July 12, 2008

Fannie Freddie Melt Down will Get the Banks

Private sector capitalism is failing, and the public sector (tax payers) is propping it up. This is a golden opportunity for fundamental socio-economic change.

Fannie Mae and Freddie Mac have been in trouble for a long time, but now the crisis phase has begun. This was all predicted in great detail, documented in the February 2003 report entitled "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO, [PDF]." The report was issued under the direction of Armando Falcon, Director of the Office of Federal Housing Enterprise Oversight (OFHEO). He warned Congress that many large financial institutions were systemically linked to Fannie Mae and Freddie Mac. If Fannie and Freddie, or real estate in general, tumbled, the rest of the economy could likely be pulled down as well. Falcon's reward for this honest insight and advice was to be fired by the Bush Administration.

This risk of the banks getting sucked down with Freddie Mac and Fannie Mae is summarized in the following, where "GSE" refers to government-sponsored entities, i.e., Fannie and Freddie:
[A]t year-end 2001 over 4,800 commercial banks—over sixty percent of the institutions in the banking industry—held GSE debt in excess of 50 percent of their equity capital. Nearly sixty percent of those banks have less than $100 million in assets; over ninety-seven percent have assets of less than $1 billion. Of banks with assets of more than $1 billion, 123 institutions —over 30 percent of banks of that size —owned GSE debt in excess of 50 percent of their equity capital.

In plain English, if Fannie Mae and Freddie Mac default on their debt, many banks will go under, unless the tax-payer bails them out. If the latter, then we, the people, should demand future part-ownership, and profit-sharing, in the entities we bail out.

For further synopsis of the report, see OFHEO Warning of February 2003.



libhom said...

I was listening to the Left Business Observer on WBAI, and now I understand why the federal government will bail out Fannie Mae and Freddie Mac.

Their securities always have had an implicit federal government guarantee. Lenders, including foreign central banks, have bought the investments, and the amounts are in the trillions of dollars.

If the federal government lets those two financial institutions go poof, it would be similar in effect to the US government going into default.

GDAEman said...

Agreed. The report cited in my blog entry quantifies this. What's of note is that the author of the report was fired by Bush cronies for writing it.