The Financial Times has hailed the
effective takeover of Fannie Mae and Freddie Mac by the US government as “what
could become the world’s biggest ever financial bail-out.” Treasury secretary
Henry Paulson has promised he will pump in ‘unlimited liquidity.’ Don’t you
wish the government would grant you unlimited liquidity? When it comes to the
food and fuel bills of the poor and the working class, the British and American
governments find that the cupboard is bare. But now it’s not bare. Predictably
markets all over the world have breathed a sigh of relief. Fannie and Freddie
have effectively been nationalised – and big business thoroughly approves!
In the Financial Times (08.09.08), Clive
Crook comments, in an article significantly entitled ‘Nationalisation in all
but name,’ “The eventual cost to taxpayers is unknown. If the housing market
rallies before long, it could be in the low tens of billions of dollars. If
things keep getting worse, it could be in the hundreds of billions. But Fannie
and Freddie have made themselves indispensable to any housing market recovery:
the cost, whatever it is, will have to be paid.”
So who are these guys? Fannies and Freddie
are private companies. They both have shareholders. But they’re also Government
Sponsored Enterprises (GSEs). In that sense they are hybrids. Their activity
has effectively been guaranteed by the government. That has been a blessing and
a curse for them.
Fannie and Freddie don’t lend mortgages direct
to the public. They guarantee mortgages. Who benefits from this? The banking
system, of course. The banks are the ones who take the flak when the housing
market heads south and people can no longer pay their mortgages.
The GSEs openly hit trouble in the summer.
) From that time on Warren Buffet, the richest man in the world, has declared
them ‘toast.’ Their share prices have collapsed. They are plainly insolvent –
they owe many times what they own. Over the past year they have been
haemorrhaging losses. A Congressional
committee estimates their losses at $25bn. That is the sum US taxpayers are
likely to have to stump up – to save the banking system. But for capitalism they
had to be saved. As we predicted in July, “The government quite simply cannot
let them go to the wall. Whatever form of words it uses and whatever devious
plan it announces (a new word – conservatorship – has been coined for the
occasion), they will be effectively be nationalised. Then it will be official –
their shares are worth nothing.”
It was realised that, as Paulson declared
“Fannie Mae and Freddie Mac are so large and so interwoven in our financial
system that a failure of either of them would cause great turmoil in our
financial markets here at home and around the globe. This turmoil would
directly and negatively impact household wealth. Or, as the London Metro
headline puts it, “£3trn deal ‘to save the world’.”
There are $12trn worth of outstanding
mortgages in the USA. Nearly half of them are with Fannie and Freddie. The
downside of government sponsorship for Fannie and Freddie was that they had to
do what the regulators told them. So, over the past couple of years 80% of
mortgages have been guaranteed with the two GSEs. This is because capitalist
banks have worked out that all was not well with the US housing market, and
they wouldn’t touch the new mortgages with a bargepole.
As is well known, the housing bubble burst
when it became known that mortgages had been handled out by borderline criminal
financiers to people with no income, no job and no assets. Not surprisingly the
borrowers were unable to pay these sub-prime mortgages, and their homes were repossessed.
The federal government did not feel the need to intervene as these people were
made homeless, for this was the magic of the marketplace at work! They’ll bail
out the banks, but not the homeless.
But free competition and bankruptcy for
people who can’t make ends meet is just for suckers and little people. Fannie
and Freddie are too big to fail. Here’s why. The sub-prime mortgages did not
remain just a little local difficulty for finance capital. The mortgages on the
GSEs’ books were sliced and diced and sold all round the world in the form of
fantastically arcane financial instruments. Some of these financial instruments
ended up in the vaults of UK banks. That is why these banks are so pleased that
Paulson and the Fed have saved their bacon as well. That is why their shares
soared upon hearing the announcement.
What the financial authorities are trying
to do is what they call de-leveraging. Basically this means they now realise
that the past boom was based on unsound speculation and the blowing up of
unsustainable bubbles, such as the house price bubble. They are trying to
unpick this pyramid of ‘leveraged’ finance. They have to be careful. If they
get it wrong the whole structure will collapse and crush everything beneath it.
Take Fannie and Freddie. According to
Gretchen Morgenstern they have credit default swaps of $62trn to their names –
twelve times their total holdings of $5.4trn in mortgages. This is a house of
cards waiting to topple. It is also a
measure of the market’s exposure.
This sort of thing is typical of the
banking sector. Most US banks have a capital adequacy ratio of about 8%. In
plain English that means that they can lend about 12½ times what they hold in
the vaults. In good times this multiplies their profits. In bad times it
multiplies the losses. It means that if only one in twelve of their debtors
default, the bank is dead in the water. The sub-prime crisis means that assets
they thought they had in their vaults to cover their lending have just
evaporated. They all need to recapitalise. It’s not a good time to be doing
this. By the end of 2009 US banks need to roll over $800bn in medium term
debts. The credit crunch is getting worse, not going away.
For Fannie and Freddie are that much worse
placed. They are reckoned to be leveraged 50 times over on their
fast-disappearing assets. This is equivalent to putting all your money on a 50
to 1 outsider. That means defaults on just 2% of their loan portfolio would put
them in queer street.
Mauldin comments, “Critics have said that Fannie and
Freddie were nothing but hedge funds with an implicit government guarantee.
This is an insult to hedge funds. Hedge funds don’t pay hundreds of millions in
campaign contributions so that they can risk taxpayer dollars, prop up their
profits, and pay huge bonuses to executives. They risk their own capital with
no safety net.
“Fannie and Freddie are banks that are levered between 40
and 50 times. I can think of two hedge funds, Carlyle Capital and Long Term
Capital Management, that had leverage at those levels. They both went bankrupt,
as will any such levered business.”
Since the credit crunch broke a year ago,
we have been told several times that ‘the worst is over.’ On the contrary
Kenneth Rogoff, former chief economist at the IMF, promises that "the
worst is to come." He continues, "We’re not just going to see
mid-sized banks go under in the next few months, we’re going see a whopper,
we’re going to see a big one – one of the big investment banks or big
banks." He’s probably right.
There are now 8 million households in the
US in negative equity. That means that over the past twelve months they’ve seen
their house price drop below the price they paid for it. That means they’re
stuck – they can’t move and they can’t really afford to stay. As unemployment
rises (now officially over 6%), many of these people will be forced to default
on their mortgages.
What we see is a classic crisis of capitalism
reflected in the financial arena. As the sharp increase in American jobless
figures reminds us, it won’t remain confined to finance but will spread to the
real economy. As we pointed out in July, “It is quite clear from the scale of
the crisis that the poison has entered the bloodstream of the capitalist
a couple of years ago, we were all recommended to admire the genius of
financiers. “O brave new world, that hath such people in it," as Miranda
says in Shakespeare’s The Tempest. As we commented in July, “Finance
capital and the whizz kids in the City were held up to us as the masters of the
universe, as ‘wealth creators.’ Now we see them as hapless bums always begging
for a handout. It’s high time to nationalise the banks.” The establishment is
being forced to take over banks to save the rest of their system. If it
survives, all it promises working class people is more hardship. It’s time to
take over the banks as part of a programme for the socialist transformation of