T Nation

Serious Question! Need Help!

Since the level of discussion here has risen tremendously of late, I think its time for a very serious question, one that effects us all.

Is our Federal government finally trapped by debt? If they bail out Freddie and Fannie, the amounts are so huge that the Feds would have to borrow trillions. This will very seriously dilute the current value of existing treasury securities. The people owning these debt instruments will NOT stand idly by while the value of their investment plunges. Our bond market will simply collapse.

On the other hand, letting Fannie and Freddie go bankrupt affects thousands of banks and insurance companies that invested in them. The Fed even let banks use F and F stocks as capital, to buttress new loans!!

I’m quite simply terrified of this scenario.

Is this a disaster approaching like Gustav, only no one is warning? Thoughts? Discussion?

They’ll put in on credit, in China.:slight_smile:

[quote]Headhunter wrote:
Since the level of discussion here has risen tremendously of late, I think its time for a very serious question, one that effects us all.

Is our Federal government finally trapped by debt? If they bail out Freddie and Fannie, the amounts are so huge that the Feds would have to borrow trillions. This will very seriously dilute the current value of existing treasury securities. The people owning these debt instruments will NOT stand idly by while the value of their investment plunges. Our bond market will simply collapse.

On the other hand, letting Fannie and Freddie go bankrupt affects thousands of banks and insurance companies that invested in them. The Fed even let banks use F and F stocks as capital, to buttress new loans!!

I’m quite simply terrified of this scenario.

Is this a disaster approaching like Gustav, only no one is warning? Thoughts? Discussion?[/quote]

That is a fabulous question, one I’m wholly unqualified to answer and one I would also like to have answered. I will say I’m sick of tired of having to worry about shit I had no voluntary part in creating.

[quote]Majin wrote:
They’ll put in on credit, in China.:)[/quote]

Considering China is the top foreign holder.

[quote]Tiribulus wrote:
Headhunter wrote:
Since the level of discussion here has risen tremendously of late, I think its time for a very serious question, one that effects us all.

Is our Federal government finally trapped by debt? If they bail out Freddie and Fannie, the amounts are so huge that the Feds would have to borrow trillions. This will very seriously dilute the current value of existing treasury securities. The people owning these debt instruments will NOT stand idly by while the value of their investment plunges. Our bond market will simply collapse.

On the other hand, letting Fannie and Freddie go bankrupt affects thousands of banks and insurance companies that invested in them. The Fed even let banks use F and F stocks as capital, to buttress new loans!!

I’m quite simply terrified of this scenario.

Is this a disaster approaching like Gustav, only no one is warning? Thoughts? Discussion?

That is a fabulous question, one I’m wholly unqualified to answer and one I would also like to have answered. I will say I’m sick of tired of having to worry about shit I had no voluntary part in creating.[/quote]

Isn’t that the truth…but it most certainly will affect us. I wonder how this will play into the presidential debates.

The level of discussion is as ankle high as ever, if anything, you personally could rise it a bit by refraining from posting.

The markets have already adjusted to the possibility of this happening. Remember that the US gov won’t have to pay all the debt backed by the GSE’s. This debt is still backed by the security of the mortgages that make up those issues. The VAST majority of mortgages are still current and in no danger of going into forclosure. At most, the gov would only have to inject enough capital to bring capital ratios up to acceptable levels going forward.

It is not the existing mortgages that should concern us, for as a matter of fact, most of us are not the investors that hold these bonds. What we should be concerned about is the availability of future funds for people to buy real estate or for that matter borrow money. If there were no GSE’s, conforming rates would look much more like those for Jumbo loans, about 1% point higher as of today.

If Fannie and Freddie fail, the mortgage market will still exist, but we can expect to pay higher rates. Hence, we should expect house values to decline or stagnate for a longer period of time.

However, we absolutely must restore confidence in credit markets. We have to remember the formula that worked to bring us out of the Great Depression. Save the Banks + Create Domestic Jobs = Fertile ground for domestic growth.

IMO, the US taxpayer has always had the potential burden of Fannie and Freddie issues regardless of whether or not they fail. What I find to be utterly worthless, is everyone (politicians, pundits, worthless CNBC reports, etc…) debating what is the cheapest way to fix the problem or Moral Hazard. Why not look at this not as a problem but as an opportunity.

Why not throw them both in Chapter 11, and allow the Social Security trust fund to buy the companies. This way it costs nothing new in tax payer dollars and the american taxpayer gets a helluva deal by buying tremendously valuable companies at an absolutely rock bottom throw away price.

A problem is that there is no Social Security Trust Fund at least if one defines a trust fund as actually possessing money or negotiable securities or notes that others are obligated to pay and can be expected to pay.

Rather, the Newspeak-named Social Security Trust Fund consists of promises of the government to repay Social Security for surpluses that it has taken and spent for the general budget.

It’s not money available to buy anything of any kind. There may not be enough actually-spendable money in it to get a Starbucks coffee (I’m not sure that there’s necessarily absolutely zero cash in hand, perhaps on a momentary basis there are funds that haven’t been taken by the Treasury yet.)


Here’s charts of these stocks. Banks and insurance companies bought billion upon billions of the shares, especially the prefs. Banks used these shares as a base to make their loans! The shares are a big chunk of their reserves!!

For all intents and purposes, most bamks now have negative equity. THAT is a disaster.

Then, senior bonds always get paid off first. That means any bailout money has to go to bondholders first, which means the Fed gives F and F trillions just to prop up the stocks. Remember, bondholders always get paid first.

This seriously scares the hell out of me!!

[quote]Bill Roberts wrote:
A problem is that there is no Social Security Trust Fund at least if one defines a trust fund as actually possessing money or negotiable securities or notes that others are obligated to pay and can be expected to pay.

Rather, the Newspeak-named Social Security Trust Fund consists of promises of the government to repay Social Security for surpluses that it has taken and spent for the general budget.

It’s not money available to buy anything of any kind. There may not be enough actually-spendable money in it to get a Starbucks coffee (I’m not sure that there’s necessarily absolutely zero cash in hand, perhaps on a momentary basis there are funds that haven’t been taken by the Treasury yet.)[/quote]

You know it, I know it, and the rest wants socialized health care.

Do you have your off-shore account yet?

Because no one will benefit if the sinking ship is taking you and your family down too.

That is all I have, democratic socialism must die a natural death too, we cannot stop it.

[quote]Headhunter wrote:
Here’s charts of these stocks. Banks and insurance companies bought billion upon billions of the shares, especially the prefs. Banks used these shares as a base to make their loans! The shares are a big chunk of their reserves!!

For all intents and purposes, most bamks now have negative equity. THAT is a disaster.

Then, senior bonds always get paid off first. That means any bailout money has to go to bondholders first, which means the Fed gives F and F trillions just to prop up the stocks. Remember, bondholders always get paid first.

This seriously scares the hell out of me!! [/quote]

While I understand that you might be scared, what you described is actually not possible. They may have a loss on that position but it would be offset elsewhere by equity on the balance sheet. Banks cannot operate with negative equity. This violates every basic accounting principle.

There are reasons to be scared of our fiscal and monetary situation but the ownership of Freddie and Fannie common stock and even preferreds is definitely not one of them. These securities are all mark-to-market and updated and reflected on banks’ balance sheets everynight. If they were at negative equity it would be reflected when they reconcile their fed wires every night.

[quote]Bill Roberts wrote:
A problem is that there is no Social Security Trust Fund at least if one defines a trust fund as actually possessing money or negotiable securities or notes that others are obligated to pay and can be expected to pay.

Rather, the Newspeak-named Social Security Trust Fund consists of promises of the government to repay Social Security for surpluses that it has taken and spent for the general budget.

It’s not money available to buy anything of any kind. There may not be enough actually-spendable money in it to get a Starbucks coffee (I’m not sure that there’s necessarily absolutely zero cash in hand, perhaps on a momentary basis there are funds that haven’t been taken by the Treasury yet.)[/quote]

You are absolutely right that the Trust Fund cash has been used and given and IOU (in actuality what it does is buy treasury securities). That wouldn’t be a bad thing if those securities yielded more than enough to keep up with the rate of inflation and the decreasing annual surplus that the program currently has. But in all actuality, it wouldn’t even matter if there was cash. We could borrow funds from the Chinese at 4.4% and use that to buy the piddly little equity that is left. That is exchanged for a face amount of the existing IOU that the Fund holds from the treasury.

Fannie and Freddie debt has the implicit backing of the US taxpayers. No matter what happens, bailout or not, we all own that responsibility. The cash flow that these companies generate is HUGE!!! Someone is going to own them and most likely it will be a sovreign fund from some middle east or asian country (for reference on this see who has provided liquidity into all recent bank capital raises). Think about that…they come with a minimal amount of capital and own the equity and all cash flows to a company whose debt is still and will be implicity guaranteed by us.

That’s the equivalent of any of us going in and buying Bill Gates’ house with only $100,000 and Warren Buffet is responsible for the mortgage. Sign me up for that one!

If the Feds bail out Freddie and Fannie, they have to issue huge amounts of debt to fund such a venture. This makes outstanding debt instruments worth less than before, simply by volume. Investors bail, and the bond market completely tanks. (I remember 30 year T-bonds paying 14% in 1981).

If the Fed doesn’t bail out Freddie and Fannie, then an asset that is very widely held by many large financial institutions becomes worthless. Those stocks were a very large chunk of their assets. In fact, the Fed allowed banks to use those stocks as capital equivalents, as a basis in fractional reserve banking.

It seems that either/or is an unprecedented disaster waiting to happen.

[quote]Headhunter wrote:
If the Feds bail out Freddie and Fannie, they have to issue huge amounts of debt to fund such a venture. This makes outstanding debt instruments worth less than before, simply by volume. Investors bail, and the bond market completely tanks. (I remember 30 year T-bonds paying 14% in 1981).

This is not necessarily the case. The only amount that would have to be issued would be enough to bring the company’s balance sheet into compliance, which it currently still is. This money would have to be added as Level 1 equity.

If the Fed doesn’t bail out Freddie and Fannie, then an asset that is very widely held by many large financial institutions becomes worthless. Those stocks were a very large chunk of their assets. In fact, the Fed allowed banks to use those stocks as capital equivalents, as a basis in fractional reserve banking.

This is absolutely not the case. The only asset that would most likely become worthless would be the common stock of Fannie and Freddie. If any bank owns shares of Fannie or Freddie this asset rests on the same side of the balance sheet as their loans, as an asset. Fractional reserve banking has absolutely nothing to do with this. You haven’t mentioned anything about the other side of the balance sheet which is the only thing that bring a bank into non-compliance (ie a simultaneous run of deposits on the bank with faltering market value of its outstanding loans). I will repeat myself here, if Freddie and Fannie stock is worthless, that event has NOTHING to do with other banks.

Not trying to be a dick here, but let’s at least have some sort of semblance of facts to this thread.

It seems that either/or is an unprecedented disaster waiting to happen.[/quote]

Let’s put this in perspective here. The US taxpayer is on the hook for the debt issued by Fannie and Freddie. This debt, for the most part is all packaged mortgage pools. The vast majority of these mortgages are fine and will never miss a payment, go into arrears, or come close to touching forclosure.

So in a nightmare scenario, all the US taxpayers are really on the hook for is the decrease in market value on mortgages that go into forclosure (this would even assume that those mortgages were 100% financing). So let’s say that somehow, this whole thing is as bad as the media makes it out to be and the entire nation jumps to 10% forclosure rates (right now national average is less than 1%!) and we see a total depreciation of 50% nationwide on those homes. What would that mean to the US taxpayer?

Fannie and Freddie guarantee about $5 Trillion of mortgage debt. That multiplied by 10% would be $500 Billion of mortgages. That multiplies by a 50% decline in asset coverage would only be $250 Billion, or to put that in context, only about half of what we have currently spent on the Iraq War. So this absolutely nightmare scenario (which would take a 10-fold increase in forclosures) would still only result in a burden to the US taxpayers of 50% of the to-date cost of the Iraq War. So no I do not think for one moment that this is a disaster of the epic proportions that you fear. The facts quite simply tell a different story.

[quote]ajcook99 wrote:
?

Fannie and Freddie guarantee about $5 Trillion of mortgage debt. That multiplied by 10% would be $500 Billion of mortgages. That multiplies by a 50% decline in asset coverage would only be $250 Billion, or to put that in context, only about half of what we have currently spent on the Iraq War. So this absolutely nightmare scenario (which would take a 10-fold increase in forclosures) would still only result in a burden to the US taxpayers of 50% of the to-date cost of the Iraq War. So no I do not think for one moment that this is a disaster of the epic proportions that you fear. The facts quite simply tell a different story.[/quote]

First off, thanks. Good responses.

Now the questions: Why are the stocks down so much? And since they are, doesn’t that mean that banks holding these stocks are taking huge losses?

Next, because of fractional reserve banking, banks can make $10 in loans for every dollar in reserve. That means 250 billion has the impact of 2.5 trillion; in other words, if 250 billion vanishes, that’s really 2.5 trillion from our economy.

Thanks again for trying to explain all this to me. It is bewildering, that’s for sure. :>

HH,

Yes the banks, mutual funds, pension funds, insurance companies, individuals, etc…that are holding the stocks could have huge losses on those holdings. But those losses are no different than the losses they would holding if they owned GM, Ford, Enron, Worlcom, etc…stock. The way fractional reserve banking works is that banks can make (with a reserve requirement of 10%) $9 worth of loans for every $10 deposited at the bank. It has nothing to do with the equity (stock value) of the banks. However, the stock value is typically a market preception of the health of the company.

In this case, the market believes that these companies might have to take further write-downs of the assets (loans) that they own. This could put them in violation some net capitalization rules for financial institutions.

In most scenarios, the companies might not have to go into involuntary Chapter 11. That doesn’t mean that the stocks aren’t worthless though. I for one as a taxpayer, would rather see our government take over these companies at $.01/share and leave the current stakeholders to bare the brunt of the risk that they took.

The rules of fractional reserve banking wouldn’t apply to the potential loss that I hypothetically spoke of. Remember that Fannie and Freddie didn’t actually make these loans, they simply guarantee them. Think of it like insurance on a new car. If you drove that car off the lot for the first time and got in accident, most likely there is a diffence between the price you paid and the market value of the car. That negative equity that insurance wouldn’t cover is your loss. You wouldn’t be out the whole price of the car.

In all actuality, most loans bought and packaged up by Fannie were not 100% financing either. The loans that were 100%, were usually made up of a 80%/20% first-second lein combo and the GSE’s only bought the first. So our exposure as taxpayers is still even buffered further by the fact that the second leinholder (20%) has to take it in the shorts before we have any exposure.

But then again none of this is sensational as, “Potential $5 Trillion exposure for US Taxpayers!”.

This whole situation is confusing, but it’s really not as bad as we might think by watching the news.

HH,
Sorry one more thing here that I think might be confusing you: it’s not the stocks of these companies that the Fed allowed banks to be able to use at the Fed window, it is the debt issues that they guarantee.

If we continue down this road of out of control entitlement spending the road will come to an end. But that dead end is still 25 to 35 yrs away.

There is plenty of time to get this in order but whether or not we can is another matter. If you talk about just slowing the growth of something/some program you are attacked as someone who wants to cut benefits on the poor or elderly.

With that said you still have to look at this in terms of GDP and our debt to GDP is still around half of Japans for instance.

So while it is cause for some concern - I do not see a catastrophe in the near term of say 20 yrs.

One has to remember that the US economy and world economy is much different and much more diversified than the 20’s and 30’s.

Another thing to look at is all the states out there. I have not looked at this lately but I do know that not too long ago if you took all the surpluses and debts of state governments and added it to the fed gov - the deficit is not all that bad when you consider the size of this economy.

100,000 of debt is quite bad if you only bring in 10k/yr. But if you bring in 50k/yr then it is not near the problem.