FNE/FRE Bailout: Best analysis I have seen..
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January 4, 2010
Timothy Geithner Meets Vladimir Lenin
John P. Hussman, Ph.D.
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“The best way to destroy the capitalist system is to debauch the currency.”
Vladimir Lenin, leader of the 1917 Russian Revolution
Last week, while Congress and the nation were preoccupied with the holidays, the Treasury made a Christmas eve announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years. The Treasury's press release notes:
“At the time the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship in September 2008, Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth. Treasury is now amending the PSPAs to allow the cap on Treasury's funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years.”
Put simply, in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone. Under the Housing and Economic Recovery Act of 2008 (HERA), the Treasury has no such open-ended authority. Indeed, the applicable portion of the Act explicitly limits the total amount of mortgage principal (not losses, but total principal) as follows:
"LIMITATION ON AGGREGATE INSURANCE AUTHORITY.—The aggregate original principal obligation of all mortgages insured under this section may not exceed $300,000,000,000."
That's $300 billion of original principal. If there is some loophole by which the Treasury's action is legal, it's clear that it was no part of Congressional intent, and certainly not broad public support. Taxpayers are now being obligated by the Treasury and the Fed to make good on a potentially much larger volume of bad mortgage loans, made by reckless lenders, guaranteed by Fannie Mae and Freddie Mac in return for a pittance (called a “G-fee”), and packaged into securities which are now largely owned by the Federal Reserve, which has acquired them through outright purchases (not traditional repurchase agreements).
As I wrote several weeks ago, “The Federal Reserve has expanded the U.S. monetary base by more than 150% since the beginning of the recession. That is not a typo. The monetary base has soared from $800 billion to over $2 trillion. Much of this has been accomplished through outright purchases of mortgage-backed securities (not repurchases) and an equivalent creation of base money. Unless these securities can be sold back out into private hands for the same value that was paid to acquire them, the Fed will have effectively forced the U.S. government to make its implicit guarantee of these agency securities explicit, without the authorization of Congress. To the extent that the underlying mortgages default, the U.S. government will be forced to issue additional Treasuries to retire the mortgage backed securities now held by the Fed. Alternatively, if the U.S. does not explicitly bail out Fannie Mae and Freddie Mac to the full extent, the Fed will have created money, with no recourse, and without the equivalent backing of assets or securities on its books. In short, the Fed is now engaging in unlegislated, back-door fiscal policy.”
The Treasury's action last week completes this circle. It provides a surprise pledge of public resources to make these mortgage loans whole, and an unlegislated commitment to make the “implicit” backing of Fannie Mae and Freddie Mac explicit. All without debate, and without the force of public will. Even as the homeowners underlying these mortgages lose their property to foreclosure.
Or worse, perhaps homeowners who have been diligently making their payments will keep their homes, and homeowners who took out mortgages they couldn't afford will keep their homes as well with no adverse consequence to the lenders – since the underlying loans are now owned largely by the Fed, and the Treasury has pledged its unlimited support. Why pay one's debts if it becomes optional, and the Treasury stands to absorb unlimited losses at public expense?
This policy is likely to lead to far more delinquencies. Whether it will lead to far more foreclosures depends on the nations' capacity and willingness to shoulder multiple insolvencies in order to protect bondholders, mortgage our national wealth to China and other large purchasers of U.S. Treasuries, or alternatively, massively inflate away the dollar value of the underlying loans. The much-vaunted TARP money that has “profitably” come back to the Treasury is a tiny sliver of what has been committed to defend the private bondholders of financial institutions from losses. Either the debt we create to save these bondholders will stand as a claim on our future national production and a diversion of our ability to spend public resources for the benefit of the public, or we must inflate it away. There is no third option. This does not deserve legislative discussion?
What is likely, in my view, is that we will observe far greater issuance of government liabilities, which will predictably create a near doubling of the consumer price index in the coming decade (though probably not for a few years due to credit concerns, which dampen monetary velocity). It is notable that the massive expansion of government liabilities beginning in the late-1960's eventually exploded into uncontrollable inflation by the late 1970's. There are lags between the creation of government liabilities and their inflationary effects. But to expand these liabilities as recklessly as the Fed and Treasury are now doing is to undermine the long-term foundations of the economy.
Long article - more....
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