Tuesday, September 9, 2008

Exposing Fannie Mae and Freddie Mac - The Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=Q8XU5XhwdyY..

In mid-July 2008, Fannie and Freddie's stock prices were plummeting, with Freddies stock getting into the low single digits. Knowing that they had to do something right away, the Federal Reserve and Treasury department announced emergency measures to rescue the two companies. First, the Fed opened its discount window to Fannie and Freddie, something that had only been available to commercial banks for more than seven decades until broker-dealers also got access to the Fed in March 2008 (it was clear that the expansion of this privilege to more and more industries was a trend in the making). Secondly, the Treasury department went to Congress with a bailout plan. Secretary Paulson asked for a blank check from the U.S. government on behalf of Fannie and Freddie on the grounds that just having such strong financial backing would prevent their problems from getting worse. In less than two months the U.S. government would be forced to take direct control of both institutions, indicating that this was either one of biggest lies or most imbecilic statements in U.S. financial history.

The U.S. congress passed the 'Federal Housing and Economic Recovery Act of 2008' in late July. In the bill, Paulson got the blank check he requested, at least until the end of 2009. Provisions were also made to give up to 400,000 homeowners lower fixed-rate interest rates loans and an additional $3.9 billion was allocated for neighborhood grants (which seemed to be some pork barrel provision). The bill also established a new regulator for Fannie and Freddie to replace OFHEO. There was nothing wrong per se with OFHEO's regulation, other than every time it tried to control Fannie or Freddie, powerful politicians stepped in to prevent it. Of course, the politicians responsible for creating the Fannie and Freddie mess were not going to put the blame on themselves, but tried to make OFHEO the fall guy instead.

Without question, the most outrageous part of the bailout bill was its cost estimate. The Congressional Budget Office (CBO) predicted it would cost only $25 billion (the same as the cost they predicted for the Iraq War, now estimated by a recent outside study to be over 100 times higher at $3.2 trillion). The CBO even made the preposterous statement that there was a greater than 50% chance the bailout would cost U.S. taxpayers nothing. What thinking, or lack thereof, led to this conclusion is not clear. Since everyone agreed that Freddie Mac was insolvent, by definition it would have to have money pumped into it to keep it operating. So from the beginning there was a zero percent chance that the bailout would cost nothing.

There is certainly evidence that Congress itself had a more realistic assessment of the potential bailout costs. As part of the rescue package, they raised the national debt ceiling $800 billion (the sixth time the national debt ceiling was raised during the Bush administration) to $10.6 trillion. If the bailout was going to cost only $25 billion, there was no need for a higher debt ceiling. Clearly the cost estimates were meant for a gullible public, not Washington insiders who knew the truth. It was the New York Investing meetup's opinion that the Fannie Mae and Freddie Mac bailout would cost U.S. taxpayers at least a trillion dollars - and even that might be an optimistic projection.

NEXT: Exposing Fannie Mae and Freddie Mac - Future Risks

Daryl Montgomery.
Organizer, New York Investing meetup.

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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