Fannie and Freddie

We in Australia cannot ignore the US economy. The US accounts for roughly 1/4 of output and around 1/3 of world trade. If the US wants to go into recession (or worse), the world will follow. Simple.

This year to date (8 September 2008), eleven banks have gone under in the US. Since October 2000, 38 have gone under. (http://www.fdic.gov/bank/individual/failed/banklist.html) Sure, these are mostly small regional banks and have largely gone unnoticed.

The banking system is the lifeblood of the economy. All the banks are interelated. If one goes under it has implications for scores of other banks. The US Goverment has already shown with Bear Stearns that they will do what ever they can to keep the banking system together. (US$ 29 billion thrown at Bear Stearns before JP Morgan kindly bought it for $2 p/share - JP Morgan were in effect doing the US Government a favour). The US Government and top bankers all know that without a secure banking system, you will not have a secure credit and debt market, a secure housing market. Market and consumer confidence is everything in economics. People want trust and security.

Anyway, getting onto Fannie Mae and Freddie Mac. These are key institutions, as they guarantee almost half of the $US 12 trillion US home loans, they are the heart and soul behind the property market. Together they have lost about US$15 billion in the last year. Their shareprices are down about 80% each this year. The US is currently experiencing the fastest growth in mortgage defaults in at least 30 years. So all eyes have been on the Government to save the property market!

Today (8 September 2008) the US Government announced it would take over the pair under "conservatorship" - a fancy word for takeover. The Government now has first dibs at becoming a major shareholder of both companies, with remaining shareholders destined to loose almost (or even) all their money in the coming year(s).

The US cannot afford for Freddie and Fannie to go under. US Treasury Secretary Henry Paulson is using even more desprite terms such as: "Our economy and our markets will not recover until the bulk of this housing correction is behind us". So by opening a blank check $100's of billions of dollars will be thrown to Fannie and Freddie in the coming years to try and prop-up property market confidence. Paulson believes a blank check will bring "additional security" and "additional confidence" to the market. It probably will for now, but give it a couple of years, the US Government is so far into debt anyway, the amount of money they throw really won't matter in the long run. The $US dollar will continue to deflate towards zero and people's trust and confidence in the $US dollar, in property, in the sharemarket will erode rapidly.

The bottom line is - we too in Australia cannot ignore Fannie and Freddie and the bad stories coming out of the US today. These are all early warning signs of worse things to come in my opinion. The US will continue to bail out banks, and will continue to throw money at Fannie and Freddie.

Australia is not immune. In the last year we have seen Babcock and Brown investment bank embark on a rapid fire sale to reduce debt. Allco Finance, Centro Properties are in a similar situation. I believe many more will follow in the coming years. Sure, there might be short term stability brought back into the market, but the long-term fundermentals remain. Australia will follow the US, and we too will do what ever we can to keep the banking system in tact, and print more money to keep people happy.

Fannie and Freddie are just the beginning, there are bigger liabilities around the corner for the US and for the world. More to come...

Best,
Scott