quinn, Telegraph, July 18, 2008.

    Also, the article you refer to is presently available online.

    “Is This Capitalism?”, Thomas G. Donlan, Barron’s, July 21, 2008.
    

    Yet people who considered themselves risk-averse bought stacks of F&F paper as higher-yielding substitutes for “risk free” Treasuries. They thought that Fannie and Freddie are backed by the federal government — even though the government always shrank from saying so explicitly.

    Myth Becomes Reality

    Regrettably, some of the naive investors were right. Fannie and Freddie — henceforth to be known as Feddie — are backed by the federal government. The Treasury, the Federal Reserve, the Congress and the White House have tuned up and now sing in chorus, declaring that Feddie is indeed the ultimate example of “too big to fail.” They will buy Feddie stock, lend to it from the Treasury or the discount window of the Fed. They will do whatever else it takes to be sure that holders of Feddie-guaranteed mortgages don’t lose their money.

    By the way, this comment helped my memory along. The quote “Capitalism is the exploitation of man by man; with socialism it’s the other way around.” IIRC was in a Len Deighton novel. The Soviet spy is bantering with the Western spy. The soviet one remarks that he thinks the remark was funny, even though he’s just arrested someone for repeating it. The commenter gives “Funeral in Berlin” for the source.

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