Thursday, September 11, 2008

Exposing Fannie Mae and Freddie Mac - The Government Takeover

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: TBA

It took only about six weeks after congress passed a bailout package before the U.S. government had to take direct control of Fannie Mae and Freddie Mac. The terms of the bailout package were open ended and extremely generous at Treasury Secretary Paulson's insistence. He claimed that if it was made obvious that the full financial power of the United States government was behind Fannie and Freddie, the need to take any action would be minimized (despite the fact that is was universally agreed that Freddie was insolvent and would therefore need continual cash infusions to keep operating). The Congressional Budget Office backed up Paulson by estimating that there was a greater than a 50% chance that the bailout would cost nothing.

On September 7th, the U.S. government seized Fannie Mae and Freddie Mac, firing their top management and taking direct control of their operations. The Treasury department announced almost immediately that it would initially be pumping $200 billion into the two companies (so much for the bailout costing taxpayers nothing). Auditors who had been examining Freddie and Fannie's books found that Freddie had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of 2008, which it wouldn't have had to disclose until early 2009. Fannie Mae had used similar methods, but to a lesser degree. Both companies needed capital and a lot of it to keep operating. One wondered how many U.S. banks and brokers were doing similar things with their books, but the public didn't know about it because there were no outside auditors to tell them.

With the government takeover, Fannie and Freddie's over $5 trillion in debt would now reasonably have to be added to the official U.S. national debt figures. Adding Fannie and Freddie's total debt to the national debt would increase it to between $14 or $15 trillion or roughly the size of the official GDP figures (the actual GDP figures were much lower than those claimed by the government and the actual national debt, including social security, medicare and medicaid entitlements was somewhere around 50 to 60 trillion dollars). Ironically, the idea of privatizing Fannie Mae was conceived of in the 1960s during the Johnson administration to get its debt off the government's books.

The government bailout was intended to support Fannie and Freddie's bonds, many of which were held by foreign governments including China and Russia. U.S. banks and thrifts also held an estimated $1 trillion of this debt. If Fannie and Freddie defaulted on their bonds, the U.S. would have had great difficulty ever borrowing again from foreign sources and both our government and economy would wind up seizing up almost immediately. A number of U.S. banks would likely have gone under soon thereafter as well in the event of a bond default. While bonds holders got bailed out, the stockholders were wiped out. This included U.S. pension funds, most of whom were major holders of Fannie Mae and Freddie Mac stock.

Fannie and Freddie were by far the largest bailout in U.S. financial history. Where would the already debt ridden U.S. government get the money to pay for it? If it couldn't borrow the money, which was indeed likely, it would have to print it. Only time would tell how much inflation this would cause and how much value the U.S dollar would lose as a result .

NEXT: Probable Future Outlook for the United States

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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