Saturday, July 12, 2008

Clive Crook: Freddie and Fannie Liabilities Are Now Larger Than Those of the Entire Federal Government

Sobering analysis from FT's Clive Crook:

The so-called Government Sponsored Enterprises, Fannie Mae and Freddie Mac, together with the Federal Home Loan Bank, have played a central role in shoring up the housing-finance market since the sub-prime meltdown began. It is not much of an exaggeration to say that they have become the entire market. But the more money they have pumped into housing, the faster their own financial condition has deteriorated. Now investors are ditching Fannie and Freddie stocks; on Thursday shares in Freddie fell nearly 20 per cent, to their lowest since 1991. Anxiety had been building for a while, then worsened suddenly when Bill Poole, a former head of the St Louis Fed, said that Freddie was technically insolvent in the first quarter under mark-to-market accounting (that is, the value of its assets was less than the value of its liabilities).

It is inconceivable that the government would stand aside and let these institutions go down: to say that they are too big to fail hardly does the case justice. Their liabilities are now larger than those of the entire federal government. If regulatory forbearance–the traditional approach to the GSEs–should fail, and the choice comes to standing by or outright nationalisation, it would be the latter in a heartbeat. The question is not whether there would be a bail-out, but how hard the terms would be on creditors and shareholders. (Bear Stearns was not allowed to fail–but its shareholders were crucified.) We may very well discover the value of that fabled “implicit guarantee”. Owners and lenders alike are having second thoughts about it: shareholders are running for the door and lenders have raised their spreads sharply.

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