Tuesday, July 29, 2008

The real reason behind the great Freddie Fannie bailout...

Today, the revamped housing bill will be signed into law and included in the sops are huge giveaways to Fannie and Freddie Mac. Martin Mayer in his column 'Mortgaged to the World' in today's Times gets it exactly right on why we had/need to bail out Fannie and Freddie Mac. Yep, it is to finance the budget deficit and our wars fought in faraway lands (the deficit by the way is set to top off at half a trillion dollars next year).

Historically, foreign central banks that found themselves with excess dollars as the result of the American trade deficit invested that money exclusively in Treasury notes and bills. As a service, the New York Fed made those investments for them, guaranteeing them the best current price and retaining legal custody of the paper as their agent.However, by the mid-1990s the countries that had large trade surpluses with the United States — primarily in East Asia and the Persian Gulf — began to demand a better return on investment than that offered by Treasury paper.

In response, the New York Fed began to buy them “federal agency” paper — including large amounts of obligations from Fannie and Freddie. This paid somewhat better interest, and while it was not officially guaranteed by the government in the way Treasury bills were — well, you know, if push came to shove, Washington could be counted on to do the right thing.
But the truth is that nobody knows. Fannie and Freddie have financed several hundred billion dollars of doubtful mortgage paper that may or may not pay off enough to meet their debts, and they cannot predict whether they will have gains or losses from their gigantic exposures in the derivatives markets.

If the government had not guaranteed the full payments of principal and interest on their paper, the foreign governments that own so much of it might have had to show losses on their dollar-denominated accounts. To say the least, this would make them reluctant to continue to finance our trade deficit, our wars and the strength (such as it is) of our dollar.

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