Freddy, Fannie, is the FDIC next?
Posted: September 07, 2008, 3:59 PM by Diane Francis
Cowboy capitalism, and the absence of rules governing half of America’s financial sector, has created the most dangerous financial period since the Dirty Thirties.
This weekend, the U.S. Treasury (read taxpayers) was forced to take over America’s two biggest financial institutions, Freddie Mac and Fannie Mae.
This is scary enough but market players worldwide are concerned that the Republicans have added a rookie running-mate to the presidential ticket who likely thinks Freddie and Fannie are a couple of Senators. Or a couple of constituents in Alaska. She is not a sophisticated or savvy investor or player. She hasn’t a clue about the underpinnings of the financial or global capitalist system and yet she could eventually be a heartbeat, or heart attack and cancer recurrence, away from becoming CEO of the world’s biggest economy.
That’s also got markets nervous.
Fed's in charge
Fortunately, The Fed exerts much control over the administration and operates with independence, apart from the President’s power of appointment. Today’s move proves that. No matter how inconvenient politically to the Republicans, America is moving closer to the ledge and has had to act to shore up its financial system.
But it’s all going to get worse before it gets better. This massive "bailout" is on the heels of eleven bank failures and the engineered takeout of Wall Street’s biggest speculator, Bear Stearns.
Things will worse because the second shoe has begun to fall for financial institutions: The first shoe was requirements to write off mortgage interest default payments. The current one involves accounting requirements that force banks, and others holding mortgages, to write down the difference between their outstanding mortgages and the actual foreclosure price they fetch.
Then, as the debt crisis deepens, the economy will slow some more and housing prices will tumble, thus increasing foreclosures, defaults and lower property values.
Eventually it will bottom, but perhaps not for years. It took a decade of easy money, and government negligence or absence, to get to this point and it will take government involvement to fix it.
Ouch
Freddie Mac and Fannie Mae are on the hook for US$5 trillion, or half of all mortgages in the U.S. They are a strange hybrid of public and private enterprise, involving government backstopping, politically appointed managements but private stock and bond holders. These investors are out of luck, perhaps forever, and have seen their values shaved by 80% in the past year.
The next rumored deal involves a shotgun marriage involving Lehman Brothers, a Wall Street giant, to foreigners or whoever is willing to take it on with its debt problems. But perhaps the most worrisome is the possibility that the 150 banks on the Federal Reserve’s watch-list will all go under and, if that happens, the Federal Deposit Insurance Corporation will have to be bailed out.
FDIC fear
Gerard Cassidy at the Royal Bank Capital markets calls the next bigger financial crisis the "Texas Ratio" and analysed banking crises in the 1980s and 1990s. His "Ratio" is the point at which a bank’s underlying value and bad debts intersect. Then they’re headed for a bust, particularly since raising equity for banks in the U.S. is nearly impossible.
"If all 150 banks fail, the FDIC will be insolvent," he wrote.
As the FDIC’s liabilities grow to 150 or more banks the insurer of last resort won’t be able to cover its obligations to deposits of up to US$100,000 in a deposit account of up to US$250,000 in a retirement account.
When that happens, Congress will have to step in to avoid massive runs on the banks.
Next on the Republican list, for a new, bigger role for government, will be Detroit, suffering from the double whammy of high oil prices and low consumer spending due to the bursting of the real estate bubble. It will need the Mother of Earmarks to chug along as it figures out what to do in future. What a mess.