Thursday, July 3, 2008

Nationalize Freddie and Fannie?


Government sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, with their combination of private enterprise and public backing have experienced a period of unprecedented financial growth over the past few decades. Both these companies are key players in the morgage market as they guarantee mortgages held by US banks. The origins of these GSEs can be traced back to the Great Depression and Roosevelt's new Deal.

But the United State's two largest mortgage finance lenders have known their share of controversies. Given their importance in the mortgage market, some observers think it is time to nationalize them. This is the radical solution proposed by Richard Suttmeier, chief market strategist of RightSide.com. He thinks the proposals to date don't go nearly far enough to battle what he calls a "cancer" that threatens to kill the economy if it's allowed to spread further. Watch the whole interview here (click to watch).

Suttmeier's view is the solution to the housing crisis isn't "from the Fed down but from Main Street up." He contends that nationalizing the GSEs would lower mortgage rates across the board, giving every homeowner in America a chance to refinance and new buyers cheap financing to help soak up the excess inventory of homes.

I am not sure I follow his argument. Yes, GSEs are a weird mix between private and public enterprises and there are compelling reasons to make them public. But lowering mortgage rates will not make an iota of a difference when people are losing their job. Today's US employment report showed that job losses in both April and May turned out to be considerably deeper than had been thought. Payrolls dropped by 67,000 in April, versus the 28,000 previously reported. And, losses in May came to 62,000, rather than the 49,000 initially estimated. So far this year, the US economy has lost a total of 438,00 jobs, an average of 73,000 a month.

Dr. Michael Hudson, President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Distinguished Research Professor of Economics at the University of Missouri, Kansas City is much harsher in what he thinks the US government should do with Freddie and Fannie. He shared the following thoughts with me:

"I say, let them go bankrupt and THEN take them over — at the post-bankrupt price. No need for the gov’t to bail out the dummies who trusted the crooks who ran these organizations. They’re under indictment. If investors thought “What the hell, let them steal. The gov’t will make us whole,” then they deserve to lose their money. That’s socialism for the oligarchs.

In KC, the post-Keynesian meeting concluded that these guys were as crooked as Countrywide, Citibank, Bear Stearns et al. I don’t think the world will be seeing any securities packaged and sold by Wall Street any more. It’s as if the Mafia have taken over (although vice versa might be more true)."


No wonder investors have been dumping shares of both companies. Over the past year, both companies have seen their share prices decline by more than 60% (click on chart above to enlarge). Their balance sheets are horrible and they will suffer huge losses as the housing crisis continues to wreak economic and financial havoc. In fact, I agree with Suttmeir's analysis that the subprime credit crisis was just the tip of the credit crunch as banks face some serious headwinds with their loans.

On that cheerful note, I wish everyone in the United States a Happy Fourth of July weekend.

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