FREDDIE MAC FANNIE MAE PROBLEMS ARE OUR PROBLEMS

The hard asset deflation problem Greenspan spoke of and that I mentioned here is now upon us. Both these lending agencies, backed by the U.S. Government and 100% involved in housing is in trouble all the way around. I have detailed here about the fake partnerships buying homes through these badly managed agencies and if this thing blows it will make the S&L crises of a decade ago look like a piggy bank deal. Forget Enron. This is potentially trillion dollar stuff.

These government backed housing loans are by their nature more risky and they lend money no sane banker would lend, in effect guaranteeing loans to people who are not credit worthy at commercial lending rates. Banks immediately sell their paper to these agencies who then repackage the loans into bonds for sale to INVESTORS, like you and me. Their combined holdings of U.S. home loans total about $3.3 trillion, equivalent to nearly 40 percent of all outstanding mortgage debt in the United States.

Earlier this spring, Federal Reserve Chairman Alan Greenspan said in a letter that Congress should keep a close eye on the risks of Fannie Mae and Freddie Mac because the markets have trouble assessing their risks because of their ties to the government. What they stand accused of is rigging their books to control interest rate volatility. Wy would they want to do that? Fear of rising rates after they make loans at low rates. The most likely scenario is that they "played" the derivatives market (heard that one before?) on the "wrong side". The accusation here is that they hid PROFITS not losses. They have been trying to "privatize" both FANNIE MAE and FREDDIE MAC since the '80s but since the entitlement class thinks they deserve cheaper housing than the rest of us this has never happened.

Most likely they were faced with defaults of their bad credit risks and could not replace the paper with paper at the old high rate and were forced to but up more collateral (housing) at lower rates to cover and so played the derivatives market in order to keep the housing replacements at one for one. More basic, loans they made at 7% defaulted and when house was resold the rate was 5% leaving a 2% gap to be filled in the bonds they sold to the public. They couldn't just replace paper as rates fell. They may have gone "long" the bond market to make up the loss in which case they made a ton of money they are not supposed to make while "smoothing" out interest rates because they could replace paper.

Don't allow yourself to get caught up in Libertarian/neo-con arguments about government here. These agencies are a fact, they hold more economic power than almost all banks combined, and we better hope that (a) they show a profit, and (b) that Congress will do their oversight job currently farmed out to a very weak and understaffed agency.

Near term it's bullish for bonds but we are in a bond bubble and this is temporary. We assume Greenspan knew of the problems at least a month ago and is ready to act.