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- The Government bailout of the debts of Fannie
Mae is but the next stage of the Tsunami catastrophe ravaging the US economy
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- George W. Bush is already predestined to go down
in history books as the Second Herbert Hoover as the Second Great Depression
deepens
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- Treasury chief Paulson and Fed chief Bernanke
are part of the 'Plunge Protection Team' to rescue Wall Street at taxpayer
cost
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- The announcement by US Treasury Secretary Henry Paulson
together with Federal Reserve chief Bernanke, that the US Government will
bailout the two largest guarantors of housing mortgage debt-the Fannie
Mae and Freddie Mac-far from calming financial markets, has confirmed
what we have said repeatedly in this space: The Financial Tsunami which
began in August 2007 in the relatively small "sub-prime" high
risk US mortgage securitization market, far from being over, is only gathering
momentum. As with the Tsunami which devastated Asia in wave after terrifying
wave in December 2004, the financial Tsunami we are witnessing is a low-amplitude,
long-wave phenomenon of trillions of dollars of financial securities being
unwound, defaulted on, dumped on the market. But the scale of the latest
wave to hit, the collapse of confidence in the two Government-Sponsored
Entities, Freddie Mac and Fannie Mae, is a harbinger of worse to come
in what will be the most devastating financial and economic catastrophe
in United States history. The impact will be felt globally.
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- The Royal Bank of Scotland, one of the largest financial
institutions in the EU has warned its clients "A very nasty period
is soon to be upon us-be prepared." They expect the S&P-500 index
of US stocks, one of the broadest stock indices in Wall Street used by
hedge funds, banks, pension funds could lose almost 23% by September as
in their term, "all the chickens come home to roost" from the
excesses of the US-led securitization revolution that took hold after
the dot.com bubble burst and Greenspan lowered US interest rates to levels
not sustained since the 1930's Great Depression.
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- This all will be seen in history as the disastrous Alan
Greenspan "Revolution in Finance,"-the experiment in Asset
Backed Securitization, a mad attempt to bundle risk in loans, "securitize"
them in new bonds, insure them via specialized insurers called "monoline"
insurers (they only insured financial risks in bonds), rate them thereby
via Moody's and S&P as AAA, highest grade. All that was done so that
pension funds and banks around the world would assume they were high quality
debt paying even higher interest than safe US Government bonds.
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- Fed in Panic Mode
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- While he is getting praise in the financial media for
his "innovative" and quick reactions to the un-raveling crisis,
Fed chairman Ben Bernanke in reality is in a panic mode with little short
of hyperinflationary tools at hand to deal with the crisis. Yet, his
room to act is increasingly bound by the soaring asset price inflation
in food and oil which is pushing consumer price inflation to new highs
even by the doctored "core inflation" model of the Fed.
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- If Bernanke continues to act to provide unlimited liquidity
to prevent a banking system collapse, he risks destroying the US corporate
and Treasury bond market and with it the dollar. If Bernanke acts to save
the heart of the US capital market-its bond market-by raising interest
rates, its only anti-inflation weapon, it will only trigger the next even
more devastating round in Tsunami shock waves.
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- The real significance of the Fannie Mae bailout
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- The US government passed the law creating Fannie Mae
in 1938 during the Great Depression as part of President Franklin D. Roosevelt's
New Deal. It was intended to be a private entity but "government
sponsored" that would enable Americans to finance buying of homes,
as part of an economic recovery attempt. Freddie Mac was formed by Congress
in 1970, to help revive the home loan market. Congress started the companies
to promote home buying and their charters give the Treasury the authority
to extend a $2.25 billion credit line.
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- The problems in the privately-owned Government "Sponsored"
Entities or GSEs as they are technically known, is that Congress tried
to fudge on whether they were subject to US Government guarantee in event
of a financial crisis as the present. Before now, it always appeared a
manageable problem.
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- No more.
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- The United States economy is in the early phase of its
worst housing price collapse since the 1930's. No end is in sight. Fannie
Mae and Freddie Mac, as private stock companies, have gone to excesses
in leveraging their risk, most as many private banks did. The financial
market bought the bonds of Fannie Mae and Freddie Mac because they bet
that the two were "Too Big To Fail," i.e. that in a crisis the
Government, that is the US taxpayer, would be forced to step in and bail
them out.
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- The two, Fannie Mae and Freddie Mac, either own or guarantee
about half of the $12 trillion in outstanding US home mortgage loans,
or about $6 trillion. To put that number into perspective, the entire
27 member states of the European Union in 2006 had an annual GDP of slightly
more than $12 trillion, so $6 trillion would be half the GDP of the combined
European Union economies, and almost three times the GDP of the Federal
Republic of Germany.
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- In addition to their home mortgage loans, Fannie Mae
has another $831 in outstanding corporate bonds and Freddie Mac has $644
billion in corporate bonds.
- Freddie Mac owes $5.2 billion more than its assets today
are worth meaning under current US "fair value" accounting rules,
it is insolvent. Fair value of Fannie Mae assets has dropped 66% to $12
billion and may as well go negative next quarter. As the home prices
continue to fall across America, and corporate bankruptcies spread, the
size of the negative values of the two will explode.
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- On July 14, symbolically the anniversary of Bastille
Day, US Treasury Secretary Paulson, former chairman of the powerful Wall
Street investment bank Goldman Sachs, stood on the steps of the US Treasury
building in Washington, a clear attempt to add psychological gravitas,
and announced that the Bush Administration would submit a bill proposal
to Congress to make taxpayer guarantee of Freddie Mac and Fannie Mae explicit.
In effect, in the present crisis it will mean nationalization of the $6
trillion agencies.
- The bailout by Paulson was accompanied by a statement
by Bernanke that the Fed stood ready to pump unlimited liquidity into
the two companies.
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- The Federal Reserve is rapidly becoming the world's largest
financial garbage dump as for months it has agreed to accept banks' Asset
Backed Securities including sub-prime real estate bonds as collateral
in return for US Treasury bond purchases. Now it agrees to add potentially
$6 trillion in GSE real estate debt to that.
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- However, the disaster in the two private companies was
obvious as far back as 2003 when grave accounting abuses in the two companies
were made public. In 2003 then President of the St. Louis Federal Reserve,
William Poole publicly called for the US Government to cut its implied
guarantee of Freddie Mac and Fannie Mae claiming then that the two lacked
capital to weather severe financial crisis. Poole, whose warnings were
dismissed by then Fed Chairman Greenspan, called repeatedly in 2006 and
again in 2007 for Congress to repeal their charters and avoid the predictable
taxpayer cost of a huge bailout
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- As financial investors warn the Paulson bailout is not
a bailout of the US economy but a direct bailout of his Wall Street financial
cronies. What until recently had been the largest bank in terms of loans
outstanding, Citigroup in New York, has been forced to raise billions
in capital from Sovereign Wealth Funds in Saudi Arabia and elsewhere to
remain in business. In its May announcement, Citigroup's new Chairman
Vikram Pandit announced plans to reduce the bank's $2.2 billion balance
sheet of liabilities. However, he never mentioned an added $1.1 trillion
in Citigroup "off balance sheet" liabilities which include some
of the highest risk deals in the US real estate and securitization era
it so strongly backed. The Financial Accounting Standards Board in Connecticut,
the official body defining bank accounting rules is demanding tighter
disclosure standards. Analysts fear Citigroup could face devastating new
losses as a result with value of liabilities exceeding the bank's $90
billion market value. In December 2006 prior to the onset of the Tsunami
crisis, Citigroup had a market value of more than $270 billion.
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