The $US 5.2 TRILLION refers to the amount of debt paper owned or guaranteed by the two huge US government "sponsored" mortgage companies, Fannie Mae and Freddie Mac. These two companies own or provide the backing for nearly half of the $US 12 TRILLION in US home mortgages. Their paper has been seen as sacrosanct for decades, with the implied backing of the US government. In this role, it has become a favourite "investment" for central banks, institutions and individuals all over the world.
By "fair accounting rules", where assets are actually valued at what they could realise on an open market, Freddie Mac is already insolvent and Fannie Mae very nearly so. The stock prices of the two "GSEs" are down almost 80 percent since the start of this year. Over the last week alone, Fannie and Freddie stock prices were down 30 percent and 45 percent respectively. In intraday trading on Wall Street on July 11, the situation was in fact much worse than that for a while. Fannie was down to $US 6.68 before closing at $US 10.25. Freddie could be bought, in the words of one wag - "for less than the price of a gallon of gas". It hit an intraday low of $US 3.89 before rebounding to finish the day at $US 7.75. The two companies, the backbone of the US mortgage market, are in meltdown on the stock market.
Meanwhile, Citigroup has staunchly kept a "buy" rating on both stocks. "Denial" is not just a river in Africa anymore.
Consider the following:
"Although there is some danger here that Fannie and Freddie may become insolvent, I think it's very, very remote unless for some reason the credit markets lose confidence in the willingness of the US government to stand behind them. It's impossible to imagine such a thing happening."
Peter Wallinson, a former general counsel at the US Treasury
The markets, both in the US and everywhere else, have always been "confident" that the US government would stand behind Fannie and Freddie. What is spooking everyone now is that the US government might cripple the entire US financial system by standing behind them.
"Even under a real stress scenario, the amount of money the government would have to come up with is not that large. The amount of money required would not be so large that it would make us worry about the US credit rating."
Steven Hess, Vice President of Moody's
It would seem that whoever elicited this quote from the gentleman did not go on to ask the next obvious question: "What WOULD make you worry about the US credit rating?"
"There is a sort of panic going on today, and that's not what ought to be. The facts don't warrant that reaction, in my view. These institutions are ...fundamentally sound and strong."
Christopher Dodd, Senate Banking Committee Chairman.
This is said of two companies which have crashed on the stock market, which are technically insolvent, and which can no longer function in their primary business because in their present financial state, they either cannot borrow or cannot afford to borrow without explicit federal government guarantees.
"Freddie Mac and Fannie Mae are very important institutions."
George W Bush, President of the United States of America
Indeed.
There are many more like this, but we have saved the best for last. As you probably know, on July 11, US stock markets went into free fall early only to be rescued later in the day. The Dow still closed down 128 points to 11100, its lowest close in two years. Normally, when US investors sell stocks they buy Treasuries. And normally, in times of fear of incipient financial meltdown, US investors stampede into Treasuries as a "safe haven".
That didn't happen on Friday, July 11. In fact, the opposite took place. Yields on Treasury debt paper with maturities of two years or more blew out. The 10-year paper, for example, saw its yield increase by 17 basis points - the biggest one-day jump since March 24. Of course, as Treasury yields go higher, the prices of the existing debt paper on the secondary markets go lower.
Here are two headline stories from Bloomberg which appeared five hours apart on July 11. The first appeared at 12:41 EDT - the second at 17:41
Treasuries Fall on Speculation US to Support Fannie, Freddie. Here's the first paragraph from that story:
"Treasuries fell, with two-year note yields rising the most in a month, as speculation the U.S. government won't allow Fannie Mae and Freddie Mac to fail reduced demand for the relative safety of government debt.
"Treasuries Fall as Fannie, Freddie Bailout Speculation Eases". Here's the first paragraph from THAT story:
"Treasuries fell on speculation the government won't have to bail out Fannie Mae and Freddie Mac, easing demand for government debt as a haven from credit-market turmoil.
We've heard of an "each way bet", but this is ridiculous! Treasuries are being sold off because the government WILL have to bail out Fannie and Freddie. Five hours later, Treasuries have been sold off even more because the government WON'T have to bail out Fannie and Freddie. Hmmmmm!??
In reality, of course, Treasuries were sold off on Friday in the face of unmistakeable proof of the insolvency of the entire US financial system. Several officials were quoted as saying that a government bailout was "not desirable" because if the worst came to the worst, it would "effectively double the public debt".
Actually, this is incorrect. The "debt to the penny" admitted to by the US Treasury was a touch over $US 9.5 TRILLION on July 10. But a complete "replacement" of the $US 5.2 TRILLION in debt paper now held or guaranteed by Fannie and Freddie would "effectively double" that part of the funded debt officially "HELD BY THE (US) PUBLIC" which totalled just over $US 5.3 TRILLION as of July 10.
There is another not so small point to ponder here. At present, the US Treasury's "debt limit" is $US 9.815 TRILLION, having been raised (by $US 850 Billion) to that level by the Congress on September 27 last year. At the current level of the "public debt", this leaves a "cushion" of about $US 310 Billion. A prerequisite for any wholesale government bailout of Fannie and Freddie would be that this "debt limit" be raised, MASSIVELY!
Any way you look at it, however, any substantial bailout by the US government and the US Treasury would flood global markets with new Treasury debt paper. That would, in turn, decimate the gargantuan "portfolios" of Treasury debt held by foreigners and foreign central banks, dry up the vital flow of foreign funds into the US, blow out US budget, trade and current account deficits, send US internal interest rates spiralling upwards and - last but far from least - devastate the US Dollar.
And another indigestible morsel has been added to the plates of the US "powers that be" as they spend the weekend contemplating the mess they have gotten themselves into. IndyMac Bank, a regulated "thrift" based in Pasadena, California (where else?) was taken over by the Federal Deposit Insurance Corporation (FDIC) in late breaking news on July 11 in the US. IndyMac is the largest "regulated thrift" to fail in US history and the second largest financial institution - after Continental Illinois which went belly up in 1984.
Over the past week, depositors at IndyMac had withdrawn $US 1.2 Billion. There are 10,000 depositors who have funds in the bank in excess of the $100,000 which the FDIC guarantees. They can start "making appointments" with the FDIC on Monday, July 14. The FDIC has announced that they will pay unsecured depositors an advance "dividend" of half the uninsured amount.
The US now has its very own version of "Northern Rock", the British bank which saw the first full on bank run in that nation for over 100 years late last year, and which was effectively nationalised by the British government.
Gold? Oh yes, it closed on July 11 up $US 18.60 at $US 960.60 on a spot future basis. This is the highest spot future Gold close since March 18, the day it hit its all time high of $US 1004.30. Gold fell $US 59.00 the next day and has not since closed on a spot future basis above $US 950 - until July 11, that is.
(Chart appears here in original analysis.)
We have extended the table below into 2008, even though Gold in all four currencies in the table is now well above its 2006 highs. Gold breaking out to new all time highs in $US terms at the end of January led to bull market highs in all four currencies. And as you can see, in March, Gold improved upon those January levels in all four currencies as spot future Gold closed above the $US 1000 level for the first time ever in the middle of March.
| |||||||||||||||||||||||||||||||||||||||||||||||||