Sunday, September 7, 2008

Fannie Mae and Freddie Mac - What does it mean?

Note added 9 September:

The Times columnist, Anatole Kaletsky, has this to say about Freddie Mac and Fannie Mae:

'Anyone betting against this package is, therefore, betting that the US economy is doomed to irreversible and inevitable decline. Such a bet has always been wrong in the past and is likely to be wrong again this time. So Sunday's probably was the Big One - and a US economic recovery is now assured.'
As will be seen below, I am not so optimistic. The idea that the biggest government intervention in history is seen as a 'good thing' suggests that the markets themselves (a curious metonymy, like they have agency?) have lost faith in themselves and the economies that they constitute.

Original post continues.......

A very quick post on the nationalisation of Fannie Mae and Freddie Mac. There appear to be very positive responses to the US government nationalisation of these institutions.

The first point to note here is that this will help the battered balance sheets of the UK banks, as many of them hold debt issued by these institutions. This is good news for the UK banking system. However, having seen the positive, it is worth considering the negative. If these two institutions were in so much trouble due to the collapse in the US housing market, what of the UK institutions?

I have often predicted runs on some of the major UK banks in the coming months, and the saga of Fannie Mae and Freddie Mac just continues to confirm my worst fears. The recent headlines do not mention that one of the problems for these institutions was that they were indirectly buying into the US sub-prime market, but the big question today is one of how you might define sub-prime. My own view is that, with a collapsing housing market and rising unemployment, there is an awful lot of sub-prime out there. However, in the case of the UK banking system, unlike the US mortgage giants, the UK lenders will be exposed to huge amounts of souring consumer credit, as well as souring commercial lending.

The big question this raises is to where it might be that the UK banks might be able to raise the finance to shore up their balance sheets. For a while, sovereign wealth funds looked like one option. However, as is reported in the Economist, they have already had their fingers burnt in the banking market, and are unlikely to come back for more pain. The Economist suggestst that. perhaps, private equity will come to the rescue, but this appears to be a forlorn hope. One has to ask why they would take on such risk.

The reality is that the UK has been bailing out the banks for some while, through the special liquidity schemes. How long can this go on?

The other problem that arises is illustrated by the US example. The US government has taken on huge liabilities meaning that, one way or another, the US taxpayer is going to pick up the bill for the problems in Fannie Mae and Freddie Mac. It is worth being 100% clear on what that means. It means that the productive parts of the economy will be picking up the bill for the financial disaster. In other words the problems of Fannie Mae and Freddie Mac will hobble the productive part of the US economy.

As the US government is aware, the collapse of the mortgage giants would have seen a systemic crisis in the whole banking system, in both the US and the OECD. They have chosen not to have the crisis. Is this a good thing?

I will confess to, for once, being unsure. On the one hand I can game out the consequences of the collapse of the institutions, and can see the financial meltdown that would follow. On the other hand there is the reality that this would create the rebalancing of the world economy faster, creating the opportunity for the OECD to make the necessary structural reforms to compete with the emerging economies. In other words, I wonder whether this is not a case of prolonging the agony? It returns to the analogy I made in a previous post about falling from a height, or climbing down a ladder.

In the case of the UK, I wonder whether the UK government will have the financial wherewithal to actually have a choice in the matter. When the next credit crisis strikes, I expect confidence in the UK economy to be at a very, very low point, and the only way the government will be able to finance the bail outs will be through 'printing' money, with all of the negative consequences that entails.

It will be interesting to watch the reaction to the nationalisation in the coming weeks. I suspect there will be a brief bounce in confidence, but that the underlying economic problems will quickly dent that confidence. The trouble is that there is no escaping the reality that there must be a massive rebalancing in the world economy, and no amount of intervention can stop that process. In such circumstances, it is quite possible that, in the long term, such bailouts will only create more pain than gain.

For the UK, perhaps bailing out the two mortgage giants may delay the next credit crisis for a few months, but nothing more than that.....and the longer the delay, the worse the crisis that will follow.

1 comment:

  1. The Anatole Kaletsky article has a very Polly Toynbee-esque feel to it, I think.


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