Sep 29

FNMA and FHLMC: The Hitchhiker’s Guide Meets Godzilla


Four months left for the Administration and the Goldman Sachs-US Treasury department.  The Greatest Deleveraging in the History of the World has destabilized financial markets and threatens to drag one developed economy after another into a recession.

In the latest move to have this occur, the US Treasury has basically taken over the largest single sources of mortgage finance in the world: FNMA and FHLMC.  In our prior post, we said:

“However, it (the mortgage market) will eventually recover, although with significant changes.  FNMA, FHLMC and GNMA (and the US Government) will continue, in some form or other, to be the cornerstone of the market.  And, where there is money to be made, Wall Street will find a way to securitize mortgages – more transparency, more risk sharing, improved ratings methodologies, etc – but I believe it will happen.  Meanwhile, we should all follow the guidance from the Hitchhiker’s Guide to the Galaxy: Don’t Panic”

As expected, the result of that “some other form” has been conservatorship…a nice legal word for bankruptcy.

Every day it seems like the US economy is starting to look more like (take your pick) the US in the 1930s or Japan in the late 1980s/early 1990s.  We prefer the later, since the former brings about results we know that the Fed can successfully deter.  As the economy slowly moves into this Godzilla-like stage of slow growth/recession coupled with asset deflation due primarily to the credit excesses of the past, we must carefully view government responses to determine if we bordering the eastern Pacific have learned anything from our friends bordering the western Pacific.

One error that the academics say Japan made was to prop up banks and other credit sources too long and not let the capitalist system wash away the bad apples and start afresh as soon as possible.  With the UST’s four point plan, it appears that some of these errors may indeed occur unless the federal government can successfully think like an entrepreneur.  Although no one doubts Mr. Paulson’s entrepreneurial capabilities (a minimum requirement for a “master of the financial universe”), one must severaly doubt if the next administration and Treasury secretary will have a similar bent.  And those doubts can easily be placed at the feet of both Presidential candidates, too busy to talk about mindless topics than the core of our financial system, which indirectly and directly supports all potential voters.

The four point plan will undoubtedly be viewed with glee by troubled financial markets: (1) an unlimited commitment to buy convertible preferred stock, (2) a 60+% reduction in their mortgage holdings over time, (3) a senior lending credit facility to provide virtually unlimited liquidity, (4) UST commitment to buy an unspecified amount of GSE mortgages.

However, such glee should also be tempered.  Note the message it is sending. “We are the government and we are here to run the mortgage business for an indefinite period of time.”  Although this plan may solve short term problems, it does not give comfort that the government will eventually let the capitalist system wash away the bad apples and start afresh as soon as possible.  And therein lies the troubling comparison with Japan in the late 1980s/early 1990s.

Four months to go, and the Administration and Goldman Sachs-UST has delivered us into a Godzilla like moment.  They think they have tamed the beast.  But, until there is assurance that the private sector will be allowed to devise new ways to securitize and sell securities without stifling competition from the federales, there is the risk that we may follow in the footsteps of our friends in Japan.