Crisis Note 2008-5: A Brief Note on the FN/FRE Actions


- This weekend’s actions by Hank Paulson to put FNMA and Freddie Mac into Conservatorship have been in the market’s thoughts for a few weeks, and were expected. In fact, the WSJ leaked on Friday that some action was likely to be taken this weekend. Most of today has been spent discussing the actions and their impact on the market.

- To me, the main beneficiaries, and the main reason to take over the GSEs, are to protect the portfolios of central banks and other overseas banks that have recently getting jittery about their FN/FH holdings. There was a news story last week that the Bank of China had reduced its holdings from 17bb to 12bb. China alone holds over 300bb of FN/FH bonds.

- In other words, this is a move to protect the dollar. If our overseas funders decide to stop buying FN/FH debt and MBS, or even worse, decide to sell, it would probably crush the dollar.

- The hyped discussion about adding liquidity to housing, finding the bottom, etc., is nonsense. FNMA and FRE were already providing liquidity in the mortgage market (to QUALIFIED borrowers), and with few exceptions, conforming mortgages were the bulk of origination. This action will not directly lead to increased mortgage availability, although pricing will now be better.

- Granted, some of their originations were being bought by overseas buyers, and without these buyers, spreads would have been wider and mortgage availability would have gone down. It is precisely these sources of financing that the Treasury needed to protect and maintain.

- This action emphasizes how dependent our economy is to foreign sources of capital.

- It IS a step in the right direction. But, we still need to create a bank for consumer and corporate lending. I've been arguing for a while that we need to create a new bank, and put the existing banking system into mothballs, as they are unable or unwilling to lend, and without lending, we cannot increase money supply. This action will not stop us from becoming another 90s-Japan-like economy.

- And, I find it shameful that the Fed is not taking the first steps in creating a new institution, to be further funded by those countries that believe in our economy, and is instead allowing the savings of other countries to be invested into the black hole of our existing financial institutions.

Samir Shah, 09/08/2008