U.S. Treasury secretary, Henry Paulson’s latest Sunday surprise announcing the U.S. government bail-out of mortgage giants Fannie Mae and Freddie Mac, sent shockwaves through financial markets around the world.
The majority of U.S. mortgages, which are sold to generate cash so financial institutions can provide more loans, were bought from Fannie Mae and Freddie Mac by Asian countries and Russia. These countries’ central banks and private citizens own billions of dollars in mortgages that are now worth far less than their initial investment price. It is estimated that China owns $500 billion in mortgage-backed securities.
The total worldwide mortgage debt that is held by, or guaranteed by, Fannie Mae and Freddie Mac is about one-half of the total U.S. mortgage debt of $12 trillion. That means the total debt of Fannie Mae and Freddie Mac was slightly more than one-half the debt of the United States when the institutions were placed in conservatorship (similar to a Chapter 11 reorganization bankruptcy) by the government. Assuming responsibility for Fannie and Freddie has caused the country to increase its total debt by more than 50 percent.
Looking at this with less zeros and in a close-to-home situation, it’s easier to grasp. If your total family debt is $1,000,000 and you decide to take over a relative’s debt that is $600,000, your total debt will increase to $1,600,000. Convert that to $16 trillion and you understand what the U.S. government has done.
Fannie and Freddie were established as government secured enterprises (GSEs). This status gave the impression (to investors) that their investments were guaranteed by the U.S. government although the legislation that established them clearly prohibits the government from guaranteeing investments sold by the companies. This has always been a confusing situation. However, until many mortgage-backed securities were misrepresented to buyers as “A” paper when they were actually a mish-mash of good to poor quality loans grouped together — with a significant portion ending up in foreclosure — there was not a serious problem with the quasi public/quasi private nature of Fannie Mae and Freddie Mac.
Because Fannie and Freddie have been publicly traded companies, which portfolio managers considered safe investments, many 401Ks plus other private retirement and investment accounts hold significant amounts of Fannie and Freddie stock. If you own these stocks, the future of your holdings is impossible to anticipate at this time. It appears that no provisions are being made to assist U.S. stockholders with investments in Fannie and Freddie.
According to the FDIC (Federal Deposit Insurance Corporation), U.S. banks are beginning to fail at a rate approaching one per week as a result of the mortgage meltdown. Because the impact of these failures tends to be local or regional, they are not attracting national attention. The takeover of Fannie and Freddie will not change this trend. In fact, this bail-out is unlikely to reap any long-term benefits for U.S. consumers, who will be responsible for the increased American debt.
Short term, foreign markets breathed a collective sigh of relief that they no longer need to worry about their investments because the U.S. government has taken responsibility for them. Long-term mortgage interest rates dropped in the U.S. and there is renewed discussion that the Fed (Federal Reserve Board) is likely to cut the prime rate. In addition, the value of the dollar has gained strength against foreign currencies after being seen as an international currency pariah for many months.
In spite of the bail-out of Fannie and Freddie, the credit crunch seems to be morphing into a credit calamity. This means money available for borrowing will remain tight and requirements to borrow money for any purpose will continue to be far more stringent than they were as recently as 2007. It now appears that this cash constriction will remain until at least 2010.
As difficult as it can be, especially in regions with extremely high living costs, this is the time to develop fiscally responsible habits:
- Learn to live on your income.
- Pay off your debts.
- Save money from every paycheck.
Even a small amount of money regularly saved will add up. When you face an emergency, you will have cash to handle it rather than needing credit, which will cost you far more — over time with interest — than the original emergency if it’s paid for with cash from savings.
While these are tough times if you need credit, this period can also provide an opportunity to establish practices that will lead you to a more secure financial future.