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.