Monday, 8 September 2008

The biggest bailout in history.

It is the biggest transfer of claims on property since Stalin took on the Kulaks. Freddie and Fannie have finally been nationalized. As a result, the US government is now holding about half of all the mortgages in America. This is shaping up to be the biggest financial sector bailout in human history. No surprises there, the US has just gone through the biggest housing bubble of all taime.

There are many aspects of this mess that are troubling. However, there is one number that I can't get over. On the one hand, Freddie and Fannie are holding $5,300 billion, yet the combined losses that caused the US Treasury to take over were quite small. I read somewhere that the losses were as low as $15 billion. Furthermore, this minimal losses didn't originate from subprime loans. These institutions specialized in high quality loans.

Freddie and Fannie failed because they were massively overleveraged. In this regard, they are no different from our prudent banks sitting on the UK high street. All are horribly undercapitalized with only a minimal cushion to absorb losses.

The harsh reality is that the US financial system is about two years ahead of us. Banks here made exactly the same mistakes and their American cousins, our housing market was far more inflated, and our banks have just the same propensity to fail.

The failure yesterday of Freddie and Fannie is a stark warning of what is about to hit us here in the UK.


peterthepainter said...

alice, you need to see this - everybody needs to see this -
Fraudie and Phoney - The Aftermath

Anonymous said...

I find the statist model implied by the bailout rather imponderable.

If a government offers cheap credit to support an inflated property market, that sounds like driving up the price of homes so that large numbers are compelled to be in lifelong debt to the state, to whose advantage it may be to keep interest rates high.

One might as well just grab property left and right like the emperors of yesteryear (I hope only yesteryear) and turn half the populace into bonded labourers and serfs.

Maybe that's what the property market in the UK does, to some degree, to those without significant inherited wealth.

A dent-burdened populace is submissive, of course. Perhaps the "Republicans" would like that.

Am I missing something?

B. in C.

Rebecca Wilder said...

Hi Alice,

How badly are the UK firms undercapitalized? Are British banks with mortgage assets subject to lower capital/asset ratio requirements as were Fannie and Freddie?


Anonymous said...

Dear Alice,

Here you have a very good article about the British economy:

Britain: Alistair Darling and the implosion of the Labour government
By Chris Marsden
6 September 2008

"The number of permanent jobs available had also plunged to its lowest level since 2001, with unemployment rising by about 70,000 this year and predicted to hit two million by Christmas. The manufacturing sector shrank for the fourth month in a row. "


Edward Harrison said...


Here's an article inspired by the Frannie bailout with a great title to it:

US bazooka for Fannie Mae and Freddie Mac trumps Brown's peashooter.

I thought you might like that one.


economicsinterpreted said...

I find it amazing that after such a great failure by the two largest of banks, the stock markets in both the UK & US have rallied and shot up.

I feel this is short sighted given that, with the US Treasury carrying this much debt, and buying back the nastiest of the US housing markets debts, would the long term prospects of the economy not indicate a huge negative correction.

I mean if its such a good idea to help the economy out like this, why don't we just run this cycle every 10 years and finish with a government intervention.

I would say its because holding this much debt is bad for an economy and will not be easy to get rid of in the next 5 years, and that's without looking at how much more limited the activities of the new Freddie and Frannie are going to be when the tax payer has to fund their activities.

Add in the jobs data, rising inflation and deteriorating consumption, and it seems the stock market reaction is once again detached from reality.

Just before I began to write this I've come across data suggesting that Credit Default Swaps on Freddie & Frannie of $1.4 Trillion (From a $62 Trillion CDS market) will have to be paid out as a result of the governments bailout. Given what you said in your article about the UK & US banks being 'under-capitalised', should this not send alarm bells ringing the world over as to how many banks this payment will take out.

Will the lack of control of CDS's cause the very catastrophe that this bailout was meant to avoid?

Anonymous said...

I think the unfortunate fact is this: when the crap hits the fan, human beings do not behave well. Rather than getting courage, you get cowardice and selfishness as everyone work hard to cover their ow arses. Expect to see more lying and more attempts to offload risk on to the state. As for the UK, I agree that we will hit a whipsaw of excrement about the beginning of 2009, as all the bad decisions here finally can't be avoided. Already, Labour is completely paralysed and can only watch and hope things will work out: they won't.

Anonymous said...

"I find it amazing that after such a great failure by the two largest of banks, the stock markets in both the UK & US have rallied and shot up."

Why? The best performing stock market in the world is Zimbabwe. We just need to borrow their magic...