The Binary Circumstance

Ron Paul is the only person who seems to understand that we can’t escape our current financial problems by borrowing and printing more money. That’s what created the problem in the first place.

The latest proposed bailout, which politicians are trying to scare us into accepting just like they did with the Iraq war, is like giving more credit cards to a person who has already maxed out all the cards he currently has even though he can’t afford the payments. And since he’s not making enough money to pay off his debts, let’s also give him a printing press so he can print all the money he wants as well.

As expected the Feds moved in to seize Fannie Mae and Freddie Mac to prevent collapse.

Under the plan, the Treasury will receive $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie and Freddie. The government will receive annual interest of 10 percent on its stake.

As a condition for the assistance, Fannie and Freddie eventually will have to reduce their holdings of mortgages and securities backed by home loans.

The portfolios “shall not exceed $850 billion as of Dec. 31, 2009, and shall decline by 10 percent per year until it reaches $250 billion,” the Treasury said. Fannie’s portfolio was $758 billion at the end of July, and Freddie’s was $798 billion.

Officials are aiming “to prevent the mortgage market from falling apart,” said former Federal Reserve Bank of St. Louis President William Poole. The Treasury’s funds “will be flowing in for quite a long time,” Poole, a Bloomberg contributor, said on Bloomberg Radio.
[…]
Banks and insurance companies have typically purchased the two companies’ preferred shares. The Federal Reserve and three other bank regulators said that they will work to “develop capital restoration plans” with the “limited number” of smaller institutions that hold Fannie and Freddie stock as a significant portion of their capital.

There is not enough detail on what they plan to do with shareholders. Typically they come last in line when it comes to getting money back.

This and other articles seem to imply that the government is going to treat institutional shareholders differently than individual shareholders. Reportedly the Fed, FDIC and others are going to help smaller banks with significant stock holdings in the two seized GSE’s to keep them from failing.

Paulson urged banks to contact their primary federal regulator if they believe losses on holdings of common or preferred shares in Fannie Mae or Freddie Mac will cause them to fall below the government’s benchmark for “well-capitalized” institutions.

Besides the Fed and FDIC, the Office of the Comptroller of the Currency and the Office of Thrift Supervision also signed onto today’s release.

That would just be another transfer of wealth to the rich and powerful at the expense of average citizens. It keeps the shareholders in those banks afloat at the expense of the taxpayers, even when the FDIC is supposed to be adequate protection for the depositors.

The good news is that they are both required to become a lot smaller.

William Poole former president of the Federal Reserve Bank in St. Louis says that taxpayers may pay $300 billion for this bailout.

Given that the government has consistently understated the magnitude of the mortgage/banking crisis, I suspect that is a very conservative estimate.

A government takeover of mortgage giants Fannie Mae and Freddie Mac is expected soon, perhaps by the end of this weekend.

WASHINGTON - The government is expected to take over Fannie Mae and Freddie Mac as soon as this weekend in a monumental move designed to protect the mortgage market from the failure of the two companies, which together hold or guarantee half of the nation’s mortgage debt, a person briefed on the matter said Friday night.

Some of the details of the intervention, which could cost taxpayers billions, were not yet available, but are expected to include the departure of Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron, according to the source, who asked not to be named because the plan was yet to be announced.

[…]

Fannie Mae and Freddie Mac lost a combined $3.1 billion between April and June. Half of their credit losses came from these types of risky loans with ballooning monthly payments.

While both companies said they had enough resources to withstand the losses, many investors believe their financial cushions could wither away as defaults and foreclosures mount.

Many in Washington and on Wall Street hadn’t expected Paulson to intervene unless the companies had trouble issuing debt to fund their operations.

This summer, Congress passed a plan to provide unlimited government loans to Fannie and Freddie and to purchase stock in the two companies if needed.

Critics say the open-ended nature of the rescue package could expose taxpayers to billions of dollars of potential losses.

I’m a little surprised with the speed at which the government had chosen to snap up these companies. The move will wipe out the equity that shareholders now have in the company.

Recent bond sales have gone well, showing that institutions which hold most the GSE debt were still willing to loan them money.

This is another example of the government putting the taxpayers on the hook for bad corporate decision-making. Previously, government (taxpayer) backing of the two private companies was only implied. Recent legislation made it explicit and this move will guarantee that taxpayers foot the bill.

Fannie Mae and Freddie Mac got “too big to fail” because the government gave them advantages in the marketplace. Now, with full government (taxpayer) backing, they will become even bigger, giving the Feds more control over the housing market than they already have.

Given the mess they’ve made of it so far, why would anybody want them to have more control?

Germany is an example of what happens when the government prints too much money to pump up the economy. Pumping up is another way of saying preventing deflation. (See my recent post about how much money the Fed is creating to keep the financial system propped up.)

We should not ignore the extreme hyperinflation of Germany in the 1920’s as an example of how bad things can become when inflation gets out of control. In January 1919 an ounce of gold cost 170 German marks. Less than five years later, the same ounce cost 87 billion marks. The hyperinflation affected everything, even postage stamps. For example, in 1923 a stamp originally issued for 300 marks was overstamped with a revised value of 2 million marks.

Source: The Demise of the Dollar by Addison Wiggin. New Jersey, John Wiley & Sons, Inc. 2008, pg. 145.

Is hyperinflation in our future?